Financial markets have demonstrated resilience following a volatile start to the year. Solid corporate earnings, continued economic growth, and steady consumer spending have helped support the markets despite ongoing concerns about inflation, particularly in energy and services. While uncertainty remains, the overall economic environment continues to show signs of strength.
Our outlook for the economy and financial markets has changed little over the past quarter. We continue to believe the U.S. economy is in the middle-to-later stages of the business cycle. In this environment, we favor a balanced investment approach, with a modest emphasis on value-oriented investments. Although recent market fluctuations have made some investments more reasonably priced, large U.S. companies continue to trade at valuations above their long-term historical averages. As a result, we believe future stock market returns will increasingly depend on companies delivering earnings growth rather than investors simply being willing to pay higher prices for those earnings.
The labor market has gradually cooled from the exceptionally strong conditions experienced in recent years. Monthly job gains have slowed considerably from their 2021 levels, but employment growth has remained positive. Wage growth has moderated, and unemployment remains relatively low by historical standards. Meanwhile, the four-week average of initial unemployment claims has provided additional evidence that widespread layoffs have not become a defining feature of the current economic environment.
Businesses are also continuing to invest in productivity improvements, including the adoption of artificial intelligence (AI). While these technologies may change how companies operate and how certain jobs are performed, the broader employment data have not yet shown evidence of widespread job losses.
The labor market is worth watching closely, particularly as businesses adjust to higher costs, changing technology, and an evolving economic environment. However, a gradual slowdown in hiring does not necessarily signal an impending recession. At this point, we do not see compelling evidence that an economic downturn is imminent, although the risks warrant continued attention.
Consumer spending remains one of the most important sources of support for the U.S. economy. Household balance sheets have generally benefited from accumulated assets, while debt payments remain manageable for many households. Household debt-service costs, the portion of disposable income devoted to paying principal and interest on outstanding debt, remain relatively low compared with historical levels.
Some areas of consumer credit have experienced stress. Student loan delinquencies increased as pandemic-era payment relief ended, although the reported figures have subsequently improved. Auto loan, credit card, and mortgage delinquencies also remain below their historical averages based on the data cited in our analysis. These trends suggest that, while some households face financial pressure, consumer debt has not yet become a broad-based threat to economic growth.
There is, however, an important qualification to the otherwise encouraging consumer picture. Spending has become increasingly concentrated among higher-income households. The top 20% of income earners account for an estimated 60% of consumer spending, highlighting the important role that wealthier households play in sustaining demand.
This concentration creates a potential vulnerability. If financial markets experience a significant decline or higher-income households become less confident about their financial outlook, their spending could weaken and affect the broader economy. For now, we believe the consumer remains in a relatively solid position, supporting our expectation for continued economic growth, although the pace of growth could moderate.
We made two adjustments to our domestic equity positions during the third quarter, and both have contributed positively to relative performance so far. Overall, we remain comfortable with allocations that stay relatively close to their strategic benchmarks.
Our positioning held up well during the first-quarter market decline and participated in the subsequent second-quarter recovery. These results reinforced our decision in late 2025 to introduce a modest value tilt into the portfolio. Value-oriented investments generally trade at lower prices relative to measures such as earnings or book value than growth-oriented investments, although they can underperform when investors favor faster-growing companies.
We continue to review holdings for signs of sustained relative underperformance. At present, no positions have been placed on our watchlist. Rather than making frequent changes in response to short-term market movements, we believe a disciplined review process and a focus on long-term fundamentals remain important.
Valuations also continue to influence our outlook. Large-cap U.S. stocks remain relatively expensive compared with long-term historical averages. That does not necessarily mean the market is headed for a decline, but it does suggest that investors should maintain realistic expectations. Strong corporate earnings and sustainable business growth will likely play an increasingly important role in determining future returns.
International equities remain one of our highest-conviction investment areas. Developed markets outside the United States continue to offer attractive relative valuations, particularly among value-oriented companies. Several factors support this outlook, including improving earnings fundamentals, fiscal initiatives in Europe, and ongoing corporate governance reforms in Japan.
We also maintain a positive outlook for emerging markets. In these economies, stock market performance has increasingly been supported by improving corporate earnings and underlying business fundamentals, rather than relying solely on a weaker U.S. dollar. Currency movements remain important because they can affect returns for U.S.-based investors, but we believe the investment case for international stocks extends beyond short-term exchange-rate trends.
International investments can also help diversify portfolios that have become heavily concentrated in large U.S. companies. Developed international value strategies and emerging markets provide exposure to different economies, industries, currencies, and sources of corporate earnings growth.
Despite sometimes discouraging global headlines, we have not made broad allocation changes based on short-term developments. International and emerging market equities delivered strong relative performance in 2025 and have continued to provide diversification benefits in 2026. We believe opportunities remain attractive, especially in value-oriented segments of international markets, and our conviction in our current holdings remains high.
The fixed-income environment continues to develop largely as expected. Credit spreads, the additional yield investors receive for holding corporate bonds rather than comparable government bonds, remain relatively tight in both investment-grade and high-yield markets. Tight spreads can indicate confidence in corporate borrowers, but they also leave investors with less compensation for taking additional credit risk.
For now, corporate credit fundamentals remain broadly supportive, and we have not seen widespread deterioration in credit quality. Defaults among high-yield borrowers remain concentrated in the riskier portions of the market, including companies with CCC ratings and lower credit quality. Nevertheless, tight spreads deserve attention because a weaker economy or a rise in corporate defaults could lead investors to demand greater compensation for holding riskier bonds.
Given these conditions, we remain comfortable with selective exposure to high-yield bonds and strategic income strategies. Our emphasis is on generating income while managing risk, rather than extending portfolio duration simply to capture a little more yield.
Duration measures a bond portfolio's sensitivity to changes in interest rates. A portfolio with shorter duration than its benchmark will generally be less sensitive to interest-rate movements, all else being equal. At this stage of the economic cycle, we believe collecting bond income while maintaining shorter-than-benchmark duration offers a reasonable balance between income generation and interest-rate risk management. This positioning has added value over the past year, and we believe it remains appropriate in the current environment.
We have also decided to reduce a modest overweight to corporate credit. This adjustment reflects a measured approach to risk management rather than a broad negative view of corporate bonds. With credit spreads already tight, we believe it is prudent to avoid taking more credit risk than necessary.
Overall, our portfolios remain relatively close to their long-term strategic benchmarks. The economic backdrop remains constructive, supported by consumer spending, continued corporate earnings growth, and a labor market that has cooled without showing clear signs of widespread deterioration.
That does not mean markets will move higher in a straight line. The fourth quarter could bring renewed volatility as investors assess uncertainty surrounding the U.S. midterm elections, geopolitical developments involving Iran, inflation, and the future direction of interest rates. Any of these factors could influence investor sentiment, even if the underlying economic picture remains relatively stable.
Rather than attempting to predict every short-term market move, we believe investors are better served by maintaining diversified portfolios, managing risk thoughtfully, and staying focused on long-term objectives. Our approach remains measured: maintain exposure to areas where we see attractive opportunities, avoid unnecessary concentrations of risk, and make portfolio adjustments when the evidence supports them.
Market volatility can be uncomfortable, but it is also a normal part of investing. By staying disciplined and avoiding decisions driven solely by daily headlines, you can remain positioned to pursue your long-term financial goals while adapting as economic and market conditions evolve.