Shifting tone as markets enter fourth quarter

Possibly the most attractive fixed-income opportunity in over two decades

As the leaves begin to turn and the puck drops on a new NHL season, autumn comes with a quiet reminder that colder days lie ahead. Markets have delivered exceptional returns through the first three quarters, yet the tone has shifted noticeably as we enter the fourth.

Alongside shorter days and cooler temperatures, a degree of risk aversion has begun to surface, with higher rates, firmer oil prices, and emerging caution in credit supporting a more selective approach. While the fundamental backdrop has not necessarily changed, markets now sit in a delicate balance as we await the full return of earnings season.

Last month, we wrote about our expectation of a choppy consolidation during a seasonally weak September, and the month lived up to that call. Following the Federal Reserve’s unanimous 25-basis-point rate hike on September 16, the U.S. 10-year Treasury yield has surged by more than 50 basis points as bond markets price in an additional 75 basis points of tightening over the coming year. WTI oil spiked $15/barrel mid-month to $105 before settling back to $90, essentially flat for September. Despite these crosscurrents and associated volatility, global equities proved resilient: The S&P 500 lost just 0.45%, the MSCI World Index dropped 1.3%, and the S&P/TSX fell 2.9%. Year-to-date, all three indices remain up between 12% and 13%.

The equity market was underpinned by robust earnings, and the U.S. economy remains on solid footing with a low, stable unemployment rate and healthy consumer spending supported by wealth creation. While higher rates are generally a headwind for risk assets, we expect a more measured rate cycle than we saw in 2022.

We do not anticipate a stagflationary scenario: Economic growth is healthy and some of the factors behind more entrenched inflation, especially higher oil prices, look more transient than structural. Inflationary pressure should abate as the Middle East stabilizes and oil again flows through pipelines and the Strait of Hormuz.

The shadow of the U.S. midterm election

Over the longer term, AI-driven productivity gains are also expected to be disinflationary. We acknowledge that newsflow heading into the U.S. midterm election on November 3 could bring more whipsaw across sectors, but the election’s conclusion should itself act as a catalyst once that uncertainty is resolved.

The latest poll forecasts a gridlock in the House and the Senate, which is bullish for the market. Reinforcing our constructive outlook for equities through year-end and 2027, the chart below illustrates that the S&P 500 has gained after every midterm election since 1950, averaging a 15% return over the subsequent 12 months.

That said, with US 10-year Treasury yields reaching 5.3%, we believe fixed income presents its most attractive opportunity in over two decades. As illustrated in the chart below, the U.S. 10-year Treasury yield decoupled from equity earnings yields and drifted toward historic lows following the dot-com crash of the early 2000s, sustained by prolonged monetary accommodation. That trend reversed sharply post-Covid as central banks raised policy rates to curb entrenched inflation, bringing bond yields back into parity with equity earnings yields.

Against a backdrop of diverging global economies, an actively managed global fixed income strategy is uniquely positioned to capture mispriced sovereign debt and high-quality credit opportunities across jurisdictions.

Ultimately, a balanced allocation across equities and fixed income provides investors with attractive risk-adjusted returns alongside reliable liquidity.

Equity performance diverged noticeably in the third quarter. Information Technology (+7%) and Communication Services (+3.5%) posted standout returns, fueled by momentum in artificial intelligence, while Healthcare delivered a solid 6% advance. As AI begins to meaningfully accelerate drug discovery, we believe Healthcare offers compelling value, with strong secular tailwinds that have yet to be fully priced in by the market.

Canada’s moves to boost economy

In conjunction with the Canada Investment Summit held in September, the Canadian government under Prime Minister Mark Carney rolled out several major economic initiatives and structural reforms designed to catalyze over $1 trillion in new business investment.

The government introduced a permanent Productivity Mega Deduction tax incentive, allowing businesses to immediately deduct 100% of the cost of a broad range of capital investments. The federal government will also seek private investment through long-term concessions to operate Canada’s four largest airports: Toronto Pearson, Vancouver, Montréal-Trudeau, and Calgary.

To accelerate economic capacity, the government introduced major regulatory reforms, including Bill C-39, the Building Canada Strong Act, aimed at bringing greater speed, certainty, and predictability to infrastructure project reviews and supporting the workers who will build them. We believe these initiatives should provide a meaningful tailwind for the Canadian economy and equity market.

Dean Orrico is President and Chief Executive Officer of Middlefield Ltd.

Robert Lauzon is Chief Investment Officer of Middlefield Ltd.

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