The third quarter of 2026 saw a sharp divergence between large-cap technology shares and the broader equity market. Energy prices reversed course again as the conflict with Iran persisted and supply and logistics through the Middle East remained disrupted. Brent crude rose roughly 42% during the quarter. At the same time, the 10-year U.S. Treasury yield climbed nearly 90 basis points to 5.29%, its highest quarter-end level in more than two decades. Despite those headwinds, continued investment in artificial intelligence infrastructure and strong earnings from major technology companies kept the headline equity indices near record levels.
Economic data remained resilient, although the labor market softened late in the quarter. Second-quarter real Gross Domestic Product was revised higher to an annualized rate of 2.2%, up from the prior 1.5% estimate, while first-quarter growth was revised to 2.5%. Consumer spending and business investment remained supportive, with real final sales to private domestic purchasers rising 4.6%. September payrolls increased by only 29,000, and the unemployment rate was 4.2%, while job gains for July and August were revised lower by a combined 60,000.
Inflation remained the main complication. The Consumer Price Index (CPI) rose 3.4% over the twelve months through August, while core CPI increased 2.4%. The Federal Reserve’s preferred Personal Consumption Expenditures (PCE) index also rose 3.4%, with core PCE at 3.0%. In response to persistent inflation and resilient economic activity, the FOMC raised the federal funds rate by 0.25% in September to 3.75%–4.00%. Policymakers also increased their projected year-end policy rate to 4.1% and their 2026 inflation forecast, reinforcing expectations that monetary policy will remain elevated.
Equity-market performance became increasingly narrow during the quarter. Large-cap technology and semiconductor companies continued to benefit from strong AI-related investment, while higher interest rates and energy costs weighed on a much broader group of companies. Small-cap stocks were particularly pressured because they are generally more sensitive to financing costs and domestic economic conditions. Market breadth weakened sharply in September even as the S&P 500® remained close to its highs, reversing the broadening trend in prior months.
For the third quarter, the S&P 500® posted a total return of approximately 2.30%, while the Russell 2000® declined 7.22% and the S&P SmallCap 600® fell 7.92%. The quarter therefore reversed a meaningful portion of the small-cap outperformance seen in the second quarter, as the combination of higher long-term interest rates, renewed inflation concerns, and a narrower AI-led market favored larger companies. In this environment, the portfolio declined less than the small cap benchmarks.
Our top three contributors to performance for the quarter were as follows:
IMAX (IMAX) led portfolio performance, benefiting from record box office results, growing international demand, and continued expansion of its global theater network. Christopher Nolan's The Odyssey became the highest-grossing IMAX release ever, while local-language films in China, Japan, and South Korea further supported results. We remain bullish as consumer demand for premium theatrical experiences looks to continue and a strong slate of movies into next year bodes well for future results.
Haemonetics Corp. (HAE), a medical device company focused on automated blood processing systems, also led performance as operating performance has been above expectations. Growth was helped by strong demand in its plasma collection and blood management businesses, while other parts of the company also showed signs of improvement. In the most recent results, management raised its expected revenue growth range, which increased investor confidence that business trends were strengthening. Positive clinical results for one of its vascular closure products and a supply agreement with a global plasma collection company also helped support the stock during the quarter.
Zeta Global (ZETA), an AI marketing software company, rounded out our top performers. The company continued its multi-year trend of beating estimates and raised its financial outlook. Management is delivering market leading results for their customers with their proprietary data and artificial intelligence tools. Solid execution, raised guidance and validation of the ROI for their customers look to continue to drive solid results for the foreseeable future, in our opinion.
The largest negative contributors were as follows:
Power Integrations (POWI), an analog semiconductor device manufacturer, was a lagging performer during the quarter after being among our leaders through the first two quarters. Although second-quarter results were ahead of analyst expectations, demand for major appliances remained soft, and the company’s third-quarter revenue outlook called for only modest growth. Investors have tempered expectations as potentially significant opportunities in areas such as AI data centers and next-generation power technology have yet to contribute meaningfully to revenue. We remain bullish given its product-focused CEO and continued investment in next-generation technologies that could support stronger growth over time.
Sterling Infrastructure (STRL), a large civil and commercial construction company, declined following substantial gains earlier in the year. The company’s most recent results and guidance were strong and above analyst estimates, yet elevated investor expectations and valuation likely contributed to profit-taking. Importantly, subsequent to quarter end, management has reiterated that demand for Sterling’s data center and other large infrastructure projects continues to remain strong.
