Nicola Wealth Market View

September was a calm month for the headline index and a difficult one for most of the market beneath it. On a capitalization-weighted basis, the S&P 500 slipped just 0.4% last month, yet the equal-weighted version fell about 4.8%, and only two of the 11 sectors in the index finished higher. At the same time, long-term bond yields kept climbing, and the U.S. Federal Reserve raised interest rates for the first time since 2023. 

We see the month as a battle between two powerful forces. Investment in artificial intelligence (AI) continues to lift corporate profits and economic growth. Higher interest rates, meanwhile, are raising the cost of capital and testing what investors are willing to pay for future earnings. So far, a small group of AI-related companies has been strong enough to carry the index and the U.S. economy. Much of the rest of the market is struggling to keep pace. 

In our view, the rise in rates reflects a strong economy and a Fed fine-tuning its policy more than the start of a long, aggressive tightening cycle. We remain concerned about government debt and recognize how quickly higher borrowing costs can strain public finances, but we do not believe debt is the main reason yields are rising today. For long-term investors, September is a reminder to respect the risks of a narrow market and a changing role for bonds, without overreacting to either. 

Key Takeaways

• Market breadth was unusually weak. The S&P 500 fell only 0.4% in September while its equal-weighted version fell 4.8%, and four stocks account for almost half of the index’s gain so far this year. 
• The U.S. 10-year Treasury yield posted its largest quarterly increase since 1994. Most of the rise came from higher inflation-adjusted (real) rates rather than higher inflation expectations. 
• The Fed raised its policy rate to a range of 3.75% to 4%. Markets expect more increases than the Fed projects, but we see this as fine-tuning rather than a prolonged hiking cycle. 
• Corporate earnings remain strong, though a meaningful share of their growth depends on AI spending that must eventually earn a return and will inevitably slow. 
• Persian Gulf oil exports have recovered to 2025 levels, yet prices remain elevated because supply buffers are thin and the conflict with Iran continues. 
• Government debt is a slow-burning concern rather than today’s main driver of yields. When stocks and bonds move together, diversification across a wider range of assets matters more. 

Chief Economist Rob Edel examines why the index and the average stock parted ways, what is pushing bond yields higher, and what a new Fed tightening cycle means for portfolio construction. Read the full commentary below. 

The index held steady while most stocks fell 

The S&P 500 ended September down 0.4%, less than 1% below the record it set in August. That resilience stands out given the backdrop: the Fed began raising rates, the 10-year Treasury yield reached its highest level since 2002, and the conflict with Iran kept energy prices high. 

Beneath the surface, the picture was far weaker. The equal-weighted S&P 500, which gives each company the same weight and is a better gauge of the average stock, fell 4.8% for the month. Only information technology and communication services advanced, helped by a 9.5% gain in the Philadelphia Semiconductor Index. Barron’s calculates that four companies (Nvidia, Micron, Apple, and Advanced Micro Devices) account for almost half of the S&P 500’s 12.7% total return so far this year. 

The third quarter told a similar story. The S&P 500 rose 2.3% (in USD) and the S&P/TSX Composite rose 1.6% (in CAD), but only four of 11 U.S. sectors gained. Energy led with a 16.5% advance, while rate-sensitive sectors lagged, with utilities down 13.0% and real estate down 6.3%. The equal-weighted S&P 500 fell 1.8% in the quarter, ending a five-quarter winning streak, and the small-company Russell 2000 fell 7.2%. 

A narrow market is not, on its own, a reliable warning sign. Research cited by Barron’s found that weak breadth alone has not been a dependable short-term bearish signal. It does, however, make index returns more dependent on the continued success of a few companies, and it can mask how a typical holding is performing, a risk to be taken seriously in portfolio construction. 

This chart shows how much of the S&P 500’s year-to-date return has come from its four largest contributors. When so few companies drive the result, the index can look healthier than the average stock, which is why broad diversification matters. 

Bond yields reached their highest levels in more than two decades 

The most consequential development of the month again took place in the bond market. The U.S. 10-year Treasury yield rose nearly 1.0 percentage points over the third quarter, its largest quarterly increase since 1994, and touched a 24-year high on the final day of September. It ended the quarter at 5.28%, with the two-year yield at 4.89%. 

Rising yields mean falling bond prices. The Bloomberg U.S. Aggregate Bond Index lost 3.5% in the quarter, and the iShares Core Canada Universe Bond Index lost 1.8%. The move was global. The average 10-year yield across G7 countries reached 4% for the first time since 2008, and the European Central Bank raised rates the week before the Fed. 

