Rising interest rates are driving market activity!
The third quarter was shaped by Kevin Warsh, the new Fed chairman. On 17 June, he delivered a well-received yet unexpectedly hawkish message by announcing a clear focus on keeping the US inflation rate capped at 2%, even if this were to entail rising central bank rates. This came as a major surprise, as he had previously been seen as someone who would look for ways to cut interest rates to please Donald Trump.
Unfortunately, this message did not hold for very long. At the end of July, Warsh announced that the Fed would communicate less in the future than it had in the past and that it therefore intended to return the role of signalling to the financial markets. In other words, it is the role of financial markets to reflect the economic situation and discipline market participants, rather than the role of the central bank to influence the economy and protect market participants from their own mistakes. Whilst this view is shared by many economists, these are new messages that the market must digest, particularly given that central bank governors in recent history have seen great value in effective market communication.
All in all, however, Warsh’s second press conference was ultimately interpreted as signalling that he would back away slightly from his uncompromising fight against inflation. In the end, the Fed Funds target rate was not raised in July, despite persistent inflation and rising bond yields. As a result, Warsh lost a considerable amount of credibility, which was reflected in a further rise in interest rates, especially for longer-dated maturities.
At the end of August, he used the annual central bank conference in Jackson Hole to emphasise that he intended to stick firmly to the inflation target of 2% p.a. and signalled an interest rate rise, which ultimately took place on 16 September. The target rate for Fed Funds now stands at 4% p.a., having previously been at 3.75% p.a. The problem is that yields on two-year US government bonds now stand at 4.90% p.a., which is almost one percentage point above the Fed Funds target rate. Many market participants regard two-year government bonds as a guide to future central bank policy.
From Kevin Warsh’s perspective, the current situation could be interpreted as the market signalling to the Fed that it is too dovish and that it must raise interest rates sharply to achieve its inflation target of 2%. On the other hand, US inflation has not risen significantly and, at 3.4% p.a., it is well below both the Fed Funds rate and two-year government bond yields.
So why are interest rates rising in the capital markets? Presumably, it is because the United States now has not only an erratic and unreliable government but also an erratic and unreliable central bank governor. Therefore, capital markets are demanding higher risk premiums. Better (traditional) Fed communication may have been able to avoid this. What an irony! Overall, this new situation is problematic and forces investors to take the additional uncertainty into account.
Focus Return Markets
Anyone looking solely at well-known equity indices from the MSCI and FTSE Russell families will conclude that the global equity markets have had a good September as well as a good third quarter. This impression is misleading. Only the well-known AI stocks, and particularly the semiconductor sector – had a very good third quarter.
By contrast, Small- and Mid-Caps, as well as European shares, had a rather poor September. It is becoming increasingly obvious that many companies are suffering from the higher interest burden as well as rising commodity prices. We can see this clearly in country indices as well as in so-called equal-weighted indices, where each share has the same weighting; in other words, 1 per cent of Micron Technologies stock instead of 25 per cent! This is quite evident in the S&P 500 Index, whose market-capitalisation-weighted version rose by 3.2 % in September, whereas the equal-weighted version fell by 1.7 %.
Apart from the much-loved semiconductor and AI shares, most global shares are now trading significantly below their annual highs and their 200-day moving average. Fortunately, our community has very diversified portfolios and has allocated a sufficiently strong weighting to technology stocks. This raises the question of the extent to which adjustments are needed. After all, many shares in the technology and semiconductor sectors are now very expensive, and the question arises as to whether the optimistic profit forecasts for the coming years can be met. Anyone harbouring doubts on this point should gradually divest from ETFs in which semiconductor shares, such as Micron Technologies, account for more than 20 % of the portfolio.
Shares in interest-rate-sensitive sectors, such as property and private equity, had a weak September following the recovery in August. By contrast, bank shares in Europe and Japan performed well, as they’re perceived to be beneficiaries of a rising interest-rate environment. Commodity-sensitive industries and regions such as Europe and India also experienced a weak September and are now clear underperformers in 2026.
Anyone looking at equity factor investing will note that shares classified under the momentum factor, enjoyed a very strong September and have once again outperformed the broader market significantly after seeing a weaker July and August. All other factors – such as value, quality, income and size – had a good to very good third quarter, even though the size factor (i.e. small caps) suffered a decline in September. The same applies to the multi-factor strategy, which tracks value, quality, size and momentum in an equal way. It is clearly in positive territory both for the third quarter and year-to-date!
