The Quarterly View

The last three months represented a stark contrast for equity markets compared to the first half of 2026. There were no new middle eastern conflicts, no new tariffs, and broadly earnings continued to meet or beat market expectations. The same easy sailing was essentially true for bonds... until late August.

Two events occurred that have driven interest rates higher, subsequently driving bond prices lower. The first was the Federal Reserve revising their interest rate stance and implying rate increases, rather than holding rates steady or cutting in the back half of 2026. This presented an issue for long-term bond markets that had already priced in rate cuts. Prices adjusted downwards to reflect future expectations. The second major move has been driven by increasing demand for debt within the economy. Government borrowings have not slowed down nor have AI related infrastructure spending. This demand has led the benchmark 10-year Treasury rate to end the quarter at 5.29% after starting the quarter at 4.24%. This represented more than a full percentage point increase in 3 months. A significant move and one that has put investors and markets on notice.

If you could get a bank CD for 5% or buy a stock with an expected return of 5%, which one would you choose?

When cost of capital goes up, investors require higher expected returns from their investments. Think of it this way, if you could get a bank CD for 5% or buy a stock with an expected return of 5%, which one would you choose? Your requirement for that stock's return needs to be higher for you to shift money away from a risk-free return. This same theory (with a lot of nuance) is playing out on a macroeconomic scale.

You might be asking yourself, that's great, but what does it mean. Primarily, the move means that investors are requiring a higher interest rate for the same unit of debt than months prior. When cost of capital goes up, it tends to tighten business investment, and personal consumption. On the personal consumption side, think housing for a minute. 30-year average mortgage rates finished the quarter at 7.28%. Subsequently home prices have flattened the last 20 months and loan demand has decreased.

What does this mean for stocks, bonds, and cash going forward?

Higher interest rates (relative to the past 10 years) are likely here to stay. This will have an impact on business investment and stock market returns but it does not necessarily signal an immediate correction or recession. What it does signal is that savvy business investment will continue to be rewarded as the risk associated with that investment is now higher. See the chart below that outlines stock performance in different rate environments. See below for our investment committee positioning.

• More attractively priced, more profitable U.S. companies
• Less attractively priced, less profitable U.S. companies

0%5%10%15%20%

12.0%

2.0%

15.6%

11.3%

13.8%

6.4%

Rising yieldsFalling yieldsAll environments

Sources: Kenneth R. French Data Library, Federal Reserve Bank of St. Louis (FRED), and Avantis Investors calculations. Notes: Monthly U.S. equity returns are from the Fama-French 5x5 portfolios sorted on book-to-market equity and operating profitability. More Attractively Priced, More Profitable Companies and Less Attractively Priced, Less Profitable Companies are market-cap-weighted composites from the most and least favorable regions of the 5x5 matrix, respectively. The analysis uses the full monthly history available from the Fama-French data library. Yield environments are based on monthly changes in the 10-year U.S. Treasury yield. Returns are annualized. Past performance is no guarantee of future results.

So where do markets go from here?

To close out the year we expect markets to try and digest interest rates, mid-term elections, and earnings to set the landscape for 2027 and beyond. Interest rate sensitive areas of the stock market will likely be the most effected by potential volatility.

See below for Year to Date Major index returns.

Index	Bar	Year-to-date return
Stocks
Nasdaq Composite		+18.49%
Russell 2000		+15.08%
S&P 500		+13.97%
MSCI EAFE		+8.10%
Dow Jones Industrial Average		+6.48%
Bonds (Bloomberg indices)
U.S. Treasury Bills 1-3 Month		+2.82%
U.S. Treasury		−2.67%
Global Aggregate		−2.72%
U.S. Aggregate		−2.77%
Municipal Bond		−3.65%
	−5%0%5%10%15%20%

Source: YCharts, data through September 30, 2026. Index level percent change, except the Russell 2000, which is shown as total return. Indices are unmanaged and cannot be invested in directly. Past performance is not a guarantee of future results.

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