Q3 2026Quarterly Update

Growth & Inflation

The economy has stayed resilient, and we see three reasons for it. AI capital spending continues to drive business investment, which is growing at roughly a 20% annual rate. Reduced immigration has kept the labor market tight even as hiring slows - payrolls rose just 29K in September, yet unemployment sits at 4.2%. And higher-income households, with asset values at record highs, are spending enough to carry overall consumption. Q2 GDP was revised up to 2.2% and third-quarter estimates are tracking above 3%. It is a narrower version of our US Resilience theme - strong at the top, softer underneath.

The strain shows up at the pump. Gasoline averages about $4.50 a gallon, diesel is at a record, and consumer sentiment is down 15% since January, with wages no longer keeping pace with prices.

Inflation is splitting in two (see chart below). Core measures are behaving - core PCE has eased to 3.0% from 3.4% in May, and core CPI is 2.4% - and headline PCE has come down to 3.4% from 4.1%. But the further relief we looked for this fall depended on crude holding near $70. With WTI above $90 and Brent above $100, headline inflation is stalling in the mid-3s rather than rolling over.

Monetary Policy & Liquidity

On September 16 the Fed raised rates a quarter point to 3.75-4.00% - unanimously - and 16 of 18 policymakers project another hike by year-end. We read the move as a bid for credibility more than a belief that higher rates can fix an oil shock. Core inflation is already easing, and the Fed cannot reopen a shipping lane.

That is why our "dove in hawk's clothing" read is delayed, not dead. Warsh again declined to submit a rate projection and distanced himself from the committee's forecast that inflation will not reach 2% until 2029. The Fed's statement now describes productivity growth as strong - the center of his case that AI allows the economy to grow faster without inflation - and his task forces deliver preliminary findings this fall. He is building credibility first, which pushes easing out. After September's weak jobs report, markets have shifted their bets on the next hike from October toward December. Whether the committee moves once more or stops here, we expect a long pause to follow, with easing a late-2027 story at the earliest.

Financial Markets

The S&P 500 gained 2.0% and the Nasdaq 2.5%, while the Dow fell 2.7%. Those figures flatter the quarter - small caps fell about 7%, the average S&P 500 stock lost ground, and in September three out of four stocks in the index declined, with technology the only sector to finish higher. The path was uneven as well: semiconductors fell roughly 25% from mid-June to late July on doubts about AI spending before recovering as earnings came in.

Bonds were the bigger story. The 10-year Treasury yield rose from 4.5% to 5.3%, with about half a point of that coming in September alone, and the 30-year mortgage rate reached 7.3%. Brent spent most of September above $100, and gold held near $4,200 despite the jump in yields.

The administration and the Fed still have every incentive to keep markets stable, but the third quarter showed the limits of that. Gasoline is back near $4.50, the truce has given way to renewed fighting, and long-term rates kept climbing even after the Treasury doubled its buybacks of long-dated bonds in August. With forecasts favoring Democrats to take the House and, more narrowly, the Senate, markets are heading into November with less of a cushion than they had over the summer, and with a bond market that is increasingly setting the terms for everything else.

Near - Medium Term (3-6 Months)

The backdrop that carried markets to record highs is still largely in place. The economy remains resilient, and earnings continue to surprise to the upside - for the third straight quarter analysts raised their estimates as the quarter went on, and they now expect 29% growth, with a record number of companies guiding higher. That strength, though concentrated in AI and energy names, has allowed valuations to ease even as prices held near their highs, with the S&P 500 now trading around 19x forward earnings versus more than 20x at mid-year.

What has shifted is the balance of risks, and interest rates are at the center of it. We view the rise in long-term yields as more structural than temporary. The wave of debt issued at near-zero rates in 2020 and 2021 is now coming due and has to be refinanced at today's levels, the Treasury is funding a deficit north of $2 trillion into soft auction demand, and AI-related borrowing is competing for the same pool of capital. A pullback in oil would offer some relief, but likely not enough to change that picture on its own, and we would not rule out the 10-year testing the 5.5-6% range before buyers or policymakers push back.

Equities have not had to contend with yields at these levels in more than twenty years, and they are doing so alongside an oil shock, a Fed that has turned to tightening, and an election now four weeks out. Taken together, we think the probability of a drawdown larger than a garden-variety correction is the highest it has been since 2022. This is not a call for a recession or for the end of the bull market, but a deeper and longer reset, potentially playing out over three to six months, has become a real possibility rather than a remote one.

The midterm elections add to the uncertainty. Divided government looks like the most likely result, which markets generally appreciate. The weeks that follow, however, bring a December 11 government funding deadline and, by several reports, the prospect of renewed military action against Iran - the kind of issues we noted in July could resurface on less friendly terms once the vote has passed.

Our approach is to treat this as a strategic event to position for. In our Enhanced Growth strategy, we are gradually reducing the portfolio's equity beta as we anticipate larger-than-usual volatility on the horizon. This is a measured shift, made by trimming equity exposure in steps and building our alternatives sleeve - gold, market neutral and long/short strategies, Treasury bill and option income, and buffer funds - positions that are less tied to the direction of stocks. We continue to see little reason to own bonds beyond one year on a structural basis, though a capitulation in the bond market could present an attractive trade, and we would approach it as exactly that.

That caution sits alongside a favorable calendar. The fourth quarter of a midterm year has historically been one of the strongest stretches of the election cycle (see chart below), and as we discuss next, our longer-term outlook remains constructive.

Longer Term (6+ Months)

Our longer-term view on equities has not changed: we want to be allocated to them. Markets should ultimately resolve higher, though the timing is difficult to pin down and the path there may be rougher than investors have grown used to. Part of our confidence comes from how we expect policymakers to respond. We do not believe a disorderly move in either bonds or stocks would be left to run. The Treasury has already stepped up its buybacks and made clear it has more tools available, and in a more serious drawdown we would expect the Fed and Treasury to act more forcefully to contain long-term yields and stabilize markets. This is also where our "delayed, not dead" read on Warsh comes back into play - the credibility being built today is what makes that kind of support believable when it is needed.

We would also expect Washington to continue, and possibly accelerate, its direct investment in industries it views as strategic. The stakes already taken in Intel and MP Materials are early examples, and we see this as an increasingly important form of support for areas tied to national priorities - semiconductors, energy, defense, and critical materials.

None of this comes free, and the cost runs through our Debasement theme. Containing yields while funding large deficits and strategic investment ultimately means more money creation, which in our view keeps inflation above the Fed's target for longer than markets currently assume. That backdrop continues to favor equities, gold, and real assets over long-dated bonds, and it is a large part of why a period of volatility does not change where we want to be invested over time.

The AI investment cycle, meanwhile, is maturing rather than fading. The five largest spenders are on pace for roughly $800 billion in capital spending this year, up over 90% from 2025. The area we are watching most closely is financing - higher rates raise the cost of every debt-funded buildout, and lenders have become more selective with lower-rated borrowers - which reinforces our preference for companies funding their investment from cash flow. Notable too is how much this spending has increased vs 2025 estimates.

Pulling it together: earnings on track for a third straight quarter of growth above 25%, record margins, and a resilient economy are not the conditions under which bull markets typically end. Yields above 5% and a Fed tightening into an oil shock are, however, the kind of conditions that interrupt them, and we think the odds of a larger interruption have gone up. We see that as something to prepare for and, if and when it comes, to use - consistent with remaining equity investors for the long term.