The third quarter delivered something markets had not seen in three years: a Federal Reserve that raised interest rates instead of cutting them. That one decision reshaped everything else. It pushed bond yields to their highest levels since 2002, put inflation back at the center of the conversation, and widened a split in the stock market that had been quietly building all year.
Three major indexes, the same three months, and two very different answers. September itself was negative for the S&P 500 and down more than 4% for the Dow, even as the Nasdaq managed a gain. That divergence runs through the rest of this letter.
The Fed Raised Rates for the First Time Since 2023
On September 16, the Federal Open Market Committee raised the federal funds rate by a quarter point to a range of 3.75% to 4.00%. It was the first increase since July 2023, and the vote was unanimous. After three of twelve officials dissented at the December 2025 meeting, a clean 12-0 vote shows how much the inflation picture has changed in the eyes of the people setting policy.
A quick word on what that rate actually is, since it gets referenced constantly and explained rarely. The federal funds rate is what banks charge one another for overnight loans. It sounds remote from your household, but it anchors nearly every other rate in the economy. When it moves, mortgages, auto loans, credit cards, and bond yields eventually follow.
The Committee's statement said inflation "remains elevated" and that the action would support "a timelier return to the Committee's 2 percent goal." Chair Kevin Warsh was blunter at the press conference, saying inflation is too high and has been too high for too long. The Fed's updated projections point to one more increase before year-end and no changes at all in 2027, with the median expectation for year-end 2026 rising to roughly 4.1% from 3.8% in June. Nearly every forecast I read through 2024 and 2025 assumed the Fed's next move would be a cut. That assumption is now wrong, and any plan built around steadily falling rates deserves a second look.
Inflation: The Last Mile Got Longer
Prices never finished coming down, and this quarter they got a push in the wrong direction.
The Consumer Price Index, or CPI, is the figure most often quoted in the press. Personal Consumption Expenditures, or PCE, is what the Fed actually targets, because it better accounts for how households substitute when something becomes expensive. August CPI rose 0.4% in a single month and 3.4% from a year earlier, with gasoline up 27.4% over the year. The PCE report released September 30 showed the same 3.4% headline, with core at 3.0%. Both core readings came in cooler than expected, the quarter's only genuine piece of good inflation news.
Energy did most of the damage. Crude started the year near $57 a barrel, sat around $70 at the end of June, and finished September close to $90 after supply disruptions in the Middle East. Gasoline is the part of the oil price households see every week, but it is not the part that does the most economic damage. Higher crude works its way into airfares, freight, plastics, fertilizer, and utility bills, usually surfacing two or three months later. That lag is why the Fed cannot look at one cooler reading and declare the problem solved.
This is the uncomfortable part of the Fed's position. Interest rates work on demand. This quarter, the problem was supply, and no federal funds rate setting puts more barrels on the water. The bond market understood that, which explains much of what happened to yields.
Bonds Finally Pay You, and That Came at a Cost
The 10-year Treasury yield reached roughly 5.30% by quarter-end, its highest since 2002, with the 30-year near 5.65%. That same 10-year yield was 4.17% at the end of 2025 and 4.47% at the end of June, so this was a substantial move in a short window.
Bond prices and yields sit on opposite ends of a seesaw. When yields rise, the price of bonds you already own falls. This move hurt existing positions, and the broad U.S. bond market was modestly negative for the year.
Now the other side of that seesaw, which gets too little attention. Every new dollar invested in bonds today locks in income at the most attractive starting yields in more than twenty years. For clients drawing income or funding a goal a few years out, that is real and usable good news. One caution, because this came up repeatedly in client conversations over the summer: attractive yields on cash make sitting still feel productive. Cash is a sensible place for money you need soon. It is not a strategy, and over the long term it has reliably lost ground to inflation.
Market Breadth: Record Highs and Record Lows at the Same Time
Now to the part of this quarter that confused the most people, including a fair number of professionals.
The S&P 500 spent much of the quarter at or near record highs. Underneath that surface, participation was thinning badly, and one September session captured it perfectly. On Monday, September 21, the S&P 500 jumped about 1.5%, and the Nasdaq surged 2% to a new record. Yet 30 companies in the S&P 500 hit new 52-week lows that day, while only seven reached new highs.