There is no single explanation for the selloff, and investors themselves are divided. In a Bloomberg survey conducted September 8 to 10, 40% of respondents named accelerating inflation as the biggest threat to Treasuries over the next six months, 38% pointed to fiscal concerns and a rising term premium (the extra return investors demand for holding longer-term bonds), and 16% cited heavy borrowing by large technology companies. 

One point is clearer. Most of the increase reflects higher real interest rates, meaning yields after adjusting for expected inflation, rather than rising inflation expectations themselves. Between late February and late August, the U.S. 10-year real yield rose 0.60 percentage points, while market-implied inflation expectations rose just 0.16 points. The same pattern held in every major market where the split can be measured. Long-term inflation expectations, in other words, remain reasonably well anchored.

Each bar splits the rise in 10-year government bond yields into the part explained by higher real rates and the part explained by higher inflation expectations. In every market shown, real rates did most of the work. That points to forces such as stronger demand for capital and a larger supply of long-term debt, rather than a loss of confidence in central banks’ ability to contain inflation. 

Growth, AI investment, and oil are pushing the cost of capital higher 

The U.S. economy is running hotter than many expected. The S&P Global flash composite purchasing managers’ index, a survey of business activity in which readings above 50 signal expansion, rose to 58.4 in September, it’s highest since July 2021. The Atlanta Fed’s real-time estimate of third-quarter growth stood at 5.1% annualized in mid-September. Second-quarter GDP growth was revised up to 2.2%, and inflation-adjusted consumer spending rose 0.6% in August, the most since March 2025. 

Strong growth naturally lifts yields. Alpine Macro estimates U.S. nominal GDP is growing at roughly 6.5%, well above the 10-year yield, and argues the bond market is simply returning to more normal levels after two decades of unusually low rates. On its estimate, the term premium has risen to around 1%, roughly where it sat in the 2000s. 

AI is also competing for capital. Fed Chair Kevin Warsh named borrowing for AI projects as one of three reasons for higher long-term yields, alongside the economy’s strength and geopolitics. The Institute of International Finance expects AI-linked corporate bond issuance to reach USD 541 billion this year, up from USD 90 billion three years earlier. Governments and technology companies are now drawing on the same pool of long-term savings, while some traditionally price-insensitive buyers of government bonds, such as central banks and defined-benefit pension plans, have stepped back. 

Oil adds a third layer. Research from the CBOE shows the relationship between oil prices and the 10-year Treasury yield is now the tightest since the first Gulf War in 1990. Brent crude rose 42% in the third quarter to $103.53 US a barrel, and U.S. consumer prices rose 3.4% from a year earlier in August. Underlying inflation is firmer than the Fed would like, but not alarmingly so: the Fed’s preferred core measure, which excludes food and energy, was 3.0% in August after revisions. For households, the squeeze is real, with inflation-adjusted average hourly earnings 0.3% lower than a year earlier. 

 The Fed began a new tightening cycle 

On September 16, the Federal Open Market Committee voted unanimously to raise its policy rate by a quarter of a percentage point, to a range of 3.75% to 4%. It was the first increase since 2023. The median projection of Fed officials points to one more increase by December and none in 2027. Chair Warsh said the committee had “removed a dose of accommodation,” language markets read as a signal that more increases may follow. 

Markets expect more than the Fed does. Federal funds futures imply three further quarter-point increases by the end of 2027, taking the policy rate to a range of 4.5% to 4.75%. The two-year Treasury yield, a useful guide to where short-term rates are heading, stood at 4.68% shortly after the meeting. Warsh does not provide forward guidance on future decisions, which leaves investors to price a wider range of outcomes. 

The immediate reaction was calm. The S&P 500 slipped 0.45% on the day of the decision, the technology-heavy Nasdaq 100 was flat, and the 10-year yield rose to 5.02%. This was not the disorderly selloff some had feared. By month-end, a softer-than-expected core inflation reading led traders to scale back bets on another hike in October, although they still expect one before year-end. 

We do not think the Fed is in a hurry. One or two more increases may come, but the current setting looks more like fine-tuning than a sustained tightening campaign. Fed officials have raised their estimate of the neutral rate, the level that neither stimulates nor restrains the economy, to 3.2%, the highest in a decade. If the neutral rate is higher, policy was less restrictive than it appeared, and a modest adjustment may be enough. A Bloomberg column draws a useful parallel with 1997, when the Fed under Alan Greenspan raised rates once in the middle of an expansion and then held. More than 80% of respondents in the Bloomberg survey cited earlier likewise saw a hike as part of a one- or two-step adjustment rather than the start of a longer series. 

The chart compares the Fed’s new policy rate with where Fed officials and futures markets expect it to be. Markets are pricing a higher path than the Fed’s own median projection. Which view proves right will depend largely on inflation and the price of oil, and it will shape borrowing costs for households, businesses, and governments. 

