A rising tide is supposed to lift all boats. But that wasn’t really the story in the markets during the third quarter.
The S&P 500 rose about 2%, but the gains were far from broad-based. Meanwhile, the bond market sold off resulting in higher interest rates. A relatively small number of large companies—particularly those benefiting from continued investment in artificial intelligence—provided much of the lift. The S&P 500 Equal Weight Index, which gives each company roughly the same influence, actually declined about 2.2%.
This makes the market’s performance in 3Q26 a little like a canal lock. When the water level rises, the boats inside the lock rise with it. But the boats outside the lock don’t go anywhere. Let’s step back and see what happened.
3Q26 was chock-full of inputs and events, and the market shifted focus constantly as participants tried to digest incoming information and discern its impact.
At the top is the U.S. economy, which remained resilient during the quarter. Recent corporate earnings, productivity, business investment and consumer spending all provided evidence of continued economic strength, while the labor market remained relatively stable. The challenge is that inflation has been slower to come down than the Federal Reserve would like, remaining above its 2% target. Higher energy prices resulting from the war in Iran, along with cost pressures associated with the AI buildout, add to the potential inflationary pressure. In short, the economy continues to grow, but inflation remains an important concern.
After considerable debate among market participants, the Fed raised its Fed Funds Target Range by 25 basis points in September to 3.75%-4.00%. While the move itself was largely anticipated by the bond market, longer-term Treasury yields continued to rise. The 10-year Treasury yield climbed from approximately 4.44% at the end of June to 5.29% at the end of September, while the 30-year yield reached 5.64%.
Higher long-term rates reflect concerns about persistent inflation, the amount of government borrowing that needs to be financed, and expectations for economic growth. The Fed does not control longer-term interest rates directly—the bond market ultimately determines the yield investors require. From an investment standpoint, however, higher rates also create an opportunity. We used the increase in yields as an opportunity to add bonds to portfolios that could take advantage of these more attractive rates.
AI took center stage for a different reason. As the capabilities of AI models continue to advance, concerns about the risks of increasingly autonomous systems became more prominent. Technology leaders, including Anthropic CEO Dario Amodei, called for greater coordination and safety measures as the industry races to develop increasingly powerful models.
Against this backdrop, the stock market’s performance was mixed and much less broad-based than in 2Q26 and than the headline numbers might suggest. While the S&P 500 gained 2.03% and the Nasdaq gained 2.47%, the Dow Jones Industrial Average declined 2.7%. To understand the divergence in returns, it’s informative to look a bit further.
The S&P 500 Equal Weight Index, which gives each company roughly the same influence regardless of its size, declined by about 2.3%. The S&P MidCap 400 fell over 6%, while the S&P SmallCap 600 declined by over 8%. When you look deeper, the average stock did not have nearly as good a quarter as the S&P 500 headline would suggest.
A handful of the largest companies in the index had an outsized impact on the overall index return. Information Technology represents roughly 40% of the S&P 500 and Communication Services represents roughly 10%. With several of the market’s largest companies concentrated in these sectors, strong performance from a relatively small number of tech and AI-related companies can—and did—have a disproportionate impact on the overall index.
Bringing it altogether, there were clearly winners and losers in the 3Q26. The boats in the lock—particularly the large companies benefiting from the AI boom—continued on their journey, while others were left waiting in line. For now, the strength of the economy and company earnings bodes well for the journey ahead. But the quarter was a good reminder that a rising market does not mean every investment is rising with it.
