Market Overview
Following the significant recovery in the second quarter, returns were more modest in Q3 as markets showcased resilience in the face of significant macroeconomic and geopolitical developments. The S&P 500 returned 2.4%, the S&P/TSX Composite 1.6%, and most major markets finished within a few percent of where they began the quarter. Risks that had been building all year materialized. The U.S. and Iran ceasefire collapsed, and oil returned to $100 per barrel. U.S. inflation re-accelerated, prompting the U.S. Federal Reserve to raise interest rates.
July and August extended the second-quarter rally, with the S&P 500 and the TSX both reaching all-time highs in August. In September, the 10-year U.S. Treasury yield crossed 5% for the first time since 2007, the Fed raised rates for the first time in more than three years, and stocks gave back a significant portion of their gains. Bonds, which often cushion a portfolio when stocks decline, had their worst quarter in years, with the Canadian bond universe down 3.1% and the broad U.S. bond market down 3.5%.
Energy prices came back to the forefront as the market began to price in a prolonged conflict with Iran. The June memorandum of understanding between the U.S. and Iran unravelled: military strikes resumed in early July, the Strait of Hormuz remained largely closed, and by mid-September Brent crude was back above $100 per barrel. Diesel also hit record prices on both sides of the border. In Canada, prices reached $2.75/litre, an increase of over 70% from one year ago. With roughly three-quarters of the goods shipped within Canada travelling by truck, this price increase has the potential to work its way into the price of nearly everything on a store shelf. By September, headline inflation had climbed to 3.7% in the U.S. and 3.1% in Canada, with energy being the main driver in both countries.
For investors, Q3 carried a different lesson than Q2. In Q2, investors were rewarded for staying invested through alarming headlines. In Q3, the market offered a glimpse into the benefit of diversifying beyond traditional portfolios of stocks and bonds. With stocks and bonds both selling off sharply in September, the alternative asset allocations in our models delivered steadier returns. This is by design. The alternative assets in Raintree’s portfolios are designed to target a return stream that is less tied to public markets, has lower volatility, and is better protected against inflation. Returns will not always keep pace with stocks in a prolonged market rally like we have seen in recent years, but their role in the portfolio is to target a consistent return stream while protecting capital in downturns and in inflationary environments. In Q3, they did that.
This commentary reviews the key drivers across Canadian, U.S., and international markets; summarizes fixed income conditions; provides fund and model portfolio results through September 30, 2026; and offers our outlook for the final quarter of the year and into 2027.
Canadian Equity Market
Canadian equities extended their rally in the third quarter. The S&P/TSX Composite returned 1.6%, its ninth consecutive quarterly gain and the longest winning streak in at least three decades, and is up 13% for the year. The index set a record high in late August before September’s surge in bond yields, the U.S. rate hike and an escalation in Canada–U.S. trade tensions contributed to a decline in September.
Sector leadership was narrow: only three of eleven sectors rose (technology, materials and energy), while rate-sensitive utilities, real estate and telecom companies were hit hardest by rising yields.
Second-quarter GDP grew at a 3.3% annualized pace, and the first quarter was revised up, so the “technical recession” we described last quarter has been revised away. However, in Q3, growth has stalled and employment has fallen for two straight months. Inflation rose to 3.1% in September, almost entirely because of energy prices; excluding gasoline it was 2.2%. The Bank of Canada held its policy rate at 2.25% in July and September.
The U.S. declined to extend CUSMA at its July review, talks broke down, and tariffs followed: 50% U.S. tariffs on $27.6 billion of Canadian goods, matching Canadian counter-tariffs, and a threatened 50% tariff on all Canadian vehicles, auto parts and steel from January 1, 2027. Despite this, the S&P/TSX finished the quarter positive, which highlights the strength of Canada’s resource and technology companies.
US Equity Markets
U.S. equities finished the quarter higher, with the S&P 500 returning 2.4% and now up 12.7% for the year. The index set records through mid-August before rising yields and the Fed’s rate hike contributed to a decline in September.
Beneath the headline numbers, the broadening in the second quarter reversed. Mega-cap technology companies outperformed while the average stock declined: the equal-weighted S&P 500 fell 1.9%, and U.S. small caps gave back much of their spring rebound, with the Russell 2000 down 7.2% in Q3.
Corporate earnings remain the strongest part of the U.S. story. Second-quarter earnings grew 52% year-over-year, more than double what was expected in June. Because earnings have grown faster than prices, the S&P 500 ended the quarter at 19 times forward earnings, below its five-year average.
The AI investment cycle continued to accelerate, with the largest technology companies raising their 2026 spending plans again. That is why we remain attentive to concentration: the ten largest companies now represent close to 40% of the S&P 500, and this quarter the market rewarded a narrow group of AI leaders while the average stock fell.
