7 Charts on Q3 Market Highlights: Stocks Tread Water While the Bond Market Shudders

Key Takeaways

• The stock market rally ran out of steam in the third quarter as AI stocks stumbled.
• A bond market selloff gained momentum, with Treasury yields rising to multi-decade highs.
• Inflation remained above target as the Fed hiked interest rates for the first time in three years.

After a mid-August bounce, stocks largely went sideways in the third quarter, as upward momentum from the artificial intelligence trade waned and rising interest rates weighed on investor sentiment.

For more than three years, the AI boom has been driving the overall stock market higher. But those stocks slowed to a crawl as a growing chorus of AI executives and researchers sounded the alarm on safety concerns for the rapidly advancing technology. Chip and memory stocks, which had been the stock market’s big winners in the first half of 2026, were among the hardest hit in the quarter.

In the bond market, anxiety over rising fiscal deficits, inflation, and the Iran war’s ongoing impact on oil prices sent yields soaring to multi-decade highs. Bond prices move inversely with yields, and the major Morningstar bond indexes all finished the quarter in the red.

Meanwhile, the Federal Reserve delivered its first interest rate hike in three years on the back of hotter-than-expected inflation data and persistently elevated oil prices.

Here are some highlights of the quarter.

The third quarter saw the blistering gains of the previous quarter slow dramatically. The Morningstar US Market Index returned 1.36%, having gained 15.65% in the previous period.

Despite a mixed quarter for AI names, growth stocks outperformed value, and the Morningstar Wide Moat Composite Index returned 4.91%, more than double the broader market.

Among the biggest detractors from the US Total Market Index’s performance were Applied Materials AMAT, Lam Research LRCX, KLA KLAC, and Broadcom AVGO—all suppliers of semiconductor equipment. The broader AI sector rallied in the last days of September, with gains seemingly sparked by the release of Muse, Meta Platform’s META new AI agent.

An exception to the downward trend was software stocks, which soared in August after lagging the rest of the market for most of the year. Once the cornerstone of the “AI loser” trade, software got a boost on continued strong earnings and improved investor sentiment when the “SaaS-pocalypse” didn’t materialize. Software giant Microsoft MSFT was up more than 33% over the course of the quarter.

Oil Prices Remain Volatile

Energy prices continued to fuel day-to-day volatility in the stock market, with the WTI oil price benchmark climbing above $107 a barrel in mid-September as the Iran conflict resurged. Oil prices have driven the overall rise in inflation since the war began, even as economists say there has been little evidence of pass-through effects to the rest of the economy. Elevated energy prices contributed to the Fed’s decision to raise interest rates in September.

Yields Keep Rising, Bonds Sell Off

Investors endured multiple selloffs in fixed income in the third quarter, with Treasury yields climbing to their highest levels in decades, thanks to stubborn inflation, robust economic growth, high government deficits, and the wave of debt sold to raise money for the AI buildout.

The yield on the 10-year US Treasury bond, a key benchmark for business and consumer lending, hit 5% in mid-September and kept climbing, reaching as high as 5.29% this week. Six months ago, 10-year yields were hovering around 4.3%. The 5% mark is seen as a psychologically important threshold for Wall Street—one where investors begin to worry that borrowing costs will weigh on the stock market and the health of the overall economy. 30-year yields are sitting even higher at 5.64%.

The Fed Delivers a Hike

The Fed raised interest rates by a quarter-point at its September meeting, bringing the federal-funds rate target to a range of 3.75%-4.00%. It was an important test for Chair Kevin Warsh, who spooked markets over the summer after refusing to offer much insight into his thought process regarding rate hikes and inflation. He offered more clarity this time around.

“The plain fact is that inflation is too high and has been for too long,” Warsh said following the meeting, adding that the rate-setting committee’s action demonstrated its “resolve to achieve price stability on a timelier basis.” Inflation has been higher than the Fed’s target for more than five years.

After the meeting, Wall Street turned its attention to the remainder of the cycle. Bond futures traders currently see 30% odds of two more hikes by the end of the year.

Looking into 2027, the picture is less certain. Morningstar senior US economist Preston Caldwell is expecting two cuts next year and four in 2028.