During the third quarter, U.S. equities continued with their “risk on” shift supported by a Goldilocks backdrop of optimistic growth expectations (boosted by AI) and dovish Fed expectations. In keeping with this backdrop, the U.S. economy and markets continued to shrug off tariff and softening labor market concerns as Q2 earnings for the S&P 500 exceeded expectations and the Fed resumed interest rate cuts. Both U.S. and non-U.S. stocks posted strong returns during the quarter, with the S&P 500 having its best return for Q3 since 2020, while U.S. government bonds also delivered positive returns.

This summary is provided by TCO; the detailed look into last quarter’s specifics is provided by NDR.

U.S. Economy & Fixed Income

Evidence of softening labor market conditions grew more apparent in the third quarter as the balance between labor demand and supply shifted toward emerging slack. The unemployment rate rose to 4.3% in August, exceeding both Congressional Budget Office and Federal Reserve estimates of the full-employment rate. For the first time since 2021, the number of unemployed workers surpassed job openings, underscoring easing labor tightness.

A widening unemployment gap typically signals slower growth, weaker demand, and cooling wage pressures. This trend contributed to the Fed’s decision to resume rate cuts after a nine-month pause, with officials projecting two additional reductions this year.

While looser policy may help stabilize demand, hiring growth remains constrained by structural labor supply challenges that monetary policy cannot address.

Labor demand has clearly moderated alongside a slowdown in corporate profit growth. Nonfarm payroll gains averaged just 29,000 in August, among the smallest monthly increases of this expansion, and preliminary benchmark revisions indicated a notable downgrade to prior employment estimates.

Multiple indicators pointed to weaker hiring momentum, including a declining employment diffusion index, softer ISM employment surveys, and a job openings rate near its lowest level since 2020. Continuing jobless claims have trended higher, while hiring announcements have dropped.

The Float-Adjusted U.S. Aggregate Bond Index gained nearly 2% in Q3 and over 6% year-to-date (see chart below). Longer-duration bonds led returns, supported by declining yields, while municipal bonds and investment-grade credit also performed well. High-yield corporates posted modest gains, and emerging market debt outpaced other segments with a 3.4% quarterly return.

Despite a modest dollar rebound, U.S. bonds continued to outperform global peers, highlighting the market’s relative strength amid shifting growth and policy expectations.

U.S. Equities

U.S. equities advanced strongly in the third quarter despite several factors that could have weighed on investor sentiment. Tariffs, profit margins, valuations, labor market trends, and questions over Federal Reserve policy independence all contributed to a wall of worry. These risks did not materialize, and stocks rallied as confidence returned. The S&P 500 gained 7.8% in Q3, marking its best third quarter since 2020 and strongest September since 2010. When the index has rebounded from a 10% correction to gain at least 10% through Q3, it has often carried that momentum through year-end (table below).

While seasonal headwinds typically weigh on markets in late September, strong underlying demand helped equities defy expectations.

Despite record highs across major indexes, investor sentiment remained surprisingly neutral, suggesting the rally has been driven more by liquidity than euphoria. Robust ETF inflows, near-record corporate buybacks, and limited selling pressure have supported the market’s resilience, with Volume Demand exceeding Volume Supply by one of the widest margins since 2021. At the same time, rising equity issuance hints at renewed corporate confidence and potential valuation awareness. Together, these dynamics point to a market where liquidity and demand remain the dominant forces, sustaining momentum into the year’s final stretch.

Within U.S. markets, small-cap stocks and growth styles led performance. The Russell 2000 rebounded as investors anticipated lower borrowing costs and easier financial conditions.

Large-cap growth gained 11.1% and continued to lead year to date with strong earnings and liquidity. Growth factors such as earnings and sales momentum outperformed, while valuation metrics like sales-to-price and EBITDA-to-enterprise value also produced gains.

Overall, the third quarter reflected renewed optimism that economic strength could sustain equity market gains into year-end.

International Equities

Global equities posted strong gains in the third quarter, with the MSCI All-Country World Index (ACWI) rising 7.6% in local currencies. Emerging markets led performance, climbing 11.6% and contributing to nine of the top 10 performing markets in Q3.

China was the largest driver, gaining 19.1% for the quarter and 38.3% year-to-date, supported by a surge in Semiconductors and Semiconductor Equipment stocks. Taiwan and South Korea also recorded substantial gains in Information Technology, while South Africa advanced 16.0%, led by Metals and Mining. In contrast, India weighed on emerging markets as its Software and Services sector declined.

Overall, 40 of 47 ACWI markets posted positive returns in Q3. North America delivered solid performance, with Canada up 11.4%, driven by Metals and Mining stocks. Information Technology and Communication Services led U.S. gains, while sector contributions were more balanced year-to-date. Europe ex-UK lagged other regions, gaining only 2.6% and underperforming the ACWI by 4.0% year-to-date. Weakness was broad-based. However, Southern European markets, including Greece, Spain, and Italy, performed strongly, reflecting both sector positioning and local market rebounds.

Despite these gains, broader market breadth remained limited. Fewer than a quarter of ACWI stocks were within 5% of their record highs, and only 15% of U.S. stocks reached 30-day highs. Global earnings momentum has stabilized, with forward growth trends indicating limited acceleration. Valuations are stretched, with ACWI trailing and forward earnings yields at their lowest levels since 2021.

With macro uncertainties from trade, policy, and geopolitical developments, equities remain exposed to potential disappointments in corporate earnings or shifts in economic conditions, which could constrain further upside for global markets.