International & Emerging Markets
International markets were broadly flat. Developed international equities (MSCI EAFE) returned 0.6% in Canadian dollar terms and emerging markets slipped 1.4%, pausing after a 21% surge in the second quarter. Emerging markets nonetheless remain the best-performing major asset class of 2026.
The regional dispersion we noted last quarter reversed. South Korea, among the world’s best markets in the spring, was the worst in the summer, falling sharply after a July selloff in the chipmakers at the heart of the AI buildout. Europe slipped about 1% as bond yields rose, inflation increased, and the European Central Bank raised rates for a second time this year.
Korea’s round trip is a reminder that a market which rises on one theme will fall on it too. Spreading investments across countries helps, but it is not a substitute for spreading them across sectors and themes.
Fixed Income Market Summary
The third quarter was the most difficult period for bond investors in several years, as interest rates repriced sharply globally.
In the U.S., the Federal Reserve raised its policy rate by a quarter point to a range of 3.75% to 4.00%, its first increase since 2023, with inflation running well above its 2% target. Bond yields moved up sharply with the 10-year Treasury yield rising from 4.4% to 5.3% during the quarter, crossing 5% for the first time since 2007, as investors also demanded more to lend to a government running a $2 trillion annual deficit. The broad U.S. bond market fell 3.5% in the quarter.
The Bank of Canada held rates at 2.25%, but Canadian yields followed U.S. yields higher, with the 10-year Government of Canada yield rising to nearly 4%, while the FTSE Canada Universe Bond Index fell 3.1%. Markets now anticipate roughly 50-100 basis points of Bank of Canada rate increases over the course of 2027.
High yield credit held up better than government bonds but began to show strain, with spreads widening modestly from the near-record tight levels of the summer. With spreads still tight by historical standards, our preference for government bonds and shorter maturities remains unchanged, but we continue to evaluate compelling opportunities to add income to the portfolio.
The larger takeaway is bond prices fall when yields rise, but higher yields mean higher future income: the broad U.S. bond market now yields about 5.5% and Canadian investment-grade bonds more than 4%, the most attractive starting point for the income side of a balanced portfolio in many years.
Raintree Fund Performance
Three of the four Raintree Funds posted positive returns in Q3, and the fourth, Core Fixed Income, held up far better than the bond market it invests in. Results through September 30, 2026, are shown below.
Raintree Funds – Returns (as of September 30, 2026)
Reference Indices – Returns (as of September 30, 2026)
Key Takeaways:
Core Equity returned 1.22% in Q3, bringing its year-to-date return to 12.97%, in a quarter when index returns in the U.S. were driven by a handful of mega-cap technology names and U.S. small caps sold off sharply. The fund has returned 23.5% annualized since inception.
Core Fixed Income declined 1.23% in Q3 as yields rose sharply on both sides of the border. The fund outperformed the broader Canadian fixed income market, which fell 3.1%. The fund’s short-duration positioning limited the downside of rising yields.
Enhanced Yield returned 1.42% in Q3, as the fund’s income-oriented holdings continued to deliver consistent distributions. The fund has returned 7.52% over the trailing year.
Alternative Strategies returned 1.56% in Q3, the top performer this quarter, delivering returns less correlated to stock and bond markets. The fund has returned 6.56% over the last year and 8.25% annualized since inception.
Model Performance
Model portfolio returns were modestly positive across most mandates in Q3, with the exception of the Preservation and Conservative mandates which hold higher weightings in fixed income, where the decline in bonds outweighed gains elsewhere. Every model outperformed its benchmark for the quarter, with the more diversified models holding alternative and income producing assets leading within each mandate.
Q3 Performance by Model
Since Inception Annualized Performance by Model
The pattern was the reverse of the second quarter. Explore+ and Core+ models, which hold allocations to Enhanced Yield and Alternative Strategies, led as those two funds delivered the strongest returns of the quarter. Flex+ models, which hold only Core Equity and Core Fixed Income, were more exposed to the bond market decline and lagged during the quarter as a result.
The models are working as intended: in the second quarter the higher-equity models captured more of the rally in stocks, and in the third quarter the more diversified models provided better returns and downside protection when both stocks and bonds stalled.
Fourth Quarter Outlook:
The Themes That Matter
Markets enter the final quarter of 2026 with less momentum and more uncertainty than they had entering the third. Valuations remain elevated by historical standards, bond yields are at multi-year highs, and inflation is rising again. Below we discuss four themes we believe will shape markets, and portfolios, through the balance of the year and into 2027.
The tightening cycle has begun
Last quarter we noted that U.S. rate expectations had swung from cuts to potential hikes. In September the Federal Reserve raised its policy rate for the first time since 2023 and signalled that another increase is likely before year-end. Bond markets repriced long rates higher, pushing the 10-year Treasury yield above 5% for the first time since 2007. For investors, this has two implications: bonds and cash now pay more than they have in years, which strengthens the income side of a balanced portfolio. Conversely, higher rates can place stress on equity valuations, and the stocks that carry the highest valuations are most likely to experience selloffs. In Canada, the Bank of Canada has held rates so far. As in the U.S., inflation has risen in Canada due to energy prices. The job market is also weakening in Canada, and the trade conflict with the U.S. is ongoing. Whether the Bank of Canada follows the Fed and hikes rates is one of the key questions for the fourth quarter.
