Through much of the third quarter, encouraging news and difficult news arrived side by side. Large U.S. stocks posted gains and corporate earnings held up, even as many households felt the weight of inflation and higher borrowing costs. Economic data stayed resilient overall, though certain industries struggled or faced disruption from new technology.
Part of the explanation is that the market, the economy, and everyday household finances are connected, but they do not always move in unison. Financial markets tend to move quickly as investors reassess the future, while changes in the broader economy unfold more gradually and unevenly. For individual households, those same forces influence decisions about housing, debt, savings, work, and long-term planning. Looking at all three together provides a more complete picture than any single headline.
Q3 In Review
In Q3, markets posted mixed results as interest-rate sensitive sectors faced renewed headwinds.
- Large Cap U.S. stocks (S&P 500 Index) gained +2.3% (+12.8% YTD): Corporate earnings held up well, with continued strength concentrated in a relatively narrow set of sectors related to AI development and higher revenues for energy companies.
- Small Cap U.S. stocks (S&P 600 Index) declined by -7.9% (+14.1% YTD): In Q3, smaller companies gave up some of their early-year gains as higher borrowing costs and a more selective market environment created additional pressure.
- International stocks (MSCI EAFE Index) gained +0.8% (+10.3% YTD), while emerging markets stocks (MSCI EM Index) declined by -0.4% (+23.4% YTD): Despite a relatively flat Q3, both indexes have provided growth this year, boosted by AI tailwinds related to memory and chip companies outside of the U.S., while facing headwinds from higher energy costs.
- U.S. Bonds (Bloomberg Aggregate Bond Index) declined by -3.5% (-2.9% YTD): Prices declined as yields moved higher on persistent inflation and a shifting outlook for Federal Reserve policy.
- Real Estate (FTSE NAREIT Index) declined by -6.7% (+6.9% YTD): Real estate continued to provide income for investors, but prices declined in response to the higher-rate backdrop.[1]
The dominant storyline this year has been a shift in expectations about interest rates. With inflation remaining stickier than markets had hoped, the Federal Reserve decided to raise rates in September, reinforcing the prospect that borrowing costs could remain elevated for some time. Yet the effects have been anything but uniform. Bond prices have faced renewed pressure, equity markets delivered gains through the first three quarters of the year, and the broader economy continues to expand even as certain businesses and households feel increasing strain.
Markets: Higher Rates Than Anticipated
In financial markets, higher rates have created different outcomes across asset classes. Bonds and real estate have faced renewed pressure as yields moved higher, while large U.S. stocks have continued to experience price growth. That divergence can feel counterintuitive, particularly because higher interest rates affect the financing costs and valuations that influence all financial assets. However, those forces do not affect every investment in the same way or on the same timetable.
History offers plenty of examples of bond and stock prices diverging following rate adjustments. In 1994, for example, the Federal Reserve raised interest rates quickly to contain inflation, and the bond market absorbed a difficult period of adjustment. Yet the broader economy continued to expand, and equity markets went on to post strong growth in the following years.[2] More recently, the rapid increase in rates during 2022 disrupted both bonds and stocks, but did not derail the longer-term growth of diversified portfolios. We are not suggesting this cycle will follow the exact same path as either of these historical comparisons. The broader lesson is simply that a difficult period for one asset class does not necessarily forecast trouble across markets or the economy as a whole.
The Economy: An Uneven Expansion
Moving from markets to the broader economy, the picture shows a similarly uneven landscape. Annual GDP, employment, and consumer-spending data continue to indicate an expanding economy. Beneath those aggregate numbers, however, the experience varies considerably by industry. Investment related to AI is helping support data-center construction, advanced manufacturing, electrical infrastructure, and portions of the technology sector. At the same time, parts of the software, media, broadcasting, and film industries are experiencing slower hiring and disruption as technology and consumer behavior continue to change.[3]
Higher interest rates and technology adoption are impacting growth in opposite ways. Small businesses, which underpin much of the economy, are facing steeper financing costs alongside the effects of tariffs and inflation. Conversely, recent data highlighted by Federal Reserve Governor Lisa Cook show that nearly half of small employer firms now use AI, with most of those firms reporting productivity gains, while new business formation has remained unusually strong.[4] The result of these various factors is an economy that can look healthy in aggregate while producing significantly different experiences across industries.
Households: Closer to Home
The same economic environment looks different again at the household level. Higher rates may cause one family to delay a home purchase as mortgage rates have risen above 7.25% nationally, or impact cash flow as costs rise with higher gas prices and food inflation.[5] Simultaneously, other households may appreciate the higher income now available from cash and bonds, or feel more secure based on higher portfolio values after the past few years. Households adapt to these conditions over time, which is one reason the aggregate economic effects of higher rates tend to unfold gradually.
Job changes, raising children, caregiving for aging parents, housing decisions, and retirement transitions often shape a family’s financial life more directly than economic statistics or market indexes. These considerations at the household level don’t impact how we construct our model portfolios, but they do affect how we implement investment strategies and advise planning opportunities for each client.
Looking Ahead
We do not believe anyone can consistently predict how long inflation will remain elevated, how interest rates will evolve, or which headline will dominate next quarter. This perspective reinforces our commitment to diversification and rebalancing as pillars of our portfolio management process. Diversification allows different parts of a portfolio to respond as markets shift, while disciplined rebalancing helps bring allocations back toward their intended targets rather than chasing whichever asset class has most recently performed best.
At North Berkeley, we work with clients to build financial plans and portfolios that can weather a variety of environments, including periods when the stock market and the economy aren’t moving in sync. Our goal is to create a strategy that can adapt as conditions change while keeping our clients focused on the long-term goals that matter most.
Resources
[1] All index return information is from Morningstar, Inc. Total return for Q3-2026 and YTD through 9/30/26 are sourced for each benchmark index. Benchmark returns do not guarantee performance in any individual portfolio.
[2] What History Says About Fed Hikes and Stocks. LPL
[3] US job losses mount in AI-exposed sectors despite labor market strength. 9/9/26. S&P Global
[4] Speech from Federal Reserve Governor Lisa Cook at Oakland Tech Week Opening Keynote on 09/28/2026. FederalReserve.gov
[5] Primary Mortgage Market Survey as of 10/01/26. Freddie Mac
