Key takeaways
The third quarter reinforced an important shift for investors. Economic growth, corporate investment and earnings remained supportive, but higher energy prices added to inflation pressure and pushed interest rates back to the centre of the market debate.
Markets continued to advance, but the conditions supporting those gains became more demanding. Higher yields increased the hurdle for valuations, while strong earnings helped equities absorb much of that pressure.
Why did the market hurdle rise?
Higher oil prices complicated the inflation outlook at a time when growth was still holding up. That combination reduced the room for easier monetary policy and contributed to higher long-term bond yields.
For investors, the consequence was broader than rates alone. A higher cost of capital puts more pressure on valuations and increases the return available from bonds, creating greater competition for capital across markets. The reason yields are rising therefore matters; strong growth can support both yields and earnings, while higher inflation without corresponding profit growth would be a more difficult combination.
What supported Canadian equities?
The S&P/TSX Composite Index advanced 1.1% during the quarter, although only three of its 11 sectors posted gains. Materials and information technology drove most of the advance, while higher oil prices supported energy. Bank earnings remained resilient, but financials were not a headline driver.
That mix continued to play to Canada’s strengths. At the same time, higher energy prices made the domestic inflation picture less straightforward, creating a tension between commodity-linked market support and a more restrictive interest-rate backdrop.
Why did equities remain resilient?
The S&P 500 advanced 2% in U.S. dollars during the quarter, despite the rise in bond yields. Strong earnings remained the key counterweight, allowing equities to absorb a higher discount rate even as the margin for disappointment narrowed.
AI investment remained an important part of the earnings and investment story, but the question continued to evolve. As the cost of capital rises, investors increasingly need evidence that spending can translate into revenue growth, stronger margins and durable cash flow.
International markets were more mixed. Europe faced greater pressure from energy costs and interest rates, while parts of Asia continued to benefit from demand across the AI supply chain.
What happened to fixed income?
Fixed income showed the clearest impact of rising yields. The FTSE Canada Universe Bond Index declined 3% during the quarter, as higher rates outweighed coupon income.
Duration was the main headwind, as rising yields reduced the value of existing bonds, particularly longer-maturity issues. High-yield bonds outperformed investment-grade bonds, although high-yield spreads widened meaningfully late in the quarter, as investors demanded more compensation for credit risk.
What matters from here?
The third quarter did not undermine the earnings backdrop, but it raised the bar. Higher yields are creating more competition for capital and making earnings growth, margins and market breadth increasingly important.
Find out more in our 2026 Third Quarter Market Review.
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