Investment Management - Third Quarter 2026

Forecasting vs. Preparing

If there is one lesson investors have learned repeatedly, it is that the future rarely unfolds according to anyone’s forecast. If you were told at the beginning of the year there would be a war in the Middle East, a spike in oil prices, stubbornly high inflation, the Federal Reserve (Fed) raising interest rates, and the yield on the 10-year U.S. Treasury would be above 5%, what would your forecast have been for markets and the U.S. economy? Most investors would have predicted substantial weakness, calling for dramatic reductions in equity exposure and sticking the proceeds under the mattress. Instead, equity markets continue to exhibit incredible resiliency in finishing the third quarter near all-time highs.

Key Takeaways from the Third Quarter

• Yield on the 10-year U.S. Treasury ended the quarter at 5.29%, the highest since March 2002.
• The Fed raised rates for the first time in three years, with Chairman Warsh signaling further tightening may be needed.
• Corporate earnings remained strong, with profit growth for S&P 500 companies estimated to be 29% in the third quarter.ⁱ
• Equity markets held up well, with the S&P 500 achieving a third straight quarterly gain.

Headlines Forecasted Fear, Markets Delivered Gains

The third quarter offered another example that markets and headlines often move in different directions. On one hand, the ongoing conflict in Iran, persistently elevated inflation, higher energy prices, and a more hawkish Federal Reserve introduced meaningful risks that cannot be ignored. On the other hand, the global economy continues to demonstrate surprising strength. Corporate earnings exceeded expectations, employment levels remained healthy, consumer spending held firm, and investment in artificial intelligence (AI) infrastructure accelerated at a historic pace. It is a reminder that markets are forward-looking and often prove more resilient than conventional wisdom suggests.

We continue to see a “two-speed economy”: AI-linked capital spending and the sectors tied to it remained a powerful source of growth, while housing and other rate-sensitive areas are showing signs of strain. That bifurcation is likely to remain a defining feature of market leadership into the fourth quarter.

Performanceⁱⁱ for various indices for the three-month (not annualized), one-year, three-year, and five-year periods appears below:

Bond Indices

Equity Indices

Geopolitics: Unpredictable by Design

Despite signals last quarter that a resolution was near, the war in Iran remained the dominant geopolitical overhang during the quarter. Continued disruptions to shipping through the Strait of Hormuz, along with a temporary shutdown of a major pipeline in September, kept energy markets on edge throughout the period. Although exports of crude oil have recovered to 98% of pre-war levels, exports of distillates such as gasoline and diesel remain at only 58%.ⁱⁱⁱ Prices remain elevated, with a 28% rise to $91 per barrel at the end of September.^iv The global economy has persevered thus far, aided by strategic petroleum reserve releases and increased production from alternative sources.

Beyond the Middle East, trade policy continues to evolve. Federal courts are hearing challenges to the Trump administration’s latest “Section 301” tariffs, which impose 10% to 12.5% duties on goods from 86 countries and cover nearly all U.S. imports.^v The case marks the latest chapter in an ongoing legal battle over the administration’s trade agenda, after the Supreme Court invalidated earlier “reciprocal” tariffs and subsequent temporary tariffs expired. If the Section 301 tariffs are upheld, companies with global supply chains could face continued cost pressures and uncertainty, while a court ruling against the administration could reduce trade-related headwinds and benefit corporate profit margins.

Two Speeds, No Forecast Required

Continuing a pattern that has characterized much of the post-pandemic expansion, the U.S. economy showed solid momentum in the third quarter, even as inflation stayed stubbornly above the Fed’s target. Consumer spending remained relatively healthy despite higher borrowing costs and rising energy prices, and business investment remained robust, particularly in technology infrastructure, data centers, and AI-related projects. As of September 30^th, the Atlanta Fed’s GDPNow model estimates annualized growth of 3.7%,^vi accelerating from the 2.2% pace in the second quarter.^vii

Additionally, business activity accelerated at the fastest pace in over five years in September, with the services and manufacturing purchasing managers’ indexes rising to 58.7 and 57.0, respectively, with any reading above 50 indicating expansion.^viii

However, inflation remains a central challenge. Consumer prices rose 3.4% from a year earlier in both July and August,^ix driven largely by energy, with gasoline prices up 28% over the past year. Core inflation, which excludes food and energy, eased to 2.4% in August, the lowest reading since March 2021. This split between improving core trends and worsening energy-driven headline inflation has fueled debate among economists over whether tighter monetary policy is the right response to what is, at its root, a supply-side shock rather than demand-driven overheating. The labor market continued to demonstrate resilience, giving the Fed more latitude to focus on price stability without an immediate growth trade-off.

Dots Are Forecasts, Not Promises

In his address at Jackson Hole in late August, Fed Chairman Kevin Warsh set the tone for the quarter’s most consequential policy shift. Stating the Fed had “work to do” on inflation and that he would be “hard pressed to describe broad financial conditions as restrictive,”^x Warsh’s speech nearly doubled market odds of a September rate hike. A hotter-than-expected August CPI report sealed the case. On September 16, the FOMC voted unanimously to raise the federal funds rate a quarter point to 3.75% - 4.00%, the first increase since 2023. The decision reflected the Fed’s growing concern that inflation remains too high and that the economy continues to operate at a pace inconsistent with achieving its long-term inflation objective.

Chairman Warsh reinforced this message in both the official policy announcement and subsequent remarks. His commentary struck a distinctly hawkish tone, emphasizing the central bank’s commitment to restoring price stability and suggesting policymakers may be willing to tolerate slower economic growth, if necessary, to bring inflation under control. Of the eighteen officials submitting projections, 16 penciled in at least one more rate increase this year, while views on 2027 remain unusually dispersed between officials favoring cuts and those anticipating continued tightening.