It is worth emphasising how well the value factor is currently performing and how it clearly outperforms all other factors in a five-year comparison. This is remarkable and shows that investors should have the confidence to consider tried-and-tested strategies, even if they lag the market over longer periods, as was the case with value stocks. We have also included a global value strategy for small-caps in our advisory universe (Avantis Global Small Cap Value – R79-F) to give the opportunity to fully capture this value trend in their portfolios. I would also like to point out that both the MSCI World Value and the MSCI EM Value have a heavy weighting in semiconductor stocks. Depending on individual circumstances, we might wish to reduce exposure here.
Our active managers also generally had a good third quarter and were able to either outperform their benchmarks or come very close to them. However, the results vary considerably in some cases: active managers who are invested to a significant extent in semiconductors (e.g. CT Global Technology, CT Global Focus and T. Rowe Global Focused Growth) are, in some cases, well ahead of their benchmarks. Managers with a focus on consumer goods and pharmaceuticals, on the other hand, have tended to underperform.
Performance of Selected Equity Funds – 2026
- O1-I | SPDR MSCI All Country World ETF
- O16-A | T Rowe Global Focused Growth Equity Fund
- R45-A | CT LUX Global Technology
Focus Bond Markets
As mentioned at the outset, the new Fed Chair has so far cut a rather poor figure and is unsettling market participants, who are accustomed to better communication. This has led to the yield on 10-year US government bonds rising from 4.40% p.a. at the end of June to more than 5.25% p.a. at present. At 5% p.a., there was a significant technical resistance level, which has now clearly been breached. Notable new resistance levels are at 5.50%, 5.75% and 6%.
Please note: a one-percentage-point rise in interest rates typically leads to losses of 7 percentage points for a 10-year government bond, which normally has a duration of 7 years. Similarly, a one-percentage-point cut in interest rates leads to gains of around 7 percentage points.
Even though the current US inflation rate is just over 3% p.a. and medium-term inflation expectations remain around 2.5% p.a., the so-called risk premiums or term premiums for long-term government bonds have risen significantly, and it is difficult to assess when this trend will come to an end. Anyone looking solely at inflation expectations will be keen to buy bonds at current levels. However, anyone mindful of the United States’ solvency will surely expect even higher premiums.
We really are living in a vastly changed world, in which the solvency of many industrialised nations is being called into question. This is also evident from the fact that, over the last five years, US dollar-denominated government bonds from Emerging Markets have performed considerably better than those from industrialised nations. The return differential between G3-A (Vanguard Emerging Market Bond Fund) and the standard B1 (Bloomberg Global Bond Index) is very clear, at +3.64% p.a. compared with –0.38% p.a. over a five-year period.
I recall writing years ago that hard-currency bonds from Emerging Markets are safer than the government bonds of many developed countries because, with few exceptions, these countries’ levels of debt are considerably lower and their population dynamics are significantly more favourable. Clearly, time has caught up with us, and we are now faced with new realities.
Bond buyers are, ultimately, lenders and expect to receive not only interest but also full repayment of their principal. This comparison also makes it clear that blindly buying ETFs or index funds in the bond market can be a mistake. Systematically and actively managed bond portfolios often deliver better results, particularly when they can be acquired at wholesale prices as part of our community. In addition to Emerging Market bonds, bond investments from specialised segments such as High Yield, Subordinated/Tier 1 Capital and CAT Bonds may perform well in the current environment. Whilst they represent niche markets, they can be an interesting addition to a portfolio for investors seeking to receive substantial interest payments. We will provide more comprehensive information on CAT Bonds during the fourth quarter!
Despite the unfortunate losses on bonds in the third quarter, it is important to emphasise that current interest rates are significantly above the expected medium-term inflation rate. Bondholders should therefore hold on to their positions with confidence, as they are needed within the portfolio context to complement the risk components and reduce portfolio volatility. Nevertheless, we would steer clear of long-dated government bonds and instead opt for bonds with short- or medium-term maturities. The aforementioned bonds from specialised sectors and Emerging Markets are also worth considering, as these currently show only a low correlation with US government bonds.
Performance of Selected Bond Funds – 2021–2026
- G3-A | Vanguard Emerging Markets Bond Fund
- B1-I | Vanguard Global Bond Index Fund
- G1-I | iShares USD Treasury Bond 20+year ETF
Focus Global Commodity Markets & Bitcoin
In my review of July, I pointed out that community members who may have bought their gold and copper mining shares too early should not give up hope and should instead consider buying more, given the low valuations. I had, however, not expected the strong rally in gold and gold mining shares to follow as early as August. In September, prices headed south again, which is why purchases can once more be considered.
