Q3 Market Recap

Hi everyone and welcome to our latest edition of our podcast. This is kind of our Q3 in review podcast for 2026. We've got a few different things that we want to discuss with you today. The first of which is going to be just kind of what happened in the quarter and where markets stand so far year to date. We want to talk a little bit about you know, interest rates and how that has impacted the bond market. And then lastly we're 31 days here from midterm elections and kind of what we're thinking about when it comes to that and you know, how we think you know, that will impact markets going forward.

So I think to kick us off here Will is going to first discuss where you know, the different indexes stand so far this year.

Hi everyone. Thanks Zach. So this is a chart of year-to-date performance of the major asset classes that we track here on this podcast and you can see from January through September 30th going from the highest returning to the lowest returning. You've got emerging markets at about 24% small cap stocks here in the US international developed stocks and the S&P 500 which is the US large cap index all coming in at 13, 12 and 10 with international being 10, small cap at 13% and the S&P 500 in the middle there right around 12 and 3/4%.

And then the bond index is down 2.9% with a lot of that loss being in the most recent month and we'll kind of take a look at that on the next slide here which is shows quarter to date June 30th to September 30th. And you know, the most impactful event that happened in the market this last quarter was the Fed raised interest rates for the first time in 3 years and the Fed you know they only control that the shortest interest rate the overnight lending rate between banks longer term interest rates 5 10 30 year yields or interest rates have also risen pretty dramatically.

And as a result of that we've seen bonds sell off about 3 and 1/2% that's the bond index in the green line there and then small cap stocks also came down after a really nice run and they're still you know up double digits year to date but when you think about small cap stocks they don't generate as much cash flow as their large company counterparts therefore they do a little bit more lending and when rates go up they're lending at higher rates they don't earn as much money and you know the stock price reflects that but that's not to you know say abandon your small cap stocks you know they've performed just fine in the face of higher rates and there's a lot of macro themes that we've been watching that are you know tailwinds for those for that category.

Yeah I think it's interesting just comparing the second quarter to the third quarter the second quarter was you know one of the best quarters we've seen in a long time there was you know some hope that you know the war in Iran was kind of coming to an end. You know that you know did not happen in the third quarter you know we're still looking for some clarity on how you know that war will end. And it's interesting also like you know looking what was talking about small cap you know the Russell 2000 being down 7% in the third quarter and in the second quarter it was up 22% so it's still done super well so far this year and one other thing I was looking at the emerging markets you know index you know, it is really the biggest three stocks are TSM Taiwan Semiconductor SK Hynix another Korean semiconductor manufacturer and Samsung.

So there's a lot of like technology overlap there in those stocks in the second quarter did you know fantastically well in the second quarter and lagged a little bit in the third quarter which I think is why it you know is down a little bit. Yeah, it was a interesting quarter looking back at it and we're you know excited to see the fourth quarter.

Yeah, and I'm going to go back to the first slide just to show year-to-date returns and emerging markets and how it's different than you know international developed before we talk about interest rates but the emerging market index has really become like a proxy for like the AI trade because of the concentration in South Korea and Taiwan with those chip and memory stocks and you can kind of see the volatility it's returning a lot it has pretty steep drawdowns there's a lot of leverage so it typically makes up a smaller piece of you know our clients portfolios but shows the value of diversification and holding it you know you can earn higher returns than your you know S&P 500 in years like this and you know the case for international developed and the small cap you know those are not nearly as tied to the AI theme as say like the S&P 500 or the emerging market index and that and that is a you know a valuable reason to hold those because as promising and exciting as the AI theme is you know as you know when a lot of dollars are chasing, you know, one specific topic or theme, it doesn't necessarily always go up into the right in a perfectly straight line.

There's usually some volatility along the way, and a diversified portfolio of these different asset classes can smooth out the ride, and you know, you could potentially earn more over a full cycle.

Yeah, I think with having those other pieces for diversification, you can protect to the downside, which lets you get more to the upside or overall to get some

Make more by losing less.

Yeah, exactly.

All right, so next slide here. We've got the Treasury yield curve, and Zach, if you want to just kind of explain what that is, and then we've got the purple line a snapshot of the yield curve on September 30th, and then the orange line on June 30th. So, in 3 months, what's happened?

Yeah, so the yield curve, I feel like it's thrown around a lot and never really explained, but on the horizontal axis, you can see, you know, from 1 month to 30 years. And that's just like the maturity schedule. So, the Federal Reserve, they are what they control what's called like the Federal overnight lending rate, which is close to that that 1 month all the way to the left. So, they control really short-term interest rates. And then as you get farther out from there, the market kind of, you know, more so controls those rates.

And you know, for example, the 2-year interest rate, so, on that purple chart or purple line showing, you know, where interest rates are as of today, you know, expects, you know, 2 years from now that federal funds rate, the very short-term rate, to be closer to 5%. And this gap up that we've seen here in that third quarter was really large compared to, you know, historical moves in rates. And a lot of that has to do with you know, geopolit- geopolitics, the war in Iran, you know, inflation has, you know, a little higher because of, you know, oil prices have gone up.

You know, the Fed did raise rates in the third quarter as well to try and slow inflation. The new Fed chair, Kevin Warsh, has been really adamant about wanting to, you know, lower inflation. Also he is giving, it seems like less guidance than his predecessor in terms of like what the Fed is going to do in the future, which has created a little bit more volatility. And you know, I think another reason as to why rates moved up as far as they did is, you know, overall data is still, you know, showing our economy is kind of running hot.