One of the more interesting debates facing investors today is why long-term interest rates have been moving higher. The optimistic view is that rates are rising because economic growth remains stronger than expected. Businesses are investing, consumers are spending, and unemployment remains low. In this scenario, higher rates reflect economic strength and increasing demand for capital. The more cautious interpretation is that investors are demanding higher yields because inflation remains elevated, federal deficits continue to expand, and corporations are issuing substantial amounts of debt to finance massive AI-related investments.

Both explanations contain elements of truth. Strong economic growth increases demand for capital, while persistent inflation and growing debt issuance increase the supply of bonds that markets must absorb. Together, these forces help explain why interest rates have remained elevated even as many investors expected them to decline. For markets, the key takeaway is that higher rates are not necessarily signaling economic weakness. Rather, they reflect an economy that remains strong, but one that is also navigating inflation pressures, significant borrowing needs, and one of the largest investment cycles in decades.

Earnings Don’t Need a Crystal Ball

Corporate fundamentals remain a key source of support. According to FactSet, S&P 500 companies are expected to deliver earnings growth of 29.1% in the third quarter.^xi If achieved, it would mark the third consecutive quarter of earnings growth exceeding 25% and the eighth straight quarter of double-digit growth. For all of 2026, the S&P 500 is now expected to grow earnings 32%, which excluding the pandemic reopening in 2021, would be the fastest pace since the recovery in 2010 from the global financial crisis.

The price of the S&P 500 has not kept pace with earnings, causing the market price-to-earnings (P/E) multiple to decline to 19X, hovering near its 10-year average. Under the surface, the market is telling a slightly different story. Previously a broad-based rally, the market has reverted to gains concentrated in AI-related investments. According to Goldman Sachs, the median stock in the index trades 16% below its 52-week high, which is atypical with the index close to all-time highs.^xii We continue to monitor and digest developments in the AI space, but currently returns on equity and invested capital remain strong. Will AI benefits spread beyond a small group of market leaders? As we will mention below, thoughtful diversification removes the need for convicted foresight.

Preparing, Not Predicting

The current market environment is showcasing new highs in equity markets and a bond market that is drastically different than just a few years ago. We continue to manage equity allocations to be within a few percentage points of portfolio targets, and where appropriate based on each client’s risk profile, invest in fixed income at rates we have not seen in many years. More specifically, we continue to trim small and medium sized company exposure, as the outperformance of these categories earlier in the year has given way to relative weakness due to macro pressures and higher interest rates.

Higher rates have weighed on bond prices this year, as existing bonds become less valuable when newly issued bonds offer more attractive yields. The inverse relationship between rates and bond prices is holding true today; however, the impact on prices from the latest rise in yields is much more muted than we experienced in 2022. The starting yields prior to a change in rates matter greatly to how sensitive bond prices will be, and the starting yields earlier this year were substantially higher than they were at the end of 2021. In our opinion, the forward return profile for investment grade bonds is the most attractive we have seen in two decades.

While the changes we make vary by account and client relationship, the common objective is to keep each portfolio aligned with its longer-term plan rather than with the market’s latest narrative.

Built for the Range of Outcomes

The speed and scale at which investment narratives emerge and evolve are greater than ever before. Transformational technology disruption and rising geopolitical uncertainty create many new opportunities and risks. We will monitor developments and remain nimble. Our goal is to analyze current opportunities and tailor a solution to each client. A durable plan does not eliminate uncertainty; it provides the discipline and flexibility needed to navigate it.

As we enter the final three months of the year, investors face no shortage of uncertainties. Whether it be midterm elections, negotiations with Iran, or corporate fundamentals, the temptation will be to forecast the outcome of each of these developments and position portfolios accordingly. History suggests a different approach. Rather than attempting to predict the next headline, successful investors focus on maintaining well-diversified portfolios designed to withstand a range of possible outcomes. The future remains uncertain, and we believe preparation, not prediction, is the more reliable path to achieving long-term success.

Preparation in Practice

We are excited to announce a few new additions to the West Financial team. In July, Tom Gaultney joined the financial planning department as a financial planner. Tom has more than 20 years of management consulting experience, and earned his Bachelor of Science in Industrial and Systems Engineering from Georgia Tech. In August, Griffin Ullsperger joined our team as an operations associate & trader. Griffin graduated with a degree in Finance from Pennsylvania State University. Also in August, we welcomed Amy Barrett to the client services department as a client service associate. She earned a BS in International Business and Finance from The Ohio State University.

Kristan Anderson, Brian Horan, Kirstie Martinez, and Victoria Henry were named to Northern Virginia Magazine’s 2026 Top Financial Professionals^xiii listing in September. Also, Laura Nash, Dan Trosch, Pat Fitzgerald, Jonathan Stolz, Brian Mackin, Matt Cohen, Tanya Carson, Kirstie Martinez, Brian Horan, and Abby Just were recognized as Five Star Wealth Managers^xiv by Five Star Professional in September 2026. Congratulations to all!!

Join us on Wednesday, November 11, for an informative discussion as Charles Schwab’s Washington insider, Michael Townsend, provides an update on how the November election outcome may change the policy priorities in Washington and how the market is reacting to the election. We are offering Policy, Politics, and the 2026 Midterms: Implication for Investors both in-person or online.

Please reach out to us with questions regarding year-end tax planning and gifting needs. Additionally, you should receive account statements, at least quarterly, from the custodian where your assets are held. If you are not receiving statements from your custodian(s), please contact us at your earliest opportunity.

Follow us on LinkedIn or go to www.westfinancial.com to view our recent blog posts. Thank you for your continued confidence in West Financial, and please do not hesitate to refer your friends, family, or co-workers who may benefit from our services.

Brian L. Mackin, CFP^® President