US markets were up double digits during the second quarter reversing the Q1 losses and then some. The rally was fueled by mispositioning, a deescalation in the Middle East and one of the strongest earnings seasons on record. By the middle of April, the S&P 500 had reversed all of the Iran induced weakness hitting new all-time highs daily. While the gains were broad-based, tech reasserted its leadership position. However, the rally overshot heading into June with many chip and memory stocks doubling or tripling during the quarter.

During the third quarter, markets navigated a complicated backdrop defined by three interconnected themes: geopolitics, monetary policy, and artificial intelligence. The Iran ceasefire quickly unraveled, and the Red Sea became a new chokepoint. Throughout the quarter markets repeatedly oscillated between fears of escalation and hopes for a diplomatic breakthrough, neither of which came to fruition. The US launched Operation Economic Outcast to isolate the Iranian economy and the situation currently seems to be at a stalemate, though the US moved additional military resources into the region last week.

Energy prices moved sharply higher during the quarter, which also put pressure on global yields, adding to an already difficult backdrop for the Federal Reserve. With oil prices rising, economic activity showing signs of acceleration, labor market resilience and inflation remaining stubbornly above the Federal Reserve’s target, Fed Chair Warsh delivered a hawkish speech in Jackson Hole at the end of August. He concluded by saying, “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.” The Committee made good on that promise in September hiking rates for the first time since 2023. However, this did not thwart the rise in yields which were up >50bps into the end of the quarter. At this point markets are pricing in at least one additional hike this year and further tightening in 2027. The move higher in yields comes from a mix of hot inflation, better than expected economic growth, concerns around fiscal deficits and as markets digest the increasing supply of AI-related debt.

Artificial intelligence remained the dominant secular market story, though leadership shifted violently during the quarter. After the aforementioned parabolic move in June, chips, memory, infrastructure and neoclouds pulled back sharply through July. The selloff ended in a climactic fashion at the end of the month with the partial liquidation of hedge fund, Situational Awareness, which was run by a former OpenAI researcher and was reportedly up >400% at the end of June before the reversal.

Tech once again led to the upside throughout the quarter. Agentic AI burst onto the scene in September adding to the AI related optimism. Software also reversed much of its YTD losses as earnings continued to beat street expectations, dispelling some of the disruption narrative while cybersecurity stocks continued to outperform. However, as oil prices and yields moved higher throughout the back half of the quarter breadth began to deteriorate. While the S&P 500 continued to hover around all-time highs the equal weight version of the index ended the quarter amidst a seven-week losing streak.

Inside the Numbers - Data compliments of FactSet Earnings Insight as of October 9, 2026

Q2 2026 Final Review

Q3 2026 EPS Estimate: +29.5% YoY

Q3 2026 Revenue Estimate: +12.3% YoY

Guidance

Valuation

CY 2026: EPS growth estimate +24.2%, revenue growth estimate ~11%

The question entering Q2 earnings season was whether corporate America could sustain momentum after repeatedly defying gravity. The numbers once again were impressive though equities struggled to make any headway given the evolving macro backdrop. Heading into the Q3 reporting season, the question has shifted again. The fundamental setup remains stronger than at any point during this earnings cycle. All eleven sectors are expected to grow both revenues and earnings. The momentum is expected to continue but investors will be on the lookout for early signs that macro headwinds are starting to slow that. From a market perspective, like the economy, it depends on which side of the K that you’re on.

The earnings bar for companies exposed to the AI capex boom remains very high as investors have gotten used to beat and raise quarters. After the early Q2 surge most of the stocks that fall into this basket have spent the last 4-5 months consolidating. According to FactSet >65% of companies in the S&P 500 cited AI on their Q2 earnings call. Investors are looking for evidence that the AI adoption cycle is moving from experimentation into deployment with real quantifiable examples. There have been no signs that demand is slowing and if there are signs of broader adoption this could help to kickstart the next move higher.

However, there is no shortage of bricks in the wall of worry. During the quarter political headwinds have emerged. Multiple states have announced data center moratoriums, and this has now become hot button issue heading into Midterms. Investors are also concerned that there has been a pull forward of demand given supply chain bottleneck and pricing concerns, just as more capacity is expected to come online in the coming years. Financing has also gotten more challenging (see CDS below) and expensive and the timeline for frontier model IPO’s have been pushed out. This backdrop leaves little room for error.

For much of the rest of the market, which we’ve defined as the lower K for this exercise, the earnings expectations are not nearly as high. Pressure on rate sensitive and consumer facing businesses have been building for some time. Rising energy and logistics costs (see Chart) will start to impact the bottom line unless they are able to be passed on. For this cohort there have been signs that pricing power is fading with more promotional activity to draw in consumers. Last quarter net profit margins hit the highest level since FactSet began tracking the data in 2009 at 17%. That is expected to moderate to 15% which is still well above the 5yr average, 12.6%. Investors will be looking to see if the cracks that have been forming around the edges start to spread. That being said, the labor and equity markets have both remained resilient, which are helping to prop up consumer spending. Many of the stocks that fall into the lower K bucket are down >20% from their respective highs which potentially sets up for a “better than feared” response.

Financials once again lead us out of the gate. Management teams have already tempered expectations highlighting a moderation in both trading and investment banking revenues after record breaking quarters. Deal activity remains solid, but we have seen a slowdown in debt underwriting during the quarter and some IPO timing has been pushed out given the uncertainty. The rise in interest rates should help NII in the short term but the focus will be on credit quality. Management teams will also give us some insight into the state of the consumer.

Earnings estimates have continued to improve throughout the quarter, bucking historical trends. This has been the primary tailwind for equity markets this year. Coming into 2026 analysts were projecting S&P 500 earnings to be up 15% YoY that is now ~34%, which has helped the forward PE drop to ~19.5X from 23X in Q4 of last year.

The earnings backdrop coming into Q3 is the strongest it has been all cycle. However, the macro backdrop is also the most complex. Markets have been in a period of consolidation, struggling to figure out which one of these forces will drive the trajectory for stocks from here. The midterm elections, now weeks away, have added a layer of political uncertainty that has historically weighed on sentiment in Q3 but typically resolves constructively by year-end.

If corporate America can once again deliver and provide investors with enough confidence to see through the clouds, this could be the catalyst needed to break the stalemate.