Bitcoin found a bottom at around USD 60K and is now clearly back above USD 80K. This time, it seems that institutional investors have been buying the popular ETFs rather than the retail community. We will find out whether that was a smart move!
Both gold and Bitcoin benefit from the renewed uncertainty caused by Kevin Warsh’s lacklustre performance, as well as from the ill-advised attempts by US Treasury Secretary Bessent to stabilise the Japanese yen and the prices of long-term US government bonds. Scott Bessent is now regarded as the Treasury Secretary who is making the most strenuous efforts to intervene in the fortunes of the financial markets. Anyone who looks to history will find that such actions are generally not crowned with success.
Oil and gas prices benefited in the third quarter from the resurgent crisis in Iran, for which there is currently no end in sight. The same applies to the Bloomberg Commodity Index (Bloomberg Commodity Index Total Return, BCOMTR:Index), which has now surpassed the highs reached in spring.
Focus Private Markets & REITS
REITs experienced a weak end to the quarter, having nevertheless enjoyed an unexpectedly strong first half of the year despite rising long-term interest rates. Although they are still slightly up for the year, they are trading well below the highs seen at the end of June. Rising interest rates are weighing on the sector. However, current valuations are not excessive, and property is likely to remain a safer long-term investment than US government bonds.
Following a stabilisation in August, shares in private equity and private credit firms have once again started to fall and are clearly in the red since the start of the year. The evergreen funds of the major PE firms have had a solid year so far, although I would describe the results as rather unremarkable compared with liquid markets. Our community has no major exposure here, which we are pleased about.
Focus Global Currencies
The US dollar has benefited significantly from the Fed’s interest rate hike and has risen sharply as measured by the DXY Index. It is now encountering technical resistance around the 101 mark and appears overbought.
The US government tends to favour a weaker dollar, and the currency appears overvalued given America’s high level of debt and based on purchasing power parity.
Diversification into intrinsically more solid currencies such as CHF, SGD, AUD and NOK may be advisable. If community members are interested in foreign currency financing, we favour CHF, SGD and HKD over the Japanese yen.
Development of our Investment Styles
We generally advocate three investment strategies or philosophies that we can confidently assume are highly likely to lead to success in the long term. They are well established and have delivered good results for investors who have consistently followed them, even if there are significant short-term fluctuations and return dispersions.
1) Traditional index investing
This strategy works very well, and there is no reason to question it. However, on the equity side, the strategy also means that many indices in the MSCI and FTSE Russell families are currently heavily dominated by US equities. It is therefore important to assess the extent to which one’s own portfolio might also be – and should be – overweight in the US.
When it comes to bond indices, the fact remains that traditional indices are inevitably more heavily invested in bonds from higher-debt issuers than in those from less indebted issuers. For this reason, investors keen on ETFs should take the trouble to compare bond indices with systematically designed indices (e.g. Dimensional) or high-quality actively managed bond portfolios (e.g. PIMCO Income). We recommend ‘traditional indexing’ as a strategy for long-term investments in equities and the money market, but not as a long-term strategy for bonds.
2) Factor-based or scientific investing
Since the start of the year, the value and momentum factors have achieved strong excess returns. Shares in small companies (the size factor) have also performed very well so far this year, particularly in Japan and the US.
The quality factor has improved significantly following a poor previous year and is now only slightly behind the broader market. Quality factor stocks are now also showing more attractive valuations compared with previous years and may see a renaissance. Ultimately, they represent one of the most successful factors for long-term investing.
As far as scientific investing in bonds is concerned, it might be more appropriate to speak of systematic investing rather than factor investing. Generally, fewer bonds are purchased than is the case with the traditional indices of the FTSE Russell and Bloomberg families. In this way, it is possible to reduce the risk associated with individual issuers and achieve a better overall return without deviating significantly from the nature of the benchmark index.
Systematically constructed bond portfolios can therefore generally perform slightly better than traditional bond indices. This has also been the case so far in 2026.
3) Investing in just a small number of securities
Many of our active managers have had a very good year so far; however, we note that some of the managers who have deliberately stayed out of the semiconductor and AI sectors have underperformed significantly, whilst managers who piled into AI and semiconductor stocks display a significant outperformance versus traditional indices.
The manager of the CT Global Technology Fund, who has been highlighted on several occasions, once again delivered a convincing performance in the third quarter and, in our view, represents a very good long-term solution for investments in the technology sector.
We follow the general guideline (exceptions prove the rule!) that, in the very short term, we rely on money market ETFs and index funds. For bonds with normal duration and for special situations in the bond sector, we rely on systematic strategies or active managers at institutional prices. For global equity strategies, we rely on a mix of factor indices and active managers.
