What goes up must come down, or so the saying goes. The U.S. stock market did not get the memo, however. Third quarter returns were yet again positive for the S&P 500, returning just under 3% for the quarter. This brings the year-to-date return on the broad index to almost 13%. Not too shabby!
Bonds, on the other hand, did not have a great quarter. The war with Iran caused oil prices to spike which modestly increased future inflation expectations. New Fed Chairman Warsh raised short term interest rates last month and will probably raise again before year end. Yields on the 10-year treasury jumped 87 basis points (0.87%) in the quarter pushing bond returns down by 3%. The outlook for future inflation is not the only thing driving interest rates higher. Growth in the economy is better than expected and that is pushing up rates too.
I am constantly bombarded with unenthusiastic comments related to future expectations about the stock market. There is no shortage of negativity, whether it is from pundits on TV, social media, print media, or clients (you know who you are!). In fact, over the summer The University of Michigan consumer sentiment indicator reached its lowest level since the survey began in 1952.
Conceptually, let’s review the bear case:
We are still at war. When the war with Iran started in March it was supposed to be quick. Seven months later, the Strait of Hormuz is still closed and while missiles are not being launched daily, the conflict has not abated.
Because of the war, oil prices have increased 42% since March. Even though the United States is much less dependent of foreign oil than the past, Americans are suffering with higher input prices in goods and elevated prices at the pump, especially on diesel fuel.
Don’t fight the Fed. Partially because of the points above, the Federal Reserve increased short term interest rates by 25 basis points (0.25%) last month. Additionally, the Fed’s 2% inflation target has not been met and it has shifted its focus from balancing economic growth and full employment to an emphasis on fighting off higher prices.
September is usually a weak month. Market did not get the memo on that either. Although September was a negative month (less than -1%), we did avoid the anticipated drawdown and now turn attention to 3rd quarter earnings announcements which will take place over the next month.
Datacenter pushback. About the only thing democrats and republicans agree on these days is that they do not want datacenters being built. I believe this is an uninformed and shortsighted view. Datacenters will not put people out of work nor will they increase prices of clean water and electricity. Admittedly, the builders of datacenters have done a horrible job of explaining the long-term benefits and incentives to Americans. Moreover, we cannot let other countries win the AI race, especially China.
Mid-term elections are five weeks away and uncertainty around potential change in political control is never a good thing for markets. It strongly appears that democrats will gain control of at least one chamber of Congress if not both. Historically, divided government has yielded the best stock market performance.
You may be thinking, “Whoa, that’s a long list!” Yet the market has shrugged everything off and still moved higher. That is very positive. Nothing on that list is unknown. Even with the strong market performance, the S&P 500 trades at a lower price-to-earnings multiple than it did at the beginning of the year because corporate earnings (+25% year over year) have risen even faster than stock prices. I maintain that stocks follow earnings and that is why the market has been so resilient. Add to that a solid labor setting and you get a relatively sanguine market outlook.
The chart below displays forward price-to-earnings multiples by sector of the S&P 500. If you only focus on the average column, you will note that 85% of the S&P 500 trades at less than 30x forward earnings. This is a huge contrast to previous bull market tops. I cannot stress enough how this is not the late 1990s where the largest tech company, Cisco Systems, traded at 120x earnings. Right now, Nvidia trades at less than 20x.
There IS Now an Alternative
For many years, investors and savers were almost forced to take risk in their brokerage and retirement accounts in order to receive a reasonable rate of return. Remember TINA – there is no alternative? Yields on cash, CDs and bonds were near zero for 15 years post financial crisis (2009). That has changed over the past couple of years. I have been recommending extending duration in bond portfolios. Over the past few months, interest rates in the bond market have accelerated even higher. The 10-year treasury sits near 5.3%. While this rate might still go higher (bond prices lower), if you are inclined to reduce risk in your portfolio, you now have options. I continue to suggest adding duration in bonds, regardless. Don’t try to catch the top in yields (or low in price). Instead, think about a rate of return that works for your longer-term plan.
I am not recommending to blindly sell stocks. We have had an amazing four years in the stock market. I think stocks will continue their accent higher over the next 12-24 months. Over the past few years, it was very difficult to recommend selling stocks in favor of low yielding bonds. Today, however, you can trim stocks and at least earn a reasonable rate of return in fixed income. And risk adjusted, it looks even better. This assumes that inflation does not spike higher or stay elevated. If inflation does intensify, fixed assets are the last place to be.
Make no mistake, I remain comfortably in the optimistic camp on stocks, especially those related to AI, and for those of you that still have a long-term outlook. It is important to remember that we are investing for growth in the future. In the short term, anything can and will happen. Market volatility can be intense as many “traders” are not investing. They can be ultra-short term focused.
Capital spending on AI in 2026 by major, large companies is expected to be around $750 billion. In 2027, expectations for spending are well over $1 trillion. The question everyone is asking is “what will be the return on that spend?” Thus far, profits have mostly gone to the hardware and component companies, specifically, semiconductor companies. As more companies develop use cases for AI, their bottom lines should be enhanced as well. We are still in the very early stages of this technology revolution. I believe these investments will pay off in spades, but I have less clarity on the timing. I will remain patient as that has been rewarded to date.
Let me try to illuminate how early we are in this AI transformation. In late 1994, a company called Netscape released the Netscape Navigator web browser which allowed people to “surf” the internet. Anyone remember what “dial up” was? Google (now Alphabet) started in 1998, but did not go public until 2004, almost 10 years after we obtained access to the web. Chat GPT has only been around for approximately 3 years. Agentic AI for less than one year. We do not know who the winners will be in AI yet. I believe the future applications built on top of and with AI could be the winners, like Google has been with the internet. Those application companies may not be in existence yet or they may already reside inside one of the major, large companies we own. To close the loop here, Netscape did not survive as Microsoft flexed its muscles and won the initial browser war.
