“The impediment to action advances action. What stands in the way becomes the way.”Marcus Aurelius
September did what Septembers tend to do, though not entirely in the way we expected. The S&P 500, the index of America’s 500 largest companies, slipped just 0.45 percent, a figure that hides how much happened beneath it. The Dow fell 4.29 percent, its worst month since March. The Russell 2000, which tracks smaller companies, lost 5.40 percent, its steepest monthly drop since March 2025. And the equal-weight S&P 500, which gives every company the same say rather than letting the giants dominate, fell 5.2 percent, trailing the headline index by roughly 470 basis points, or 4.7 percent; a basis point is simply one hundredth of a percent. In plain terms, the average stock had a far harder month than the headline number suggests. Only the Nasdaq, carried by technology, finished higher, up 1.86 percent. The story of the month was the bond market. The yield on the 10-year Treasury, the rate the government pays to borrow for ten years and the benchmark for mortgages and loans across the economy, rose 55 basis points to 5.30 percent, its highest level since 2002, and the Federal Reserve raised rates for the first time in more than three years. Below, where we were wrong, what we believe the market is overlooking, and why the earnings case behind our outlook is, if anything, stronger than it was a month ago.
From the Desk.
First, an admission. Last month we wrote that we expected the Federal Reserve’s rate-setting committee to hold rates steady in September. We were wrong. It is worth pausing on why that matters so much. The Fed sets the short-term interest rate that ripples through nearly every other rate in the economy, from mortgages and car loans to what businesses pay to borrow. Raise it, and borrowing becomes more expensive and the economy cools; lower it, and the opposite happens. Think of it as the economy’s thermostat. On September 16, the Fed turned that thermostat down a notch, raising its target range by a quarter point to 3.75 to 4.00 percent in a unanimous vote. Fed Chair Kevin Warsh called the move “removing a dose of accommodation,” Fed language for easing off the gas pedal, and said he would be hard-pressed to call conditions restrictive, meaning he does not yet see rates as high enough to slow the economy.
Where we would push back is on what the market has chosen to overlook. At his first meeting as chair in June, Warsh set up five task forces to study how the Fed communicates, its balance sheet, the economic data it relies on, how new technology such as AI is changing productivity and jobs, and how it approaches inflation, with most, if not all, expected to finish by year-end. He pointed to year-end again in September. Markets have spent the month hanging on every word from each meeting while paying almost no attention to a review that could reshape how this Fed thinks about all of it. The productivity work matters most to us. Unit labor costs, what businesses pay in wages to produce each unit of output, rose just 1.4 percent over the past year, a sign that workers are getting more done and that a strong economy does not have to mean runaway inflation. We believe the clearest read on the path of rates arrives with those findings at the end of the year. Until then, and especially after this morning’s soft jobs report, we are not convinced more hikes are coming. One more is possible, but we lean toward a hold, and we expect the Fed to hold at its next meeting. As we noted last month, small hikes have often coincided with economic expansions rather than ending them.
The bond market carried the month, and several pressures stacked on one another: weak demand at government bond auctions, renewed worry about federal borrowing, a Treasury program to buy back older bonds that underwhelmed, firmer prices at the producer level, and above all, energy. With the conflict with Iran in its seventh month, oil held above $100 a barrel and diesel above $6 a gallon. It is hard to overstate how much those two prices matter. Nearly everything we buy either rides on a truck, train, ship, or plane that burns diesel or jet fuel to reach us, or is made from oil itself, in plastics, fertilizer, packaging, and countless other materials. When oil and diesel rise, the cost of almost everything rises with them, and that is exactly the kind of inflation the Fed is charged with watching. Then came the hike. The parts of the market most sensitive to interest rates fell hardest: financials dropped 7.28 percent, materials 6.93 percent, real estate 6.70 percent, utilities 6.14 percent, and consumer discretionary 5.91 percent.
Financials, the month’s weakest sector, deserve a closer look, because the large banks kick off third-quarter earnings season in mid-October and face two headwinds at once. The first is the shape of the yield curve. Rates rose across the board in September, but short-term rates kept pace with or outran long-term ones, so the gap between them narrowed, what the bond market calls a bearish flattening, and the Fed’s hike only added to it. That matters because banks have long made easy money on the spread between what they pay on deposits and what they earn by lending those funds out or buying higher-yielding Treasuries. When that gap narrows, so does the profit. The second headwind is newer. Personal AI agents, such as Meta’s Muse and OpenAI’s newly launched Dots, promise to manage everyday tasks in the background, and economists are already warning that agents built to chase the best return on idle cash could pull low-cost deposits away from banks, taking away more of that easy spread. We expect both forces to color how investors hear the banks’ results this month.
