Stocks limp to the Q3 finish line. Will higher rates cause more pain in Q4?

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL

WEEKLY MARKET PERSPECTIVES —  October 5, 2026

Stocks limp to the Q3 finish line. Will higher rates cause more pain in Q4?

The S&P 500 Index rose +2.0% in the third quarter, and the NASDAQ Composite gained +2.5%, while most other measures of the market fell. For example, the Dow Jones Industrial Average lost 2.7%, the small-cap Russell 2000 Index dropped 7.5%, and the equal-weighted S&P 500 declined 2.2%. By quarter's end, only about one in four S&P 500 stocks traded above their short-term trading average, down from roughly two-thirds at the end of Q2.

Simply, rising interest rates were the largest drag on stocks in Q3, especially in September. The 2-year Treasury yield rose 74 basis points in Q3, its largest quarterly increase since Q2'23. The 5-year yield topped 5.0% for the first time since 2007. And the 10-year yield finished September at 5.29%. Notably, the 10-year and 30-year reached their highest levels since 2002 in the final days of Q3.

In our view, several forces simultaneously pushed yields higher. Inflation remained above the Fed's target, with core personal consumption expenditures (PCE) inflation sitting above +2.0% for 66 straight months. Higher oil and diesel prices during the quarter added to price pressures, and producer prices came in firmer than expected. Growth also remained solid. Nonfarm payrolls averaged roughly 50,000 per month in Q3. In addition, September's flash composite purchasing managers' index (PMI) reached its highest level since July 2021. Importantly, concerns about federal deficits, weak Treasury auctions, and heavy AI-related corporate borrowing added further pressure on longer-term yields throughout Q3.

That backdrop led the Federal Reserve to raise rates by 25 basis points in September, its first hike since July 2023. Fed Chair Kevin Warsh said the committee would be hard-pressed to call monetary policy restrictive, and other Fed officials echoed that sentiment. The committee and markets currently expect another quarter-point rate hike by December.

As one might expect, rate-sensitive sectors took the largest losses in Q3. Utilities fell 13.0%, the worst of any S&P 500 sector, and Real Estate dropped 6.3%, as Treasury yields near or above 5.0% gave income investors an attractive alternative. Further, small caps, homebuilders, building products, and housing-related retailers fell in Q3 as financing costs and affordability pressures rose. Banks and credit card companies also saw steep declines as the yield curve flattened. Notably, higher interest rates and fuel costs also weighed on economically sensitive stocks. Industrials fell 9.9%, with weakness across trucking, rail, parcel delivery, airlines, and aerospace and defense. Consumer Discretionary declined 5.2% as restaurants, travel and leisure, autos, and casino stocks lost ground. And Materials (-3.2%) and Consumer Staples (-2.4%) also declined in Q3.

That said, most of the market’s pain was felt in September. Although the S&P 500 slipped just -0.5% for the month, the equal-weight S&P 500 fell 5.2%, while the Russell 2000 posted its largest monthly decline since March 2025. Five sectors lost more than 5.5%, with Financials, Materials, Real Estate, and Utilities each down more than 6.0% in September. Technology and Communication Services were the only sectors to finish the final month of Q3 higher, each gaining more than +4.0%, as investors gravitated to areas with visible/secular profit drivers.

Outside of stocks, oil prices rose as the U.S./Iran conflict remained unresolved. The June 18 U.S./Iran memorandum of understanding fell apart in mid-July, when Iran attacked vessels in the Strait of Hormuz, and the U.S. responded with strikes. Houthi attacks on Saudi Arabia's energy infrastructure, which temporarily closed the regionally significant East-West pipeline in mid-September, kept crude prices elevated, with diesel topping $6.00 a gallon in Q3. However, oil supply improved late in the quarter as flows through the Strait increased and the East-West pipeline partially reopened. For the quarter, WTI crude rose +28%, and diesel rose +45.2%

On the positive side of the ledger, Energy led all sectors with a +16.5% gain in Q3, with refiners at the front of the group as fuel prices rose. Technology rose +7.1% as AI demand offset rate pressure, though results varied within the sector. Semiconductors fell 11.4% in Q3 after gaining more than +230% over the prior six quarters, as investors grew more cautious about AI spending, monetization, and safety. Conversely, Software rose +17.5% as fears that AI would disrupt subscription software businesses eased, and tech hardware outperformed. Yet chip stocks began to rebound in September as new model releases and early adoption of AI agents suggested durable demand.

Importantly, we believe corporate profits kept a lid on the selling pressure. S&P 500 second-quarter earnings per share (EPS) grew nearly +53% year-over-year, and 86% of companies beat estimates, the highest share since Q2'21. Consensus expects Q3 earnings growth near +29%, which would mark a third straight quarter above +25%.

Finally, the U.S. declined to extend the U.S.-Mexico-Canada Agreement, and the U.S./China trade truce was extended to January 10^th. Gold rose +3.7% for the quarter, and the U.S. Dollar Index finished roughly flat.

Looking ahead: Interest rates accelerated higher in September. Unsurprisingly, stocks and bonds both fell as borrowing costs climbed and the rate outlook grew less certain. In our view, it’s important to recognize that the S&P 500 and NASDAQ hid much of that weakness, as both indexes are dominated by large technology companies, which investors see as having durable AI-driven profits. Even so, borrowing costs are now higher than at any point this year. If investors' confidence in the future weakens, we wouldn’t be surprised if that tech durability is eventually tested.

Thus, we believe the direction of interest rates is the most important macro factor to watch as the fourth quarter begins. Investors likely want to see yields settle at a stable level sooner rather than later. Whether that happens depends on the outlook for deficit, supply and competition factors, as well as how far the Fed goes with rate hikes, and whether growth remains firm without fueling inflation. Notably, corporate profits remain the market's primary support beam, and with expectations high, companies can ill-afford to disappoint.

However, stocks have historically weathered rising-rate periods when the economy and profits kept growing. In our view, stocks have room to move higher if the 2027 outlook for growth and profits remains firm, energy prices stabilize/fall, and the Fed signals its rate-hiking path will be short-lived. Of course, any advance in stock prices through year-end will likely require a steady AI trade as well.

Finally, we would be remiss if we didn’t point out that elevated interest rates increase the risk that something could break in the economy or that expectations for slower growth and weaker profits may feed on each other. That’s the primary risk from our vantage point heading into year-end. Higher oil prices, more Fed tightening than markets expect, or slower AI spending as financing costs rise, would also likely produce meaningful headwinds in the final months of the year.

Bottom line: As we noted a couple of weeks ago, where stocks finish the year matters far less than an investor's long-term strategy. In our view, investors are best served by keeping allocations close to strategic targets, staying diversified, and using volatility to rebalance heading into 2027. That means diversifying across company sizes and regions, managing technology concentration, locking in attractive yields on high-quality bonds, and adding real assets and alternative strategies to your portfolio. We suggest reaching out to your Ameriprise financial advisor to put these strategies to work sooner, rather than later.

The week ahead:

• September ISM Services on Monday, the September FOMC meeting minutes on Wednesday, and preliminary October University of Michigan consumer sentiment and inflation expectations on Friday are the week's key releases.
• The U.S. Treasury will auction $58 billion in 3-year notes, $39 billion in 10-year notes, and $22 billion in 30-year bonds.
• The Q3 earnings season kicks off to a quiet start, with PepsiCo, Delta Air Lines, and Constellation Brands reporting this week, and ahead of the big banks opening the third-quarter earnings season next week.

These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes or investment/product fees or expenses, which would reduce the figures shown here. An index is a statistical composite that is not managed. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.