Tecnoglass Holdings (TGLS), a leading producer of high-end aluminum and vinyl window and architectural glass, rounded out our lagging performers for the period. Though management reported results ahead of expectations, they lowered the full-year profit outlook. Higher costs from tariffs, transportation, aluminum, and a stronger Colombian peso led the company to this reset of expectations. Importantly, commercial revenues were healthy while they have been gaining share in the single-family residential market, though within a challenging macro environment.
During the quarter, portfolio turnover was higher than usual. We exited Hillman Solutions (HLMN),
Brightview Holdings (BV), Crane NXT (CXT), Franklin Electric (FELE), and Calix (CALX). Further, we
trimmed our positions in IMAX, ZETA, SentinelOne (S), UMH Properties (UMH), and Itron (ITRI).
We deployed some of these proceeds to Cellebrite (CLBT), Adeia (ADEA), and AeroVironment (AVAV). Further, we initiated positions in several sector-specific, small-cap ETFs. They were in the financials, consumer discretionary, energy, industrials, staples, and technology sectors. We outline this strategy further in our outlook below.
The portfolio enters the final months of the year overweight Healthcare, Technology, Materials,
Industrials, and Utilities. We are underweight Financials, Real Estate, Energy, Consumer Staples and
Consumer Discretionary and are equal to our benchmark in Communication Services..
As we enter the final months of the year, our economic outlook remains roughly the same. Corporate investment in AI infrastructure remains a continuing driver of domestic growth. This massive domestic investment, as highlighted by the Wall Street Journal, is on track to be greater than previous investment cycles, including railroads, highways, and the more recent telecom and fiber boom. This is driving growth across numerous domestic industries, broadly supporting employment, and boosting corporate profits. All of which translates to consistent GDP growth.
This solid demand is leading to upward pricing pressure on both goods and services, thus
contributing to inflationary measures consistently above the Fed’s target of 2%. Further, the war
with Iran and refining disruptions have led to dramatically higher fuel costs, particularly diesel,
increasing costs for businesses and consumers, adding another inflationary component to the mix. Together, these pressures have reinforced expectations that monetary policy will remain restrictive, with the possibility of additional rate increases extending into 2027.
While this is driving short-term rates higher, stronger economic growth and corporate bond issuance to fund the massive investment cycle competing with Treasury issuance is contributing to higher rates further out on the maturity curve. Additionally debated is the degree to which fiscal policy concerns are leading to higher rates at the far end of maturities. The result of all has been a dramatic shift of higher rates across the maturity spectrum.
For the small cap asset class, higher rates have generally led to underperformance relative to large
caps, which did occur during the quarter, yet we remain cautiously constructive. Aside from concerns around rates, GDP growth and indicators like the ISM manufacturing and services indices, which are in expansion territory, are supportive of forward returns. Additionally, healthy employment levels are generally a positive indicator, while valuations are attractive relative to large caps. Though investors may concentrate back towards the largest companies for safety in bouts of volatility, economic indicators seem to support our constructive view.
At the portfolio level, we are actively monitoring our exposures to a number of cross currents,
including the AI investment cycle, interest rates, credit availability, and commodity costs. We remain focused on quality, cash flow, solid balance sheets, and future sales and profit growth. Some of the companies we exited reflect a rebalancing around these factors.
As indicated above, we have initiated several positions in S&P 600 benchmarked sector-specific ETFs. We initially began this strategy specifically focused on the pharmaceutical/biotech space early this year. In prior commentaries, we have noted market dynamics within the small-cap space over the past several years where returns have often been driven by narrow groups of stocks, rapidly shifting between industries, themes, and factors. Our team evaluated the likely continuation of these dynamics and determined that allocating a portion of our portfolio to these sector ETFs would allow us to balance a “core-satellite” structure which combines broad diversified exposure with concentrated active positions. Consistent with our long-term strategy, we believe we will be able to more specifically allocate our active risk exposure to high-conviction holdings while also maintaining broader market participation to moderate our risk profile relative to the benchmark.
In our prior commentary, we had indicated our opinion that performance of some holdings did not
match results or guidance. Performance for some of these companies came through in the third
quarter, which validated our investment thesis. For our individual holdings, we concentrated further
on companies we believe are of high quality with solid balance sheets, niche products and services,
and good management teams. Our ETF holdings seek to balance this concentration with diversified,
sector, factor, and thematic exposure.
In totality, the portfolio continues to emphasize quality with a tilt towards growth over value. Our
broad sector holdings and a couple of specific company exits have diversified our interest rate
sensitivity to be more neutral while also improving our momentum and thematic exposures.
Our team is available to discuss the portfolio and our outlook in more detail at your request.
Thank you.
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