That was not a one-day quirk. New 52-week lows on the New York Stock Exchange outnumbered new highs for ten straight sessions in late September, and in fourteen of the prior fifteen. A record index and a deteriorating market were true at the same time, and understanding why tells you a great deal about where we are.
The S&P 500 is weighted by company size, so the largest companies carry far more influence than the smallest. As of September 30, J.P. Morgan Asset Management put the ten largest companies at 40.6% of the index's market value, while those same ten produced 36.1% of its earnings (slide 8). Those two figures being so close together is the point. These companies are not large because investors find them exciting. They are large because they earn a great deal, and the premium paid for them is narrower than the headlines suggest.
Picture a town with 500 businesses. Five of them are booming, expanding, hiring, and paying enormous taxes. Most of the other 495 are quietly cutting back and reducing headcount. The town announces record tax revenue and calls it a historic year. Both the record and the problem are real. If you only read the revenue number, you would never know that 495 businesses were cutting back.
That is market breadth: how many stocks are actually participating in a move. In a broad market, most stocks rise together. In a narrow one, a small group does the heavy lifting while everything else drifts.
This quarter's numbers were striking. Mike Wilson, chief U.S. equity strategist at Morgan Stanley, noted that the share of S&P 500 companies trading above their 200-day average price fell from roughly 75% to below 50%, a common gauge of whether a stock is in an uptrend, even as the index itself kept setting records. Widen the lens beyond the largest companies, and it looks worse still: more than half of the Russell 3000, which covers most of the investable U.S. market, sits at least 20% below its June high.
September made the split impossible to miss. Technology was effectively the only sector to finish the month higher, while nearly every other major sector fell, most by 5% to 7%. Smaller companies fared worse still, with small caps underperforming large caps by the widest margin since 2020. Art Hogan, chief market strategist at B. Riley Wealth, described the mechanism plainly: what has been selling off keeps selling off, so "the creation of new lows has an easier glide path than the creation of new highs with today's leadership." One statistic captures how lopsided the year has been. Of the fifty best-performing companies in the S&P 500 this year, thirty-one are technology companies (slide 12). Utilities, financials, real estate, and communication services contributed none.
What Narrow Markets Have Actually Meant
The longer record is more mixed, and more useful. Even in 1999, the narrowness persisted for well over a year before the market finally peaked. An investor who sold in 1998 on breadth data alone was eventually proven right about the risk, badly wrong about the timing, and missed a very large gain in between. More recently, leadership in 2023 and 2024 was famously narrow, the warnings were constant, and the market went on to rise and then broaden out.
Narrow breadth is not a sell signal, and I would discourage anyone from treating it as one. It has no useful record as a timing tool. What it does tell us is that the market is standing on fewer legs than usual, which makes the ride less forgiving when the leaders stumble. The useful response is not prediction. It is awareness. Knowing how much of your portfolio sits in that small group of leaders, and whether it got there by design or by drift, is worth understanding. For the next several years, what you own may matter more than where the index goes.
Concentration: We Have Seen This Before
Concentration of this kind is not new, which is why it is worth studying rather than fearing. In 1980, oil and gas companies made up roughly 29% of the S&P 500. Today they are around 3%. At the peak of Japan's equity boom in the late 1980s, Japanese companies represented about 44% of the global developed stock market. Today they are near 5%.
Neither predicts today's leaders, and neither was obvious as it unfolded. They make a narrower point: index weights reflect what investors believed yesterday, not what will prove true tomorrow. The leaders of one era are rarely the leaders of the next. Said differently, if you own a broad index fund today, you own a considerably more concentrated bet than you did ten years ago, and you did not choose that. The index chose it for you.
AI: The Opportunity Is Real, and So Is the Price
Artificial intelligence drove most of this quarter's divergence, and it deserves an even-handed treatment rather than a verdict.
The case for it keeps getting more concrete. Goldman Sachs Research expects global AI investment to exceed $1 trillion this year, with $581 billion of that in the United States alone. Dollar figures that large stop meaning much, so here is a better yardstick: AI capital spending now equals roughly 1.8% of everything the U.S. economy produces, and Goldman expects that share to approach 2.8% by 2028. This is no longer a story about chatbots. It is a capital spending cycle with concrete, copper, transformers, and semiconductors in it, landing in corners of the economy that have nothing to do with software.