Two pieces of perspective are worth holding onto. First, much of this rise in rates reflects an economy running hotter than expected, not one breaking down. August hiring and retail sales both came in well above forecasts, consumers posted their strongest month of inflation-adjusted spending since March 2025, the September purchasing managers’ surveys, which ask businesses each month whether activity is growing or shrinking, reached their strongest reading since July 2021, and the Atlanta Fed’s running estimate of economic growth has tracked the third quarter at roughly 3.7 to 5 percent. Higher yields driven by stronger growth are a very different animal from higher yields driven by fear. Second, a 5.30 percent 10-year looks high only against two decades of unusually low rates. Through the 1990s, the 10-year averaged about 6.7 percent, well above today’s level, and the S&P 500 still more than quadrupled over the decade. Higher rates are designed to make the climb for equities steeper by making borrowing costs higher and providing a more appealing alternative for capital. They did not cause an equity crash then, and we do not believe they will now.
That growth is showing up where it matters most, in earnings, and it is worth stating plainly why we keep returning to them: earnings growth is one of the highest correlators with stock market growth. Over time, when companies earn more, their stock prices follow. Ed Yardeni’s figures show that what analysts expect S&P 500 companies to earn over the next year has risen roughly 28 percent this year, while the price investors pay for each dollar of those earnings has fallen about 12 percent. Put another way, profits have grown faster than prices, so the market is cheaper today relative to its earnings than it was in January. Third-quarter earnings are expected to grow nearly 30 percent, which would be the third straight quarter above 25 percent and the eighth straight quarter of double-digit growth. Technology, up 4.42 percent, and communication services, up 4.26 percent, were the only two sectors to finish September higher, and the semiconductor index gained 9.5 percent despite a mid-month scare when several leading AI developers called for a slower pace at the frontier. Chipmakers’ earnings are expected to grow about 113 percent this year and 73.5 percent next, yet investors pay about $16.50 for each dollar of their expected earnings, less than the roughly $19.20 they pay for the market as a whole. Those are not bubble valuations.
No single report made the case better than Micron’s. Last month we noted, with some amusement, that the memory-chip maker traded as the third cheapest stock in the S&P 500. On September 30 it reported record quarterly revenue of $54.2 billion, nearly five times what it brought in a year earlier and well ahead of the $50.8 billion analysts expected, while keeping about 87 cents of every sales dollar after the cost of making its chips. It then guided the current quarter to $61.5 billion, against roughly $57 billion expected. More telling than the numbers was the confidence behind them. Management said more than 75 percent of its production for the coming fiscal year is already spoken for, and that it expects memory supplies to grow even tighter in 2027 and 2028. Management also made a point of signaling larger share buybacks ahead, with its chief financial officer saying that over time the company expects to return 100 percent of its excess cash to shareholders, a way of handing record profits back to its owners and a bullish signal in its own right. That is not the language of a business at its peak. The stock barely moved on the news, a sign of how much skepticism is still priced into the AI buildout, not of a trend running out of road.
On the Radar.
Zoom out and the setup into November looks much as we described it last month. We expected choppy markets into early October in a midterm election year, and September delivered. We still see the potential for a sell-off in the weeks before the November 3 elections, with rates elevated, the Fed in motion, and a market leaning on a narrow group of leaders. As the election approaches and through the end of the year, however, we remain bullish, and that remains our case unless unforeseen factors come into play. History rewards that patience: since 1950, the S&P 500 has posted a gain in the twelve months following every one of the nineteen midterm elections. Should weakness arrive before the vote, we would view it as an opening rather than an omen.
Between now and the next issue, third-quarter earnings season begins in earnest, led by the large banks in mid-October, and we expect it to confirm the strength described above. The Federal Open Market Committee, the group of Fed officials who vote on interest rates, meets October 27 and 28, and we expect it to hold rates steady. It meets again December 8 and 9, right in the window when Warsh’s task forces are expected to report. This morning’s September jobs report supports our lean: employers added just 29,000 jobs, August was revised lower, and wage growth slowed to 3.0 percent over the past year, all of which takes pressure off the case for more hikes. Beyond that, we are watching oil and diesel for the reasons above, whether the Treasury steps up its support for the bond market, and, of course, the midterms themselves.
On a personal note, the mock Ironman 70.3 on Bald Head Island over Labor Day weekend went to plan. I finished just fine, though the heat made it a long, punishing day. The Cape Fear Marathon brings me back to Bald Head on October 18, the last major tune-up before the Panama City Ironman in November, and, as in markets, the race will be decided in the back half, where patience matters most.
Yours in confidence,
John Bennett Woodard IIIInvestment Advisor Representative
Always Buy Quality and Diversify®