Stocks shrug off a cruel quarter for bonds
The story of the third quarter depends on where you look. Equity investors finished it within touching distance of record highs. Bond investors finished it nursing some of their heaviest losses in years.
Equities entered July in good shape. Earnings were strong, oil prices had been falling and the path ahead for the AI juggernaut looked clear. That calm did not last. The Middle East conflict re-escalated, exports from the region were curtailed and oil reversed sharply. Brent rose around 40 per cent over the quarter, ending back above $100 a barrel and up roughly 70 per cent for the year.
Asia felt the first tremor. The memory chipmakers at the heart of the regional rally sold off sharply in July, as profit-taking snowballed into heavy retail selling. South Korea's market fell almost 20 per cent from its peak, recording its worst quarter since the pandemic, although it remains roughly twice as valuable as it was a year ago.
Equities have since found solace in the resilience of the US economy. Growth, consumer spending and private payrolls have all surprised to the upside, and corporate capital expenditure shows little sign of slowing. Earnings remain the anchor, with S&P 500 profits expected to rise by around 30 per cent this year. US and Japanese equities have continued to lead the charge, despite concerns about energy costs and diesel prices in particular. World equities ended the quarter around 2 per cent below their record and more than 12 per cent higher for the year.
Bond managers have faced a far tougher quarter. The march of higher yields took on renewed momentum as the Federal Reserve raised rates in September for the first time since 2023. Investors had hoped for a more accommodative Fed under Kevin Warsh, but the new Chair used his Jackson Hole address to prepare markets for the pivot. The committee duly raised rates and hinted at another increase later this year. The US 10-year yield rose more than 80 basis points over the quarter to above 5 per cent, its highest level since just before the financial crisis, while yields in Japan, Germany, France and the UK climbed to multi-year highs.
Heavy government issuance continues to weigh on bond prices, and much of the move has come through rising real yields. For existing holders, that has been painful. For portfolios, it creates a good problem. With real yields where they are, we can now harvest meaningful returns from both fixed income and equities, rather than relying on equities to do the heavy lifting.
Within fixed income, the shorter-duration positioning we adopted at the start of the year has had a positive effect on portfolios, sparing them the worst of the sell-off. We rely on the flexibility offered by active fixed income managers to adjust exposure as conditions evolve, and we will be reviewing positioning carefully as we move into 2027.
Within equities, rising short-dated yields and a flatter yield curve have adverse implications for value and smaller companies, which led for much of the year but have lagged in recent weeks. We are watching closely for any broader shift in market leadership.
As always, we remain mindful of incoming data and continue to monitor markets for signs of stress. The final quarter brings plenty to watch, from US midterm elections in November to a UK Budget and further central bank decisions.