For individual equity themes such as technology, healthcare and Emerging Markets, we usually rely on active managers. For investments in traditional equity markets, we generally rely on indices.
Development of Model Portfolios
We use the Dimensional World Allocation Portfolios as our standard model portfolios, as they provide a highly representative picture of global financial markets, are very cost-effective and cover all our FairHorizons in all relevant currencies (USD, EUR, GBP and SGD). All six model portfolios have had an exceptionally good year so far, which is primarily due to the strong performance of the Dimensional equity strategy. It is currently benefiting significantly from the strong performance of small-cap companies as well as the overweighting of the value factor. Given their very low costs, we are happy to showcase these strategies to our community members who are very dissatisfied with the asset management services provided by major banks.
The current performance of the Dimensional portfolios is very encouraging and reinforces the fact that it can be worthwhile to stick with the same strategy in the long term. I would even go so far as to suggest that these portfolios outperform more than 90% of all asset management services offered by private banks and independent providers. This is because the low costs and systematic approach cannot be replicated by private banks and are often derided by Warren Buffett wannabes.
For investors whose reference currency is EUR or GBP, Vanguard also offers a range of investable model portfolios (Vanguard LifeStrategy), which likewise serve as an alternative to the asset management services provided by private banks.
Furthermore, for CHF, EUR and USD investors in the FairHorizons Yellow (7–10 years) and Orange (10–15 years) categories, there are a few other interesting solutions that are also suitable for long-term investment (e.g. ARERO, Global Portfolio One, PIMCO Balanced Growth).
All the strategies mentioned have had a good to very good year so far, although the outperformance of the Dimensional World strategies is particularly striking!
Outlook for the Coming Months
The third quarter, which has just ended, is generally regarded as the most challenging quarter of the year and is typically characterised by increased volatility and sharp price movements. This year, this primarily affected the bond markets and those segments of the equity market that are most sensitive to interest rates. However, anyone looking at AI and semiconductor stocks will see nothing but strong gains, even in the third quarter!
The fourth quarter is usually accompanied by positive sentiment and rising values, especially towards the end of the year. Given that yields on long-dated government bonds have now risen considerably and appear technically heavily overbought, there could be a countermovement in the fourth quarter. This would be particularly likely if the US midterm elections on 3 November were to result in a significant weakening of Donald Trump’s administration. In this scenario, US government spending would likely be cut sharply, which should take considerable pressure off the bond markets. Should the Republicans, however, emerge victorious from the election, a further sell-off in bonds would be expected! It is therefore quite possible that we will see a strongly politically driven stock market performance in November.
The current very negative sentiment amongst market participants also suggests that there could be positive surprises as the quarter progresses. This is primarily because bond market valuations reflect substantial risk premiums relative to current and expected inflation.
There are now substantial term premiums on long-term bonds of up to 1.5% p.a., which had completely disappeared during the Covid pandemic and the following period of low interest rates. At the time, it was claimed that long-term premiums were superfluous, as there was no longer any inflation and investors therefore did not need to be compensated for holding investments over longer time horizons!
In the 1970s and 1990s, term premiums ranged between 1.5% p.a. and 4% p.a. and, particularly in the 1970s, reflected concerns about the oil crisis and associated inflation expectations. Due to the prolonged period of disinflation following the fall of the Berlin Wall, term premiums fell steadily, as bond buyers had greater confidence in the stability of the financial system and the inflation outlook.
This trend has clearly changed, and it is impossible to say where this will ultimately lead: on the one hand, current inflation rates are considerably lower than in the 1970s and early 1980s. On the other hand, public debt is significantly higher than it was back then.
Seen in this light, perhaps a term premium should currently reflect not so much the risk of inflation as the potential restructuring risk associated with government bonds in industrialised countries!?
As yields on short- and medium-term government bonds already appear attractive, we would remain cautious on long-dated bonds whilst the widening of risk premiums is still underway. Bonds from Emerging Markets, as well as high-yield and CAT bonds, appear to be a good alternative for supplementing equity portfolios.
As far as equity markets are concerned, the technical picture still points to an ongoing consolidation, even though projected valuations are looking more attractive again. It remains to be seen whether the positive earnings outlook for AI and semiconductor stocks will hold, as semiconductor stocks in particular are known to be very cyclical in nature. What currently looks like a low forward P/E may therefore not be realised in 2027.
As has been emphasised on several occasions, the respective valuations of a financial instrument are ultimately the best guide for an investor. If we therefore look at the current valuations of the high-return and portfolio-stability components in our high-rise charts (pages 11–14), we can see that the current yields on bond investments, regardless of the investment horizon (FairHorizons: purple to green), are all above the expected medium-term inflation rate of around 2.3–2.5% p.a.