Energy is an inflation problem again
Last quarter we described the June ceasefire as fragile and noted that a breakdown would push energy prices higher again, which is largely what happened. Strikes resumed in July, the Strait of Hormuz remained mostly closed, and oil was back above $100 per barrel by September. There is little sign of relief in the near term. The International Monetary Fund’s October outlook assumes the Strait will not begin to reopen until March, and the International Energy Agency expects diesel supplies to stay tight well into 2027. Central banks can usually look past a brief spike in oil prices, but when high prices persist, they work their way into shipping costs and, over time, the price of most goods.
AI is still the concentrated theme driving the market
The build-out of artificial intelligence is still the biggest driver of the market. The largest technology companies are on track to spend more than $700 billion on data centres and related infrastructure this year, and that spending is showing up in earnings, with S&P 500 profits expected to grow more than 30% in 2026. The drawback is how much the market now depends on this one theme. When chip stocks sold off in July, South Korea’s market fell more than 10% in a single day, and in September a small group of the largest U.S. companies kept the S&P 500 roughly flat while the average stock declined. As an investment team, we are cognizant of how the market has become increasingly dependent on AI capital expenditure and are watching concentration risk closely.
Canada-U.S. Trade War
Last quarter we flagged the CUSMA renegotiation as the key domestic risk, and the situation has since deteriorated. The U.S. declined to extend the trade agreement in July, negotiations broke down in August, and both countries now have tariffs in place on each other’s goods. The U.S. has also threatened a much larger tariff on Canadian vehicles, auto parts and steel starting January 1, 2027. Some of the effect is already visible in the economy through employment. In October the International Monetary Fund lowered its growth forecast for Canada, citing the energy shock and trade uncertainty. Despite the headwinds, the TSX just completed its ninth straight quarterly gain. Canadian markets have been resilient due to the technology, mining and energy companies, whose results depend more on global prices and customers than on the Canadian economy.
Our Positioning
Core Equity: We remain moderately underweight the U.S. and moderately overweight global and Canada, where valuations are more reasonable. We started the quarter by trimming our Emerging markets exposure from overweight to closer to neutral. Within our U.S. allocation, we favour quality businesses with long track records of consistent earnings and dividend growth adding Vanguard Dividend Exposure, a low cost exposure in our ETF allocation. We are keeping our exposure to AI-related names slightly underweight relative to the index after 3 years of significant growth in the segment. U.S. small caps lagged this quarter as rates rose, but we see value in quality small-cap exposure as a source of return and diversification.
Core Fixed Income: We continue to tilt the portfolio toward short duration and government bonds, and it served the fund well this quarter with long rates rising, driving down bond prices. With credit spreads still near historically tight levels and the inflation outlook uncertain, we do not believe investors are being adequately compensated for taking on additional credit or interest rate risk at this stage. The higher yields now available on bonds improve the fund’s ability to generate income, and our investment team is constantly evaluating opportunities to position the fund to benefit from higher yields.
Enhanced Yield: The fund’s allocations did not change substantially during the quarter. It remains diversified across public credit managers, private credit, equity yield and alternative income strategies. Late in the quarter we added to a preferred security issued by Regimen, a manager our team knows well, which pays a distribution of 10% per annum.
Alternative Strategies: Our investment team is reducing the allocation to liquid market-neutral strategies and increasing the allocation to private market strategies in the portfolio. At the end of the quarter, we increased our real estate allocation and are in the process of completing due diligence on additional private equity strategies. In a stickier inflationary environment, our investment team favours real assets, businesses with pricing power, and select real estate assets that offer compelling risk-reward in a higher rate environment.
Final Thoughts
The third quarter did not produce the dramatic swings of the first half of the year, but it did surface risks: interest rates have begun rising and higher energy prices are beginning to flow through into inflation statistics. The alternative assets we hold in our model portfolios remain an important diversifier for our clients’ portfolios, especially if we continue to see inflationary pressures.
Against this backdrop, we continue to believe that well-constructed portfolios provide the soundest approach to an uncertain macro and geopolitical environment. For us that means balancing globally diversified equities with significant exposure outside of the dominant AI theme, fixed income that now offers its best yields in years, and meaningful exposure to real assets and income strategies that help mitigate volatility and inflation. Together, the models are built to provide returns across a range of market conditions over the long term.
If you have any questions about this commentary or your portfolio, please don’t hesitate to contact your advisor or our team. We’re here to help, and we appreciate your trust in Raintree Wealth.