I continue to recommend staying the course. There are undoubtedly enough negative macro themes that if you choose to focus on them, could make you extremely bearish. I believe that strong, accelerating corporate profits and a tight labor market will trump (no pun intended) the macro data. I urge you to focus on the profits instead of the noise and keep dancing to the music that has played so beautifully for four years.
As always, we are extremely grateful for your confidence and loyalty over the past four and half years since we started Trifecta Capital Advisors. I hope you enjoy the change in seasons.
Insights
Quarterly Review: Q3 2026
What goes up must come down, or so the saying goes. The U.S. stock market did not get the memo, however. Third quarter returns were yet again positive for the S&P 500, returning just under 3% for the quarter. This brings the year-to-date return on the broad index to almost 13%. Not too shabby!
Bonds, on the other hand, did not have a great quarter. The war with Iran caused oil prices to spike which modestly increased future inflation expectations. New Fed Chairman Warsh raised short term interest rates last month and will probably raise again before year end. Yields on the 10-year treasury jumped 87 basis points (0.87%) in the quarter pushing bond returns down by 3%. The outlook for future inflation is not the only thing driving interest rates higher. Growth in the economy is better than expected and that is pushing up rates too.
I am constantly bombarded with unenthusiastic comments related to future expectations about the stock market. There is no shortage of negativity, whether it is from pundits on TV, social media, print media, or clients (you know who you are!). In fact, over the summer The University of Michigan consumer sentiment indicator reached its lowest level since the survey began in 1952.
Conceptually, let’s review the bear case:
You may be thinking, “Whoa, that’s a long list!” Yet the market has shrugged everything off and still moved higher. That is very positive. Nothing on that list is unknown. Even with the strong market performance, the S&P 500 trades at a lower price-to-earnings multiple than it did at the beginning of the year because corporate earnings (+25% year over year) have risen even faster than stock prices. I maintain that stocks follow earnings and that is why the market has been so resilient. Add to that a solid labor setting and you get a relatively sanguine market outlook.
The chart below displays forward price-to-earnings multiples by sector of the S&P 500. If you only focus on the average column, you will note that 85% of the S&P 500 trades at less than 30x forward earnings. This is a huge contrast to previous bull market tops. I cannot stress enough how this is not the late 1990s where the largest tech company, Cisco Systems, traded at 120x earnings. Right now, Nvidia trades at less than 20x.
There IS Now an Alternative
For many years, investors and savers were almost forced to take risk in their brokerage and retirement accounts in order to receive a reasonable rate of return. Remember TINA – there is no alternative? Yields on cash, CDs and bonds were near zero for 15 years post financial crisis (2009). That has changed over the past couple of years. I have been recommending extending duration in bond portfolios. Over the past few months, interest rates in the bond market have accelerated even higher. The 10-year treasury sits near 5.3%. While this rate might still go higher (bond prices lower), if you are inclined to reduce risk in your portfolio, you now have options. I continue to suggest adding duration in bonds, regardless. Don’t try to catch the top in yields (or low in price). Instead, think about a rate of return that works for your longer-term plan.
I am not recommending to blindly sell stocks. We have had an amazing four years in the stock market. I think stocks will continue their accent higher over the next 12-24 months. Over the past few years, it was very difficult to recommend selling stocks in favor of low yielding bonds. Today, however, you can trim stocks and at least earn a reasonable rate of return in fixed income. And risk adjusted, it looks even better. This assumes that inflation does not spike higher or stay elevated. If inflation does intensify, fixed assets are the last place to be.
Make no mistake, I remain comfortably in the optimistic camp on stocks, especially those related to AI, and for those of you that still have a long-term outlook. It is important to remember that we are investing for growth in the future. In the short term, anything can and will happen. Market volatility can be intense as many “traders” are not investing. They can be ultra-short term focused.
Capital spending on AI in 2026 by major, large companies is expected to be around $750 billion. In 2027, expectations for spending are well over $1 trillion. The question everyone is asking is “what will be the return on that spend?” Thus far, profits have mostly gone to the hardware and component companies, specifically, semiconductor companies. As more companies develop use cases for AI, their bottom lines should be enhanced as well. We are still in the very early stages of this technology revolution. I believe these investments will pay off in spades, but I have less clarity on the timing. I will remain patient as that has been rewarded to date.
Let me try to illuminate how early we are in this AI transformation. In late 1994, a company called Netscape released the Netscape Navigator web browser which allowed people to “surf” the internet. Anyone remember what “dial up” was? Google (now Alphabet) started in 1998, but did not go public until 2004, almost 10 years after we obtained access to the web. Chat GPT has only been around for approximately 3 years. Agentic AI for less than one year. We do not know who the winners will be in AI yet. I believe the future applications built on top of and with AI could be the winners, like Google has been with the internet. Those application companies may not be in existence yet or they may already reside inside one of the major, large companies we own. To close the loop here, Netscape did not survive as Microsoft flexed its muscles and won the initial browser war.
I continue to recommend staying the course. There are undoubtedly enough negative macro themes that if you choose to focus on them, could make you extremely bearish. I believe that strong, accelerating corporate profits and a tight labor market will trump (no pun intended) the macro data. I urge you to focus on the profits instead of the noise and keep dancing to the music that has played so beautifully for four years.
As always, we are extremely grateful for your confidence and loyalty over the past four and half years since we started Trifecta Capital Advisors. I hope you enjoy the change in seasons.