Even the yields on money market investments are close to or above current inflation rates and help preserve purchasing power, even if we must contend with the sharp rise in oil and gas prices.
Regarding the high-return/equity components we select for longer-term investment horizons (FairHorizons: yellow to red), we always communicate a minimum target return of 6% p.a. or a projected long-term yield of between 6% and 8% p.a. This corresponds to price-to-earnings ratios (P/E ratios) of between 14 and 17.
Most of our equity components currently have valuations that make these long-term returns possible. Only technology indices such as the Nasdaq 100 Index are significantly below this level, which is why they could lag the performance of other markets in the coming years. This may also apply to sector indices such as semiconductors, with very high earnings expectations for 2027 and 2028. It may be argued, however, that technology indices represent the best and most profitable companies in the world, even if they are not currently cheap to buy. Perhaps these companies are, after all, a safer bet than long-term bonds issued by heavily indebted countries!?
Shares in Europe, Asia and Emerging Markets carry risk premiums (i.e. target returns) of between 7% and 8% p.a., which is why we are readily on the buy side here.
The valuations of the components of our ‘losers of 2025’ – namely Indian stocks, REITs, quality factor index ETFs & quality fund managers, the healthcare sector and listed private equity firms – remain attractive to very attractive.
The healthcare sector is already benefiting from a rotation out of the technology sector.
The Indian market had stabilised, but unfortunately the outlook is looking bleaker again and the technical picture has worsened. This is likely due to the persistently high oil price, as India is a net importer. It is important to take a long-term view here. In my opinion, the valuation level is attractive and should be used as an entry point. The same applies to the shares of private asset managers. They can now be added once again to broadly diversified portfolios as satellite investments.
Shares in precious metal and copper producers weakened again in September following the recovery in August. They are very attractively valued and can serve as portfolio diversifiers. The same applies to our preferred commodity investments.
The reality of global conflicts and spiralling government debt in industrialised nations remains unchanged and tends to be inflationary, which has a positive effect on commodity prices. Anyone who has considered an allocation of around 10–15% to commodities since 2020 has been able to significantly optimise a portfolio consisting of stocks and bonds (see the ARERO Strategy). We would therefore use corrections in commodity prices as an opportunity to build up a 10–15% allocation within a portfolio.
Over the long term, investments in metals and precious metals have outperformed commodities that must be acquired via futures, which involve significant roll costs and erode returns. These include, above all, energy and agricultural commodities, which account for around 60–70% of some commodity indices. This explains our preference for metals and precious metals, or shares in metal and precious metal producers.
As regards our three preferred investment styles, we can emphasise once again that all three strategies perform very well in the long term, even if they may prove disappointing in the short term. Investors should therefore definitely stick to their chosen investment styles and not change them based on short-term disappointment.
Those who simply wish to replicate current trends with fresh capital should continue to investigate value and now also quality strategies, as well as momentum and multi-factor strategies. Here, the positive trend of recent years appears to be continuing, and valuations remain favourable. We would, however, currently exercise a degree of caution regarding the MSCI EM and MSCI World Value building blocks, which have a high weighting towards semiconductor stocks.
Please also look at our new building block from Avantis, which screens small companies globally based on the value factor. It has performed exceptionally well over the long term and complements our very popular small-cap sub-fund from Janus Henderson very well.
The Avantis team was originally associated with Dimensional Fund Advisors and is therefore well versed in value strategies. Interestingly, traditional fund and ETF providers do not offer a comparable investment, which is why we turned to Avantis.
Generally, we recommend indexing for money market investments, active management for most bond strategies, and a mix of indexing and stock picking for equity investments. This is the approach we take ourselves, and we are delighted when we see the positive results.
For ‘fresh money’, we recommend our proven concept of FairHorizons, which we have developed based on established asset allocation principles. It offers a simple way of creating portfolios that can beat inflation and earn attractive risk premiums.
Please also look at our standard investment portfolio ideas on pages 17–21, which follow the principles of investment legends like Jack Bogle, Eugene Fama/Kenneth French and Warren Buffett/Charlie Munger.
Whilst all of them represent different investment philosophies, they’re all very effective and successful in the long term.
If you are worried about whether your portfolio is well equipped for the significant changes in today’s world, just get in touch with us. We’ll be more than happy to check it for you.
Otherwise, I would be delighted if you could tell your friends and family about Das Family Office so that they can also become part of our community.
With best wishes for a successful final quarter!
Yours,
Mario Becker
