September was a challenging month for markets. Even as stocks have otherwise been strong this year, the Fed rate hike and rising borrowing costs weighed on investor sentiment. Meanwhile, bonds faced renewed pressure as interest rates moved sharply higher amid resilient economic activity and persistent inflation concerns.
Against that backdrop, two themes stood out in September. Long-term interest rates continued to rise as investors weighed strong growth, heavy borrowing, and uncertainty around the Federal Reserve’s path. At the same time, equity market gains remained unusually concentrated, with a small group of technology and semiconductor companies driving much of the strength. That narrow leadership was evident in market breadth: only 23% of stocks outperformed the market-cap-weighted S&P 500.
Monthly Market Recap
Fixed Income Markets
Rising Treasury yields and uncertainty around the Federal Reserve’s policy path stressed fixed-income markets. Fiscal and government-borrowing concerns also added upward pressure to longer-term yields, while geopolitical and policy uncertainty weighed on overall sentiment.
- U.S. taxable bonds retreated 2.6%, as hotter-than-expected inflation data prompted the Federal Reserve to raise rates for the first time in three years. The 10-year Treasury reached its highest level since 2002.
- Tax-exempt bonds fell by 5%, significantly more than the decline in taxable bonds, as record new issuance of municipal bonds coincided with investor outflows. With more bonds to absorb and fewer buyers, 30-year municipal yields climbed above 5%, the highest since at least 2011.
- High-yield bonds declined approximately 2.5% as rising Treasury yields increased the return investors demanded for credit risk, just as issuers brought the busiest month of new deals this year.
- International bonds also declined 2.2%, as higher energy prices and central-bank tightening pushed yields higher across major developed markets. Japan’s 10-year yield reached its highest level since 1996, while German yields hit their highest since 2011.
Equity Markets
Global equity markets declined in September but remained up double digits year to date. Higher oil prices and rising interest rates created pressure late in the month, while performance continued to vary widely across market segments.
- U.S. large-cap equities slipped 0.4%, as gains in the largest technology companies offset losses across much of the market. AI enthusiasm sparked a rally in semiconductor stocks early in the month.
- U.S. mid-cap equities declined approximately 4.2% and small-cap equities fell 5.6%, reflecting their greater exposure to rate-sensitive areas such as financials, particularly regional banks, real estate, and industrials, and their smaller allocation to the technology companies that supported large-cap returns.
- International equities fell approximately 2.4%, led by European stocks, which posted their first monthly decline in six months, as inflation risks from the Middle East conflict pushed bond yields higher.
- Emerging-market equities declined by 0.6% as higher prices weighed on energy-importing countries, which offset strength in Asian semiconductor companies.
The Long End Is Rising: What Is Driving Yields Beyond the Fed?
There is an important difference between how short- and long-term interest rates are set: the Federal Reserve directly sets the overnight rate that banks use for very short-term lending, which has a strong influence on other short-term rates, while medium- and long-term Treasury rates, including 10- and 30-year bonds, are set by investors based on the return they believe they need for lending over a longer period, largely reflecting expectations for inflation, economic growth, and future Fed plans.
That distinction became particularly important in September. The 10-year Treasury yield reached 5.3%, its highest level since 2002, while the 30-year yield rose above 5.6% for the first time since 2004.
Most of September’s increase did not come from a sharp rise in long-term inflation expectations. The 10-year Treasury yield rose about 0.52 percentage points during the month, while long-term inflation expectations rose only about 0.05 percentage points. The larger increase came from real yields, or the return investors require above expected inflation.
That is consistent with resilient economic data. Hiring data remained strong, retail sales exceeded expectations, and business activity reached 5-year highs. At the same time, real yields may also reflect policy expectations, the additional return investors demand for holding longer-term debt, and Treasury supply coming to market.
We believe that three forces can help explain why.
- Heavy Bond Issuance: The Congressional Budget Office expects the federal deficit to reach approximately $2.1 trillion this fiscal year, higher than previous estimates. Companies are also issuing substantial amounts of debt, including to finance AI infrastructure. As higher interest costs add to borrowing needs, investors may demand greater compensation to absorb the additional supply.
