From the Bow of the Boat: Our Perspectives on the Market & Economy

While the overall equity market produced modest gains during the third quarter, much of that performance came from a relatively small group of large companies. Beneath the surface, many mid-size and smaller companies struggled, highlighting a continued narrowing in market leadership.

The energy sector recorded double-digit gains in the third quarter as oil producers and refiners benefited from the rebound in crude prices. Driving oil prices higher were the continued tensions in the Middle East as the U.S. and Iran exchanged missile strikes. The conflict spread as Iran-proxies in Yemen increased hostilities and Saudi Arabia shut down major oil pipelines following an increase in attacks. Conversely, the utilities sector was the leading detractor as the bond-like equity sector sold off as interest rates increased.

Inflation and Interest Rates Rise

Headline and core inflation numbers accelerated into the end of the quarter with a hotter-than-expected September CPI report. Headline inflation gained 0.6% for the month, translating to 3.7% annually, while Core CPI topped projections with a 0.3% monthly increase, equivalent to 2.6% annually. With headline and core inflation accelerating together, there is evidence that the underlying price pressures are proving more stubborn than expected. As a result, the markets increased the likelihood of an additional rate hike by the Federal Reserve this year to roughly 80%.

Garnering increased attention last quarter was the move higher in interest rates both domestically and internationally. The influential 10-year U.S. Treasury rate started the quarter at 4.44% and ended at 5.27%, surpassing levels previously reached in 2007. In addition to the higher inflation expectations, converging factors of increasing economic growth dynamics, investor concerns about increasing government deficits, and a surge in corporate issuance used to fund the AI buildout further pushed interest rates higher. Why do higher interest rates matter? Higher rates can create headwinds for both bonds and stocks by raising borrowing costs and increasing the return investors can earn from safer assets. While these higher rates can create short-term market volatility, they also provide investors with more attractive yields and may create opportunities for patient long-term investors.

Show Me the Money!

As discussed in our Q2 update, investors continue to shift the artificial intelligence (AI) conversation from fervent enthusiasm toward fundamentals, cash flow, and return on invested capital. The question is: will these large investments start to pay off?

River Wealth continues to recognize the long-term economic benefits of AI and believes the best approach to investing in AI is through a diversified portfolio of companies exposed to various aspects of the AI ecosystem. We favor companies with proven earnings power, diversified businesses, strong balance sheets, and the ability to fund AI investments without relying excessively on external capital markets.

What We Are Watching

The investment team continues to monitor the strength of the US consumer. The labor market showed signs of a cooldown headed into the end of the quarter as September’s employment report showed the economy added only 29,000 jobs, down sharply from August’s gain of 133,000. Unemployment rate rose slightly from 4.1% to 4.2%, while wage growth slowed to 3.0% year-over-year. A cooling job market and stubborn inflation could erode consumer purchasing power in the months to come, impacting economic growth. Although the consumer is slowing, current data reflects more of a moderation in strength rather than a significant contraction. We continue to monitor various geopolitical events, primarily the conflict in the Middle East. Should tensions ease and the Strait of Hormuz fully reopen, oil prices should decrease and provide financial relief for consumers worldwide.

Offsetting a slower consumer is robust investment from companies amid the continued spending on AI and technology infrastructure. The spending is translating to strong corporate earnings. Should Q3 earnings meet expectations, that would mark three consecutive quarters of +25% earnings growth. As a result, the economy is expected to report Q3 GDP growth of 2.8%, up from 2.2% for the second quarter. 

Takeaway

Despite a more challenging environment characterized by higher interest rates, persistent inflation, and signs of a slowing consumer, the broader economy continues to benefit from healthy corporate investment and solid earnings growth. While markets may experience periods of volatility as these forces evolve, River Wealth remains focused on building diversified portfolios designed to participate in long-term opportunities while managing risk.