When do higher yields become a problem for stocks? 

Rising yields and rising stocks can coexist when both reflect a strong economy, as they did in 2016. The combination becomes harder when yields rise because the Fed is tightening to cool inflation. In 1994, a surprise Fed hike sent the S&P 500 down as much as 8% before it recovered, and in 2022 aggressive tightening contributed to a difficult year for both stocks and bonds. 

Valuations have already adjusted. The S&P 500’s forward price-to-earnings ratio has fallen from about 23.5 times to about 19.5 times as earnings estimates rose while prices stalled. That suggests some of the risk from higher rates is already reflected in prices. Even so, the forward earnings yield on U.S. stocks (expected earnings divided by price) was about 4.6% in mid-September, below the 4.85% then available on a 10-year Treasury. Investors are not currently being paid extra to own stocks rather than government bonds. 

Many investors are focused on specific thresholds. In the Bloomberg survey, about 30% of respondents said a 10-year yield of 5% to 5.25% would be enough to trigger a 10% stock market correction, while more than two-thirds said the speed of a rise in yields matters more than its level. We share that view. Bloomberg strategist Simon White adds an important caution: historically, when 10-year yields have moved much above 5.25%, stocks and bonds have almost always moved in the same direction. In that environment, bonds stop offsetting equity losses and can amplify them. 

History offers some reassurance. Société Générale finds that the S&P 500 has typically struggled for one to three months after the Fed restarts rate increases, then often reached new highs within six months. The notable exception was 2022, when the yield curve inverted, meaning short-term rates rose above long-term rates. That has not happened this time, and the gap between two-year and 10-year yields remains positive. 

Earnings remain strong, but their foundation deserves scrutiny 

Earnings continue to provide the strongest support for stocks. Analysts expect S&P 500 earnings to grow 29% from a year earlier in the third quarter, which would be a third consecutive quarter of growth around 25%. 

The sources of that growth deserve a closer look. Goldman Sachs estimates that roughly $800 billion US of data-center spending by the largest technology companies this year accounts for almost half of the expected growth in S&P 500 earnings. Much of that spending shows up immediately as revenue for chipmakers and equipment suppliers, while the cost to the companies doing the buying is spread over many years. Corporate profits have risen to a record 12.1% of U.S. GDP, even as inflation-adjusted wages have barely grown. 

The scale is unlike anything in recent history. New estimates published by the Brookings Institution put U.S. investment in data centers and related AI infrastructure at $10.3 trillion US from 2025 to 2032, or about 3.6% of GDP a year, with a growing share financed with debt. Investment booms tend to end when the supply of fresh capital dries up. There are early signs of caution.  OpenAI has ruled out a public listing this year and Anthropic has delayed its planned initial public offering from October to November, though both still appear able to raise money privately. That window has not closed. 

Credit markets are sending a mixed signal. A credit spread is the extra yield investors demand to lend to a company rather than the government. Spreads on the lowest-rated corporate bonds, rated CCC, rose above 10 percentage points at month-end from 8.6 points at the start of September, the widest since the regional banking stress of March 2023. Spreads on higher-quality corporate bonds have held relatively steady, however. The weakest borrowers are usually the first to feel higher rates, so this is an area we are watching closely. 

We continue to believe AI investment is real and is supporting growth, but we would like to see that spending show up in broad productivity gains and measurable returns, not only in rising profits for a select group of suppliers.

Oil supply is adapting, but the cushion is thin 

Oil markets have adapted to the conflict with Iran more than many expected. Goldman Sachs estimates that oil exports from the Persian Gulf, including so-called dark exports from tankers that disable their tracking systems, recovered to 23.3 million barrels a day in late September, in line with their 2025 pre-war average. Exports doubled during the month, led by Saudi Arabia, even after an attack disrupted a key Saudi pipeline that bypasses the Strait of Hormuz. 

Prices remain high nonetheless. Exports of refined products such as diesel, gasoline, and jet fuel are running at about half of 2025 levels because of damage to regional refineries, and U.S. diesel prices reached a record $6.23 US a gallon in mid-September. Chevron’s chief executive warned that the buffers that cushioned the market earlier in the conflict have largely been used up. China has helped by keeping its crude imports nearly 3 million barrels a day below seasonal norms, and Goldman expects them to remain low, for now. 

Goldman’s base case is for Brent to ease to about $85 US a barrel by year-end and $80 US in 2027, but it identifies further damage to energy infrastructure as the main upside risk. With buffers this thin, we expect oil to remain a source of volatility for both inflation and interest rates.

Government debt is a slow-burning risk, not today’s main driver 

U.S. gross federal debt has passed $40 trillion US, publicly held debt has reached 100% of GDP, and annual deficits are running at about 6% of GDP. Across the OECD, interest payments already consume more than 3% of GDP, and nearly 5% in the U.S. As older, low-rate debt matures and is refinanced at today’s yields, those costs will rise. 

