Overview
The US government shut down on October 1st and remained closed until November 12th. The shutdown affected the release of economic data, including key surveys needed to calculate inflation. Despite this, markets reacted more to tariff announcements and continued their upward path consistent with strong corporate earnings growth. Consumer sentiment has not increased with market growth. Possible explanations for this divergence (between Wall Street and Main Street) include political polarization, the negative influence of social media, and growing inequality. (The top 20% of pre-tax earners account for almost 40% of spending.) Income tax refunds are expected to stimulate the economy in 2026.
The Fed trimmed its policy rate twice by 25 basis points ending with a range of 3.5% to 3.75%. The Fed cited again slowing job gains and a modest rise in unemployment while acknowledging inflation had moved up. There were three dissents from the Fed decision, two that would not have made the second change and one that would have gone further. The so-called “dot plot” shows dispersion in the longer run target rate. The futures market expects cuts in the second and third quarter of 2026.
Bond Market
Treasury rates were mostly unchanged for the quarter, and rates shorter than 20 years declined for the year, supporting bond returns[i] of 0.9% for the quarter and 6.3% for the year. Real interest rates also fell during the year with the 5- and 10-year TIPS both declining by 0.5%. Breakeven inflation[ii] over the next 5 years held steady at ~2.3%.
Figure 2: Treasury Yield Curve
In global fixed income markets, rates were mostly unchanged in the UK but increased in Canada, Germany, and even more significantly in Japan. (Rising rates led to decreases in bond prices in those markets.)
Figure 3: Global Yield Curves[iii]
Stock Market
US stock markets[iv] returned 2.4% for the quarter and 17.1% for the year. Small cap stocks were positive for the quarter and year with returns of 2.2% and 12.8%, respectively, underperforming large stocks. US growth stocks outperformed value stocks in both large and small companies for the year.
Developed international markets and emerging markets outperformed the US market during the quarter with returns of 4.9% and 4.7%, respectively. For the year international markets substantially outperformed the US with the international developed markets returning 31.2% and emerging markets returning 33.6%. International value stocks[v] were the best performing asset class returning 42.2% for the year. The weakening of the dollar significantly contributed to the outperformance of European stocks during the year but not in other non-US markets.
Domestic real estate[vi] had a negative quarterly return at -0.8% and lagged behind both domestic and international markets for the year with a return of 3.7%. US utilities[vii] also had a negative quarterly return with a return of -1.6% but returned 16.5% for the year. Alternative lending posted modest gains of 1.1% for the quarter and 4.5% for the year while reinsurance posted a gain of 10.7% for the quarter and 29.6% for the year.[viii]
[i] Bond returns based on the Bloomberg U.S. Government Bond Index.
[ii] Breakeven inflation is the difference between the nominal US Treasury and TIPS of the same maturity and reflects both inflation expectations and an inflation risk premium.
[iii] Source: Bloomberg Government BVAL Curves.
[iv] Large, small, and broad market returns are based on the Russell 1000, 2000, and 3000. Value and Growth are based on the respective Russell indexes. International developed and emerging market equities are based on EAFE and MSCI Emerging Markets indices, respectively.
[v] MSCI World ex USA Value Index.
[vi] Dow Jones US Select REIT Index.
[vii] Utilities are represented by the MSCI US IMI/Utilities Total Return Index.
[viii] Reinsurance and alternative lending represented by Stoneridge Reinsurance Risk Premium Interval Fund (SRRIX) and Stoneridge Alternative Lending Interval Fund (LENDX), respectively.