Inflation is is high with, the war, like I said, but also the economy is really strong. You know, GDP in the second quarter was 2.2%. You know, right now the expectations for the third quarter is closer to 3.7%, so the economy is really strong and the way to kind of slow the economy, or one of the tools the Fed has is to raise interest rates, which, you know, unfortunately for bonds, when interest rates move up like this, you get higher yields, so higher coupon, you know, pay coupons on your bonds, but your price of your bonds kind of moves inversely, so when interest rates move up like this, the price of your bonds falls, but, you know, for somebody who's going to hold on to bonds for a long period of time, it ends up being, you know, better for long-term returns because you're collecting, you know, higher yields.

And another thing to mention, you know, for in terms of how we think about bonds, like we want to control our duration, which duration is kind of just your average, your sensitivity to the interest rate movements in bonds. So if you have a duration of, you know, six we'll say, is kind of the core, the aggregate bond index is a duration close to six. For every, you know, interest rate move from 1% higher, you lose 6%. But for every 1% interest rate lower move, you gain 6%.

So if, you know, your starting yield is is somewhere around 5 or 6% and you get a 1% move down in interest rates, you could be looking at double-digit interest rate returns or double-digit returns on your bond fund. So we think the outlook for bonds going forward is is, you know, really strong. We're excited to see, you know, what they do over the next, you know, two to three to five years.

Yeah, and I think in the near term, it's maybe frustrating for clients and investors that get their quarterly statement, look at their bond funds, and maybe they're down a percent to three in some circumstances, and you know, that and you're kind of thinking, well, stocks didn't have the best month in September, aren't the bonds supposed to be the diversification or the balance in my portfolio? And yeah, they are. You're getting double-digit returns in the stock market this year, and bonds have moved down 3% after a really, you know, at least near term, like one of the bigger interest rate moves up.

So, we're kind of that's happened, you know, it's our it's over, it's priced in, and now it's like going forward, you've got a really nice, you know, you see you're seeing these five and seven-year bonds in the five and a half range, and this is just the Treasury. You've got all sorts of different bonds, with corporates, mortgages, you name it. You know, we tell people to be very diversified with the types of bonds. That provides a nice cushion, you know, that's 5% like Zach was talking about, regardless of rates are up or up or down from here, that that yield can, protect you cuz as you know stocks are risky.

So, we do think that the balanced portfolio is back and alive and well, you know, regardless of what you're reading or seeing on the shows. It's a great time to be a diversified investor.

And for you know, somebody well much like a balanced portfolio, you know, that's some something like a 60% stock 40% bond portfolio. You know, if rates stay here and you can earn 5 and 1/2% on the more conservative piece of your portfolio. That kind of positions a portfolio to do really well going forward because from I don't 2008 to in the last we'll say 2008 to 2023, interest rates were really low in that you know, conservative piece of your portfolio. You were only earning what maybe 2 or 3%?

So, if you can earn double that with you know, it would get higher interest rates. That seems like a really you know, good position for a well diversified portfolio.

And I think next thing we wanted to talk about with it's going to be top of mind for a lot of people and coming up here in about 1 month. Midterm elections.

Yeah, like I said earlier we're 31 days from midterm elections. It seems like we're getting a lot of more advertisements and everything, but I think this chart does a really good job of illustrating kind of historically what's happened in midterm elections and you know, historically the incumbent has lost seats in the house or in the Senate. And there's really two reasons for that. You know, first off it seems like the party who is currently in power the or the party not in power has higher voter turnout because they're you know, upset with how things are going whereas the party in power people tend to vote during midterms less and also in the first 2 years of a presidency historically the approval rating is a little bit lower.

People are unhappy with how things are going and maybe those swing voters vote the other way. And overall gridlock or you know, divided House and Senate versus you know, the executive branch tends to be pretty good for markets. And I think that's this what people are expecting now. Gridlock after midterm elections.

It would be so and I think this chart shows what three of in all of history of midterms what since 1934 the incumbents lost seats or has not lost seats only three times. So, it's that's the expectation. It almost always happens. And then you know, we always tie these things back to the market and you know, being a long-term investor and you know, why you should stay you know, if whether your party is replaced or stays in there. Tw- you know, a typical 12-month return following September 7.4% all other years or I'm sorry, midterm years your 12-month return after a midterm election is 15.1% so about double your return after a midterm there.

So, and that's historical obviously no guarantee that that's going to happen exactly this time but history is on your side for sticking through the elections.

Yeah, and you know, I feel like we've mentioned it a lot of times on these podcasts that just the market doesn't really like uncertainty. And right now midterms and kind of the makeup of you know the house and Congress is something that is uncertain and you know once that's out of the way in November going forward those one year returns are really strong and we'll get some more clarity also just on like the state of you know fiscal situation post midterms you know chances are if there's gridlock they'll be less you know agreement on fiscal spending going forward which is good also for like a federal debt and things like that so hopefully we'll get midterms out of our way and we'll see what happens in November and December and onwards in 2027.

That's right.

Yeah and also just one last thing to mention is you know if the markets didn't really they were flat in the fourth quarter we've had you know above average year for you know the S&P 500 for example returning close to or a little over 12% so far this year whereas you know historically you know the markets have returned you know 10% a year or the S&P 500's returned 10% a year going back to I think it's 1926 is kind of the first year of all that that history but we've had a really strong start to the year and there's definitely a lot of different things going on for the fourth quarter but will do anything else?

No we'll see everyone one quarter from now and in the new year it'll be January and we'll see how things wrapped up but as always you know give us a call with any questions and we're always happy to do a review of your accounts and let you know where things stand.

All right thanks everyone take care bye.

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