Q3 Market Update for Informed Investors

Divergence, moderation, and diversification

JPMorgan’s theme for the third quarter of 2026 is “Divergence and Moderation.” At North Star, we would add a third word: Diversification.

Inflation was one of the defining stories of the quarter. Renewed price pressures contributed to a significant change in interest-rate expectations, with the Federal Reserve ultimately raising short-term interest rates by 25 basis points—a notable divergence from the rate cuts investors had expected earlier in the year.

Another important divergence has been the rotation toward value stocks. After years of growth stocks leading the market, the Russell 1000 Value Index has gained 23.81% over the past year, compared with 7.50% for the Russell 1000 Growth Index—a remarkable 16.31 percentage-point difference. This rotation is a reminder that market leadership does not last forever. Over time, valuations and fundamentals can reassert themselves.

The bond market has also adjusted to the possibility of higher-for-longer interest rates. Treasury yields have risen to levels not seen since 2002, creating meaningful price declines in existing bonds but also providing investors with substantially more attractive income opportunities.

Everything in moderation—and diversification matters. The past quarter has provided another reminder that markets rarely move in a straight line. Leadership can change quickly as investors rotate into areas that are trending after having been overlooked for years. Diversification across growth and value, stocks and bonds, and other asset classes can help investors participate in areas of current strength while reducing the risk of being overly concentrated when market leadership changes.

Key Highlights:

Inflation

Inflation is no longer the 2% environment investors became accustomed to before the pandemic. Energy prices, tariffs, supply-chain changes, labor constraints and large government deficits can all create upward pressure on prices.

Inflation remains elevated as we begin Q4, with headline CPI at 3.4% and core PCE (the Federal Reserve’s preferred inflation measure) at 3.0%. Core inflation has remained near this level since the beginning of the year, well above the Federal Reserve’s long-term 2% target.

We continue to believe equities are one of the best long-term hedges against inflation because companies can raise prices, grow earnings and potentially maintain their purchasing power over time.

Oil

Energy prices, particularly oil, have dominated headlines throughout the year. Since the conflict with Iran began, both major global oil benchmarks—Brent crude and West Texas Intermediate (WTI)—first rose above $100 per barrel, then fell below $70, and recently moved back above $100.

Higher oil prices contribute to inflation and increase gasoline and diesel costs. The impact extends beyond the pump, affecting manufacturing, transportation, shipping, agriculture, and other industries. Higher energy costs can be particularly important for farmers during the fall harvest season.

Interest Rates

Interest rates are at their highest levels in more than 20 years. Persistent inflation has remained above the Federal Reserve’s target, contributing to the Fed’s decision to raise short-term interest rates by 25 basis points at its most recent meeting.

The Fed continues to balance its dual mandate of maximum employment and price stability. Markets had been anticipating higher rates before the Fed made its move.

The 10-year Treasury yield is around 5.30%, while the 30-year Treasury is around 5.60%, up to levels not seen since 2002. The cost of capital has clearly become more expensive.

Higher yields create both challenges and opportunities. They can benefit investors seeking current income, while putting pressure on housing and other interest-rate-sensitive areas of the economy. Higher mortgage rates have reduced housing affordability and affected housing activity.

For tax-free income investors, longer-maturity municipal bonds can also provide attractive tax-equivalent yields, in some cases exceeding 8%.

Economic Growth and Corporate Earnings

Higher interest rates could create headwinds for the stock market, but strong corporate earnings expectations are providing an important counterweight.

S&P 500 earnings are expected to continue growing at double-digit rates into 2027. The key question is not whether earnings are growing, but whether that growth is sustainable, particularly as expectations surrounding artificial intelligence remain sky-high. At the same time, S&P 500 price-to-earnings ratios have moderated.

The U.S. economy also continues to expand moderately, with GDP growth around 2.2%. Consumer spending remains relatively strong at an annualized rate of approximately 3.8%, despite continued inflation concerns.

The combination of solid economic growth and corporate earnings remains encouraging, although higher interest rates and persistent inflation as mentioned earlier still warrant continued attention.

Equity Markets

The themes of Divergence and Moderation that we mentioned earlier are also evident in the equity markets. Leadership has diverged from the areas that dominated earlier in the year toward different sectors and asset classes.

U.S. large-cap companies, particularly value-oriented companies, have been recent winners as investors have favored higher-quality, established businesses.

The theme of moderation also argues against excessive concentration in any one area of the market. As we know by now, leadership can change quickly as investors move between sectors, styles and regions.

Artificial intelligence continues to influence a growing number of areas, from private equity and private credit to U.S. small-cap companies and emerging markets.

As the performance chart shows, U.S. large-cap stocks continue to lead, while U.S. small-cap and international markets have experienced some recent weakness. Emerging markets, however, continue to perform well, with the MSCI Emerging Markets Index up more than 26% year to date.

Fixed Income

Fixed income markets broke out of their previous range as investors anticipated higher interest rates because of persistent inflation and changing Federal Reserve policy. The rapid increase in yields caused meaningful price declines in individual bonds and bond funds.

The important takeaway, however, is that higher yields have created a return to meaningful income opportunities. For the first time in many years, investors can construct portfolios in which fixed income can contribute both income and total return.

Fixed income also continues to serve an important role in providing portfolio stability during periods of increased market volatility such as what we are experiencing so far this year. We continue to recommend caution in lower-quality fixed income sectors, where credit spreads remain relatively tight and investors may not be adequately compensated for taking additional credit risk.

Looking Ahead

As we finish the year, the theme of diversification may continue to play an important role. We believe a well-diversified portfolio can help moderate the impact of changing market leadership and economic conditions.

Strong corporate earnings, continued investment related to artificial intelligence, solid consumer spending and improving international growth provide reasons for optimism. At the same time, substantially higher fixed-income yields offer investors an opportunity that has been largely absent for more than 20 years.

Markets are likely to continue rotating among asset classes as inflation, interest rates, earnings and economic growth evolve.

Risks remain, including inflation, monetary policy and geopolitical developments. However, there are currently no clear indications of either a global recession or a significant economic slowdown.

At North Star Investment Resource Center, we believe diversified portfolios and disciplined investment strategies provide the best approach to long-term investing. Diversification can reduce concentration risk, smooth performance over time and help investors navigate uncertainty rather than attempting to predict the future.

We welcome the opportunity to discuss your investments. If your financial situation or investment time horizon has changed, please reach out to your advisor.

Written by the North Star Investment Resource Center