Economic Update: A Review of Third Quarter 2026

The U.S. economy continued to expand during the third quarter, although the pace of growth has become more uneven across sectors. Business investment remains healthy, particularly in areas tied to artificial intelligence and digital infrastructure, while consumers continue to spend despite elevated borrowing costs and inflation concerns. At the same time, employment growth has slowed, inflation remains above the Federal Reserve's long-term target and policymakers are signaling a willingness to continue to raise rates if necessary.

Equity markets posted mixed results during the quarter. Continued investment in artificial intelligence, strong corporate earnings and resilient consumer spending provided support for major index stock prices. This is despite higher interest rates and ongoing geopolitical uncertainty. Large energy and technology-related companies led the market, while smaller, more interest-rate-sensitive stocks struggled.

U.S. Economy

According to the Bureau of Economic Analysis, U.S. GDP increased at an annualized rate of 2.2% during the second quarter of 2026. First quarter growth was revised to 2.5%. Consumer spending, business investment and exports all contributed positively to growth, while rising imports partially offset those gains. The second quarter estimate was revised upward from earlier reports, reflecting stronger investment and consumer activity throughout the quarter.

Corporate profits also moved higher, supported by continued investment in technology, productivity improvements and resilient demand across many service-oriented industries. Both GDP growth and corporate profits have also recently been boosted by tariff refunds as well. 

Despite these favorable trends, there are signs that economic momentum is beginning to slow. Businesses remain willing to invest, particularly in technology and artificial intelligence initiatives. However, higher interest rates continue to pressure borrowing-sensitive areas of the economy. Housing activity, for example, remains uneven.

Inflation remains one of the most important issues facing policymakers and investors. The Bureau of Labor Statistics reported that the Consumer Price Index increased 3.4% over the twelve months ending in August. While core inflation was only 2.4%, rising energy prices contributed meaningfully to overall inflation during the period. Gasoline prices increased sharply during August and remain a source of uncertainty heading into the fourth quarter.

The labor market continues to show signs of resilience, although hiring activity has slowed. The Bureau of Labor Statistics reported that nonfarm payroll employment increased by only 29,000 jobs during September. Unemployment ticked up to 4.2%. Despite this recent increase, unemployment remains relatively low by historical standards. 

The Federal Reserve continues to face the challenge of balancing its dual mandate of price stability and maximum employment. At its September meeting, policymakers voted to increase the target federal funds rate by 25 basis points, bringing the target range to 3.75% to 4.00%. Federal Reserve officials cited continued inflationary pressures as the primary reason for the increase and emphasized their commitment to returning inflation to the long-term target of 2%.

According to the Federal Reserve's latest economic projections, policymakers expect moderate economic growth to continue through the remainder of 2026. Inflation is projected to gradually decline over time, although it is expected to remain above the long-term target in the near term. The unemployment rate is expected to remain relatively stable, reflecting an economy that is slowing but not contracting.

International Economy

The global economy continues to expand, although growth remains uneven across regions. In its July 2026 World Economic Outlook Update, the International Monetary Fund projected global GDP growth of approximately 3.0% during 2026. According to the IMF, advances in artificial intelligence and increased investment in technology infrastructure are helping offset the negative effects of geopolitical tensions, elevated energy costs and ongoing trade fragmentation.

Inflation remains a challenge globally as well. Higher energy prices have affected many economies, particularly those that rely heavily on imported fuel. As a result, central banks around the world continue to balance inflation concerns against the need to support economic growth.

Europe continues to experience modest economic growth. While inflation has moderated from its peak levels, higher energy costs, slower productivity growth and geopolitical uncertainty threaten. Business investment has improved somewhat, but growth throughout the region continues to lag that of the United States.

Many emerging markets continue to demonstrate stronger economic momentum than developed economies. Countries benefiting from participation in technology supply chains, manufacturing growth and favorable demographic trends remain attractive sources of long-term economic growth. However, they are also not immune to geopolitical uncertainty as well.

Markets

U.S. large-cap equities, as represented by the S&P 500 Index, finished up 2.30% during the quarter and are now up 12.75% total for the first half of the year. Developed international equity markets, as represented by the MSCI EAFE Index, performed slightly worse with a quarterly gain of 0.81% and a nine-month gain of 10.33%. The MSCI Emerging Markets Index pulled back slightly with a decline of 0.37% as of quarter-end but is now still up 23.38% year to date.

Bonds did not perform well due to interest rate increases. During the third quarter, the Bloomberg U.S. Aggregate Bond Index was down 3.51%, the Bloomberg Hedged Global Aggregate Bond Index was down 2.53% and the Bloomberg U.S. Inflation-Linked Bond Index was down 3.24%. Year-to-date, they are down 2.91%, 1.42%, and 2.12% respectively. 

Energy prices spiked, which caused commodities to strongly rebound during the quarter. The Bloomberg Commodity Index gained 16.19% during the period but remains up 32.87% year to date. Interest-rate-sensitive Real Estate, on the other hand, did not fare as well. The Wilshire REIT Index was down 6.22% during the quarter and is up 10.36% year to date.

Outlook              

The first nine months of 2026 have once again demonstrated the value of maintaining a diversified investment portfolio. Investors who remained disciplined during periods of market volatility have generally been rewarded as both corporate earnings and economic growth have remained positive.

The economic outlook remains positive, but several risks warrant attention. Inflation is still above the Federal Reserve's target while the labor market is stagnant. Interest rates will likely stay elevated longer than investors expected earlier this year. Together, these factors could slow economic growth in the fourth quarter and into 2027.

Current U.S. stock market valuations remain above historical averages, particularly within portions of the technology sector. While strong earnings growth has helped justify some of these valuations, investors should maintain reasonable long-term return expectations. Periods of volatility are likely to continue as markets evaluate inflation data and corporate earnings trends.

Fixed income has become increasingly tempting as higher interest rates have increased yields available to investors. Higher starting yields generally improve long-term return prospects for fixed income investors. Note, however, it is not clear at this point that interest rates have peaked.

As always, we recommend a diversified portfolio containing a reasonable amount of equity exposure for any investor with a long enough time horizon.