The administration argues the U.S. can grow its way out of the problem, but the arithmetic is demanding. The Penn Wharton Budget Model estimates that average growth of 3.5% to 4% over a decade would be needed to stabilize the debt-to-GDP ratio, compared with the Congressional Budget Office’s baseline forecast of 1.8%. Even a Yale Budget Lab scenario of rapid AI adoption, with growth above 2%, still shows debt rising relative to the economy. 

The larger risk is what the Financial Times describes as a doom loop, in which rising interest costs worsen a government’s finances and prompt investors to demand still higher yields. The Economist estimates that the U.K., Italy, and France would need primary budget surpluses (surpluses before interest payments) of 1.2% to 1.5% of GDP just to keep debt stable if they had to refinance at current five-year yields. The U.S. would need 1.0%. France is already under pressure: the extra yield it pays over Germany has risen above one percentage point, the most since early 2012. 

In our view, the U.S. fiscal path is unsustainable, but debt is not the main reason yields have risen this year. U.S. Treasuries have performed better than Japanese, U.K., and German government bonds in 2026, which is hard to square with a U.S.-specific fiscal scare. Foreign investors have also continued to commit capital to the U.S., buying a record $942 billion US of U.S. equities and investment funds in the 12 months to July, although their appetite for U.S. debt has cooled. Countries such as France are being exposed by higher rates. We do not believe the U.S. or Canada is in that position, at least not yet.

Each bar shows the surplus, before interest costs, that a government would need to run just to stop its debt from growing faster than its economy if it had to borrow at today’s five-year rates. Japan can still run a small deficit because its growth is expected to exceed its borrowing costs. The chart helps explain why bond markets in the U.K. and France have come under more strain than others. 

Canada: contained inflation, softer momentum 

Canada’s inflation picture remains more benign than in the U.S. Consumer prices rose 3.0% from a year earlier in August, lifted by gasoline prices 22.8% higher than a year ago, but the Bank of Canada’s preferred median and trim core measures held at 2.0% and 1.9%, close to its 2% target. The Bank held its policy rate at 2.25% for a seventh consecutive meeting on September 2, while warning that the longer the conflict in the Middle East continues, the greater the risk that higher energy costs spread to other prices. 

Growth momentum softened. Employment fell by 41,700 in August, well short of the gain economists expected, and the unemployment rate held at 6.4%. That followed a strong second quarter, when the economy grew at a 3.3% annualized pace, and employment remained 217,000 higher than a year ago. Trade is still a risk. The U.S. imposed 50% tariffs on about $20 billion US of Canadian goods in late August, and Canadian counter-tariffs were scheduled to take effect September 8. Governor Tiff Macklem noted the tariffs are steep but apply to a relatively narrow base, about 5% of Canada’s exports to the U.S. 

Canadian bonds were not immune to the global selloff. The 10-year Government of Canada yield rose 0.52 percentage points in the quarter to 3.99%, still well below comparable U.S. yields. With core inflation near target and growth uncertain, we believe the Bank of Canada has more room to be patient than the Fed, even though markets in mid-September were pricing a meaningful chance of a hike at its October meeting.  Given how much Canadian households owe relative to their incomes, we expect the Bank of to be extra cautious in raising rates, to the detriment of the Canadian dollar, which fell more than 2% last quarter.    

What this means for long-term investors 

Markets are at a crossroads. One path leads to a stable balance in which AI investment and productivity gains continue to support growth and earnings while the Fed makes modest adjustments. The other leads to an economy weighed down by higher borrowing costs as the Fed works to bring inflation back to its 2% target. We think the first path is more likely, but the second deserves respect. 

Our view is that the recent rise in rates reflects stronger economic growth and the prospect of some fine-tuning by the Fed, rather than a sustained hiking cycle. If growth slows and the Fed pauses, or even cuts, yields would likely fall. Longer term, governments will need greater fiscal discipline to put their debts on a more sustainable path.  In the meantime, higher yields mean high-quality bonds offer more income than they have in many years. 

September also reinforced two principles. First, when a handful of companies drive index returns, the cost of being wrong about those companies rises, which is why we favour diversification across companies, sectors, and regions. Second, when stocks and bonds move in the same direction, bonds alone cannot be relied on to cushion equity declines. Diversification across a broader range of asset classes, beyond traditional stocks and bonds, helps portfolios remain resilient across more outcomes. 

Headlines about yields, oil, and the Fed will continue to shift. A disciplined, well-diversified portfolio built for a range of outcomes remains the most dependable way to pursue long-term goals through them.