October 2026 edition

Key takeaways

• The S&P 500 declined only 0.5% in September, but the average stock and small caps fell roughly 5%, while nine of 11 sectors finished lower.
• Technology (tech), where we remain overweight, reasserted its leadership, gaining 4.4%, while communication services rose 4.3%, together masking broader weakness beneath the surface.
• Valuations have reset, with the S&P 500’s forward price-to-earnings (P/E) ratio declining to 19x, near the oil-shock low, and the tech sector’s forward P/E falling from 32x to 21x since last October, near its level when ChatGPT launched in late 2022.
• During midterm-election years, the S&P 500 has averaged 6.6% in Q4. It has gained in 12 of the past 13 fourth quarters, with 2018 the exception amid a Fed repricing. The Fed and higher yields remain key risks to this positive backdrop, though markets have already reset rate expectations.
• Higher yields are challenging for borrowers but positive for investors, restoring meaningful income and diversification opportunities across fixed income.
• The reset is creating tactical opportunities: We raised our existing preference for growth, upgrading it from more attractive to most attractive, and extended our cautious view on international developed markets, downgrading them from less attractive to least attractive. We also upgraded high yield from neutral to more attractive and leveraged loans from least attractive to less attractive.

Looks can be deceiving: A reset creates fourth-quarter opportunities

The S&P 500 declined just 0.5% in September despite the Federal Reserve’s (Fed) first rate hike since 2023, a nearly 50-basis-point (0.50%) rise in the 10-year U.S. Treasury yield, higher energy prices, geopolitical tensions, and renewed debate over the pace of artificial intelligence investment. That apparent resilience masked considerably greater weakness beneath the surface.

The average stock, as measured by the S&P 500 Equal Weight Index, and small caps declined roughly 5%. Nine of the 11 S&P 500 sectors finished lower, and seven sectors are now more than 8% below their 52-week highs, including rate- and economically-sensitive areas such as utilities, financials, real estate, and industrials.

AI-related leadership held up the headline index. Technology, where we remain overweight, gained 4.4%, while communication services advanced 4.3%. Together, these sectors represent roughly half of the S&P 500 and helped mask the broader weakness.

The market’s resilience does not reflect complacency. The S&P 500’s forward price-to-earnings ratio has declined from 22x to 19x, near the level reached during the recent oil shock. Technology’s reset has been even sharper, falling from 32x last October to 21x, near where it stood around the launch of ChatGPT.

Market breadth tells a similar story. Only about 21% of S&P 500 companies are trading above their 50-day moving averages, approaching levels typically associated with an oversold market. Selling has become widespread and, in some areas, increasingly indiscriminate.

Oversold conditions do not eliminate downside risk, but they have historically improved the prospects for a near-term bounce. The headline index understates the reset already seen in prices, valuations, and sentiment, creating a more favorable risk/reward backdrop in select areas

A more favorable seasonal backdrop

With the S&P 500 roughly flat since June, the market has loosely followed the historically choppy midterm-election pattern. The seasonal backdrop becomes more constructive as we head deeper into the fourth quarter.

Since 1950, the S&P 500 has gained an average of 6.6% during the fourth quarter of midterm-election years and advanced 84% of the time.

More recently, the index has risen in 12 of the past 13 fourth quarters. The notable exception was 2018, when concerns about further Fed tightening contributed to a sharp selloff. The distinction today is that markets have already repriced the path of monetary policy and experienced a meaningful valuation reset.

Seasonality is not a stand-alone investment thesis. Still, the combination of an internal market correction, oversold conditions, lower valuations, and a historically supportive fourth-quarter pattern improves the near-term setup.

A sustainable rally will likely require stabilization in interest rates and continued earnings growth. Markets have already repriced a higher path for Fed policy, while the rise in Treasury yields appears increasingly extended. Most important, earnings, this bull market’s north star, continue to show positive momentum.

The return of income

For much of the decade following the global financial crisis, bond yields were unusually low. The 10-year U.S. Treasury yield averaged just 2.4% from 2010 through 2019, contributing to the view that “there is no alternative,” or TINA, to stocks.

That environment has changed. The 10-year Treasury yield reached 5.25% during the quarter, allowing investors to once again earn meaningful income from high-quality bonds. While current yields appear elevated relative to the post-financial-crisis period, the 10-year yield averaged 6.6% during the 1990s, partially reflective of stronger nominal growth.

The speed of the rate reset presents challenges for borrowers, but higher starting yields are positive for long-term investors. Our work shows a strong relationship between starting yields and subsequent bond returns, while higher coupons provide a cushion against the possibility of a further increase in rates.

More broadly, higher yields should allow bonds to once again provide meaningful income, diversification, and potential ballast during equity-market weakness.

Taking advantage of tactical opportunities

We remain overweight equities, the U.S., and growth. The broader market reset has led us to make several tactical allocation changes.

Growth

• We further raised our existing preference for growth, upgrading it relative to value from more attractive to most attractive.
• Tech remains dominant within growth, supported by strong earnings trends and a more favorable valuation. Moreover, relative price trends for the sector ended the quarter at fresh record highs.

International developed markets

• We extended our cautious view on international developed markets, downgrading them from less attractive to least attractive.
• These markets recently reached an 18-month relative price low versus the S&P 500. Relative earnings trends continue to deteriorate, valuations are neutral, and they are generally less insulated from higher energy prices.

High yield

• We upgraded high yield from neutral to more attractive.
• Yields near 8% provide an improved starting point for total returns and a cushion against modest spread widening. We favor pairing high yield with high-quality U.S. government and investment-grade bonds, recognizing its greater credit and economic sensitivity.

Leveraged loans

• We upgraded leveraged loans from least attractive to less attractive.
• Attractive yields, floating-rate exposure, and a higher-for-longer rate environment improve the outlook. However, software concentration and mixed credit-spread signals limit the case for a larger upgrade.
• Alternatives should also expand the opportunity set for qualified investors, particularly amid greater market dispersion and global crosscurrents.
• Taken together, the reset in growth and tech valuations and the rise in yields are creating more attractive opportunities to deploy cash.

Bottom line

The bull market continues to deserve the benefit of the doubt. Beneath the surface, a healthy reset in prices and valuations is creating opportunities as the fourth quarter begins.

Earnings remain this bull market’s north star, while stabilization in interest rates will likely be needed for the historically strong fourth-quarter pattern in midterm-election years to play out.

Meanwhile, higher yields have restored income and improved the forward return potential of fixed income.

Risks remain. Rates could overshoot, elevated energy prices could weigh on consumers, or AI-related earnings could disappoint.

Still, the weight of the evidence currently supports remaining overweight equities, maintaining our preference for U.S. growth, and selectively adding income opportunities.

As always, we will continue to follow the weight of the evidence, keep an open mind, and update you as our views evolve.

Looks can be deceiving: Beneath the resilient headline index, a healthy reset is creating opportunities in U.S. growth and credit, while higher yields restore portfolio income.