OCTOBER 2026 MARKET INSIGHTS

By: DOUGLAS A. RILEY, CFA, PORTFOLIO MANAGER

Although it seems to have taken a back seat to other events, the Iran conflict deserves at least a brief comment. Not much has changed since last month, other than the Houthi’s in Yemen have stepped up their offensive activities, provoking the Saudi’s and adding another dimension to the theater. The Iranians remain defiant and appear to be pressing while crude products flowing through the strait have rebounded sharply, by some reports approaching 80% of pre-attack levels^[1]. Trump continues to make contradictory statements which the media dutifully report but that mostly amount to nothing. Oil continues to bounce around in the $90-$100 per barrel level, depending on the day’s headline and likely held hostage by uncertainty surrounding the outcome of the US Midterms1.

We were in the minority insomuch as we did not read Fed Chairman Warsh’s August Jackson Hole presentation as foreshadowing a September rate hike. However, they did raise rates 25 basis points on September 16^th to 3.75%-4.0%, in line with the consensus, citing inflation concerns^[2]. But, with inflation driven by a supply side shock (oil), one wonders if a demand-side tool (rates) is the appropriate response. There did not appear to be any “smoking gun” definitively arguing for a hike, just a general statement that “inflation remains elevated.” Compared to June, the Fed’s own economic projections in September showed only a 0.1% increase in expected PCE inflation for 2026 coupled with a 0.2% decrease in the unemployment rate^[2]. For 2027, the median projection of Federal Reserve Board members was unemployment steady at 4.1%, a 0.1% increase in real GDP (to 2.4%) and no change in PCE (2.3%) or Core PCE (2.5%) inflation2.

Perhaps, the Fed was signaling a stronger economy and is looking to move the Fed Funds rate closer to nominal GDP growth? Indeed, the median 2027 forecast of Federal Reserve Board members is more optimistic than the Wall Street consensus on all three metrics; real GDP, Unemployment, and the PCE price indexes. Recent data has been encouraging regarding economic growth while validating that inflation pressures are real. Non-Farm Payroll growth YTD appears to be troughing and real wage growth has rebounded back into positive territory^[1]. The unemployment rate ticked up in September, offset by an increase in the labor force participation rate (for the third consecutive month), a positive sign indicating people are returning to the workforce^[1]. The participation rate for the “prime” working age cohort (25-54) rose 3/10 of one percent to 83.7% and is approaching the post-Covid high of 84%^[1]. The latest ISM Manufacturing Prices Paid Index came in at 77.9, well above expectations and has been above 70 since February^[1]. The ISM Services Prices Paid Index for September also exceeded forecasts and was above 70 for the third consecutive month, indicating pipeline inflation is a legitimate concern1.

Bond yields moved higher in September, and the yield curve steepened in the middle^[1]. The 10-year treasury note settled at 5.28%, up 81 basis points since the end of Q2 to the highest monthly closing yield in almost 25 years (5.39% in March 2002)^[1]. Accordingly, the aggregate bond index fell -3.48% in the quarter pushing the YTD return into the red^[1]. Corporate bond spreads remain near their lowest levels in decades, but they did widen with the investment grade spread over the 10-year treasury ending the month at 80 basis points, up 6 basis points in Q3^[1]. Of greater concern, High-Yield spreads jumped 50 basis points in September to 3.11%, near the highest monthly close of the year (March) which followed the attack on Iran^[1]. The rise appears largely driven by a combination of rising treasury rates on top of heavy supply.

Equities limped to the finish line in September with US large cap stocks down slightly, buoyed by “Big Tech” growth names^[1]. However, surging interest rates were too much for value stocks, small caps and real estate, each of which declined in Q3^[1]. Still, REITs are positive on the year and the broad equity indices posted double-digit returns through the first three quarters of 2026, led by non-US and Large Value stocks^[1]. The broadening equity rally -recall that the equal-weighted S&P 500 Index and small cap stocks (+22%) outperformed large caps in the first half of the year- reverted to the narrow, tech-driven leadership that has characterized much of the past few years^[1]. Information Technology (+2.71%) contributed more than the entire return for the bellwether S&P 500 benchmark (+2.29%) in Q3^[1]. Two stocks, Microsoft and Nvidia, contributed 2.69% (117% of the total)^[1]. The top 10 contributors added 5.17% with the remaining 490 stocks producing a net return of -2.87%^[1]. Only 168 stocks (33%) outperformed the index while 311 stocks (61%) were outright negative^[1]. In a random selection you were nearly twice as likely to lose money as outperform.

The composition of performance fits the earnings outlook. S&P 500 earnings are expected to grow 14% in 2027, driven by 38% YoY growth in the Technology sector^[1]. Only two additional sectors are expected to grow by more than 10%^[1]. Earnings revisions tell the same story with 2027 Technology sector earnings increasing by 75% over the past 52 weeks compared to 25% for the benchmark^[1]. Overwhelmingly, the AI horse is pulling the market carriage, Economic growth has become highly dependent on capital investment to fund the buildout of the AI ecosystem, so any disruption in that space poses a disproportionate risk to the overall economy unless we see a material broadening out of activity.

Bloomberg Catholic Values Indices^[2]	Period Total Return
	Month %	QTD %	YTD %
Large Cap 1000	-0.42	1.65	12.63
Large Cap 1000 Growth	0.92	2.54	12.27
Large Cap 1000 Value	-4.79	-1.35	13.28
Small Cap 2000	-4.79	-1.35	13.28
World ex-US Large & Mid Cap	-2.53	0.09	15.03
US 1-3 Year US Government/Credit	-0.58	-0.18	0.59
Bloomberg US Aggregate Bond	-2.60	-3.48	-2.89
US REIT 3000	-5.72	-5.97	8.26

By the time the next Market Insights is published in roughly four weeks, we will know the results of the US midterm elections. Most key House and Senate races are close calls, but polls currently show Democrats slightly favored to capture both houses of Congress. The rise in bond yields may reflect concerns that a Democrat controlled Congress with a stronger influence from the Socialist wing could prove more fiscally irresponsible than the current Republican majority, if that is even possible. A split Congress (Democrat House, Republican Senate) is a good bet and may be why stocks have been largely ignoring bonds. Research shows that historically, a split Congress (gridlock) is good for stocks and the economy. Personally, I long ago stopped taking polling numbers too seriously; not because they are often wrong but because I see polling as more art than science, despite claims to the contrary.

[1] Source: Bloomberg

[2] Source: https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20260916.pdf