Money spent is not money earned. An economy leaning this heavily on one buildout has a great deal riding on whether it pays off. The effect on jobs is already visible. Through September, U.S. employers announced 573,195 job cuts, and artificial intelligence was the most frequently cited reason, named in roughly 120,000 of them. That is a real cost, and it falls on real households. It is also worth holding alongside a longer view: research by the MIT economist David Autor and his colleagues found that roughly 60% of people working today hold jobs in occupations that did not exist in 1940. New technology reliably destroys jobs and reliably creates them, rarely on a timeline that feels fair to the people caught in between.
The investment risk, in my view, is not that AI disappoints. It is that AI arrives roughly as promised and the price already assumed something better. That debate has grown louder as the spending has grown larger. It is a different risk than the one most headlines describe, and a more manageable one, because it is a question of price rather than whether technology works.
It is also worth keeping the valuation picture in proportion. The S&P 500 finished September at 19.0 times expected earnings (slide 4 & 8), against a thirty-year average near 16.9 and the 25.2 times it carried at the March 2000 peak. More surprising still, the ten largest companies trade at roughly 20.9 times, almost exactly their own long-run average. The other 490 companies sit further above their own history. The market is expensive, but not where most people assume.
The November Midterms
Congressional elections arrive in November. Markets have done reasonably well under every arrangement of political power we have tried. Morgan Stanley's work on this cycle makes the familiar case that divided government reduces the odds of large legislative swings, and that markets tolerate predictability well. I would hold it loosely. These are small samples across very different decades, and positioning a portfolio around an election outcome remains one of the more reliable ways investors have hurt themselves. I have put the historical pattern at the end of this letter, where I think it belongs.
Investor Takeaway
This quarter posed a fair question, and I have been asked some version of it a dozen times: if the index is at a record, why does so much of the market feel heavy?
Both things are true at once, and usually are. Averages conceal, and this quarter they concealed more than usual. The Fed changed direction. Oil reset the inflation math. Bonds finally pay something worth having, and the path there was unpleasant for anyone who already owned them. None of that adds up to a forecast, and I would be skeptical of anyone who tells you it does.
What I keep returning to is that your results over the next decade will depend far more on how you behave than on whether the Fed moves once more in December. Rates will move. Oil will move. Leadership will change hands eventually, as it always has. The investors who come through these periods in good shape are rarely the ones who called each turn correctly. They built a strategy that never required them to. Diversification still matters. Discipline still matters. And staying invested through stretches that feel uncomfortable still matters most. Discomfort is not a signal that something has gone wrong. It is the part of investing you are being compensated to tolerate.
If you have any questions or would like to discuss your personal circumstances, please do not hesitate to reach out to me. Thank you for your continued confidence.
Rob Leiphart, CFP®
203-220-6474
rleiphart@rbcapitalmanagement.com
Appendix: Midterm Elections and Markets
Research from Alger examined all 19 U.S. midterm elections from 1950 through 2022 and found a consistent calendar pattern.
The usual explanation is that campaign season generates a stream of competing proposals, and markets dislike unresolved policy questions more than they dislike any particular answer. Once votes are counted, the range of plausible outcomes narrows, and investors return to pricing earnings rather than uncertainty.
What does that suggest about the months ahead? If the pattern holds, some of the heaviness we felt in September is ordinary for this point in the four-year cycle rather than a verdict on the economy, and the resolution matters more than the result. That is a reasonably encouraging frame, and I would attach two caveats. Nineteen observations are a small sample, and an average conceals a wide range of outcomes, including some genuinely bad years. More to the point, this quarter has its own drivers unrelated to the calendar: a Federal Reserve that just reversed direction, oil near $90, and the narrow market described above. The seasonal pattern is useful context. It is not a reason to do anything differently.
Other research points in the same direction. J.P. Morgan Asset Management finds the S&P 500 has averaged 9.2% in midterm years since 1937 against 13.3% in all other years, while Capital Group puts the average twelve-month return following a midterm at 15.4% since 1950 and finds double-digit average returns under unified government, a split Congress, and a Congress opposed to the president alike. Every one of those averages is positive. All of them rest on small samples spanning very different decades, so I treat them as background rather than a plan.
Past performance does not guarantee future results.