NEW YORK, Oct 2 (Reuters) - Investors head into a part of the calendar that tends to be upbeat for US stocks, but that seasonal strength is under threat from a number of challenges, including a surge in bond yields and the market's apparent dependence on massive AI spending.
As the fourth quarter kicks off, the stock market is already on pace for a solid year. The benchmark S&P 500 was last up 12% in 2026, and less than 2% below its mid-August record high, while the tech-heavy Nasdaq Composite was up more
than 15%.
Markets face a busy end of 2026, with the start of corporate earnings season and a pivotal Federal Reserve meeting in the next few weeks, along with the looming November 3 midterm elections that will decide control of the US Congress.
"It does tend to be a seasonally strong period, however I think this year investors are facing some headwinds as we go into the fourth quarter," said Tracie McMillion, head of global asset allocation strategy at the Wells Fargo Investment Institute.
Q4 TENDS TO SEE STOCK GAINS
Since 1945, the S&P 500 averaged an increase of 4.2% in the fourth quarter, with the index posting gains 85% of the time, according to research firm CFRA. That average percentage rise is more than twice that of the other three quarters.
Fourth quarters of midterm years have generally been even stronger, with an average gain of 6.4%, as stocks "benefit from the lifting of election uncertainty," Sam Stovall, chief investment strategist at CFRA, said in a note.
While fourth quarters tend to be strong, mid-term years overall historically have been subpar, a trend stocks have defied so far in 2026. The S&P 500 has averaged a 15% dip in midterm years historically, while the deepest drop so far this year has only been 9%, according to McMillion of the Wells Fargo institute.
The firm is on "high alert" for a pullback between now and election day, she said, for example, if it looks like the Democrats can wrest full control of Congress from President Donald Trump's Republican party.
"If we were to see a change in the leadership in the House and the Senate combined, then we think that that could have some policy ramifications that could impact the markets," she said, while adding that a pullback could be a buying opportunity.
SPIKING YIELDS IN FOCUS, FED MINUTES DUE
The most immediate issue for stock investors is the jump in bond yields. The benchmark 10-year Treasury yield on Thursday hit 5.34%, its highest level in 24 years. Yields, which rise when bond prices fall, have soared amid expectations for strong economic growth, surging energy costs that are driving up inflation, and increased competition for capital as companies issue debt to fund AI expansions.
Higher yields likely already are impeding the market's advance, investors said. They can create more investment competition for equities and pressure stock valuations, while translating into more expensive borrowing costs throughout the economy.
"The interest rate story is the biggest headwind," said Chuck Carlson, chief executive officer at Horizon Investment Services. "You're going to need some relief on that front. I don't necessarily think the market will tank per se, but to get a meaningful rally in the face of that, I think is going to be a struggle for the market."
Another factor driving yields is the Fed's plans for monetary policy. The US central bank hiked interest rates last month for the first time in three years in an effort to cool above-target inflation. Minutes covering that meeting will be released on Wednesday and could offer Wall Street clues about the Fed's rate outlook, including the potential for another hike in October or December.
BIG EARNINGS GROWTH SEEN, AI SPEND IN SPOTLIGHT
PepsiCo and Delta Air Lines are among the handful of large companies set to post third-quarter results next week, before major banks kick off the reporting season more broadly the following week.
This year, corporate profits have surpassed already-lofty projections, propelling the stock market's rally. But they have also raised the bar for stellar performance that could test the market. S&P 500 companies overall are expected to have increased earnings by more than 30% in the third quarter from a year earlier, according to LSEG IBES data.
Particularly important are developments related to the massive spending by AI hyperscalers to build out infrastructure, which has lifted profits at a wealth of companies.
The US stock market's performance has been highly correlated to the AI theme, said Nelson Yu, head of equities at AllianceBernstein.
As it relates to AI this upcoming earnings season, "the number one thing to watch for is capex revisions from the hyperscalers," Yu said. "Because that does kind of start the whole chain."
(Reporting by Lewis Krauskopf, editing by Colin Barr and Jonathan Spicer )