- Strong Economic Growth and Persistent Inflation: A resilient economy and above-average inflation put pressure on the Fed to keep rates high. At the same time, bond yields are rising overseas. Japan’s 10-year yield is at its highest level since 1996, while yields in the United Kingdom and Germany are at multi-year highs. Because bond yields are set in a global market, higher yields abroad can require U.S. Treasuries to offer more attractive returns.
- Federal Reserve Policy Uncertainty: Ongoing global supply chain disruptions and persistent price pressures have made the Fed’s path harder to predict. That uncertainty affects bond markets because investors must account for the possibility that short-term rates stay higher for longer
We expect pressure on rates to continue if borrowing remains high and demand for new bonds stays soft. However, longer-term yields could reverse course if economic growth slows or inflation becomes less stubborn.
That range of outcomes is why Sage combines shorter-duration strategies with high-quality intermediate-duration bonds. Shorter maturities generally experience smaller price declines when rates rise and return principal more quickly for reinvestment at higher yields.
We also continue to like intermediate-duration bonds, which can provide diversification and potential appreciation if growth stalls and yields decline. The Bloomberg U.S. Aggregate Bond Index has a current yield-to-worst of 5.6%, a measure that historically has been a strong predictor of future returns.
Technology Supports Equity Returns for Now
Equity indexes have delivered strong returns this year, but a narrow group of technology companies, semiconductors above all, has accounted for a significant share of those gains. So far, the benefits of the AI buildout have flowed mainly to the companies supplying it: chipmakers, large cloud providers, data-center operators, and their suppliers. The average stock has not kept pace:
- U.S. Equities: Micron, AMD, Nvidia, and other semiconductor companies have had an outsized influence on large-cap index returns even as the typical stock has lagged. Just 10 companies account for roughly 62.2% of the S&P 500’s year-to-date gain.
- International Equities: As of September, just three prominent companies (Samsung Electronics, SK Hynix, and TSMC) made up roughly 30% of the broad emerging-markets index and 68% of year-to-date returns, which means the index’s return has largely been the return of three semiconductor companies.
September offered a hint that the mix of winners may be changing, even if leadership remains narrow. For example, Meta and Microsoft performed well as customers began rapidly adopting their new AI products, suggesting investors are beginning to reward companies for putting AI to use, not only for building the infrastructure behind it.
If that continues, the next phase of the AI cycle may depend increasingly on which companies use the technology effectively. In our view, the biggest beneficiaries will be companies with large, labor-intensive operations, though not every application will pay for itself.
Recent years have been a notably strong period for stocks, and Sage portfolios have participated through their equity exposure. In months like September, however, when a narrow group of very large companies drives market returns, diversified portfolios may not keep pace with the headline index.
That is a tradeoff we accept in building portfolios for a range of outcomes rather than a single source of return. Ultimately, we measure success by how well a portfolio supports your financial goals over time, not by whether it keeps pace with the strongest part of the market in any one month.
Closing Thoughts
As we enter the final three months of the year, three questions remain at the forefront:
Will higher long-term interest rates begin to slow the economy? Bond issuance and the possibility of further Federal Reserve increases could keep rates elevated. At some point, however, higher financing costs could weigh more meaningfully on growth.
Can today’s narrow equity leadership continue? AI-related earnings have been strong enough so far to offset pressure from higher rates. Investors will be watching whether those companies can continue delivering earnings growth and whether the benefits of AI begin to spread more broadly.
How will energy prices and geopolitical risks evolve? September showed how quickly oil markets and interest-rate expectations can respond to events in the Middle East. Further disruptions could affect inflation, growth, and financial markets at the same time.
None of these questions has a clear answer. A multi-asset class portfolio is designed for this reason, with each component responding differently as conditions change. We believe that Sage’s portfolio approach remains especially relevant amid these ongoing economic and policy uncertainties.
Previous Posts
- Sage Insights: Higher Rates Meet Broadening Productivity
- Sage Insights: Higher Rates and a More Selective Equity Market
- Sage Insights: Mid-Year Review
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