Economic Commentary

Coming into 2026, our expectation was that tailwinds would outnumber headwinds for the economy and markets. We expected the buildout of artificial intelligence infrastructure would provide a powerful growth impulse. Nine months into the year, this thesis appears largely intact. Strong growth and persistent inflation have provided a surprise to interest rates and Federal Reserve policy, but as we enter the final quarter of the year, the most important lesson from 2026 may be that economic resilience has proven more powerful than many expected.

Last month we discussed some of the downstream effects that AI was having on markets, particularly through long-term interest rates. That conversation remained front and center throughout September as investors grappled with the implications of strong corporate earnings, persistent inflation, and a Federal Reserve that remains committed to maintaining price stability. Throughout the month, interest rates continue to rise across the yield curve.

Against this backdrop, the Federal Reserve opted to increase rates in September by 25bps, marking the first increase since 2023. The market had been anticipating this increase since June but has since priced in three to four additional hikes by the end of 2027. These shifting expectations pushed yields up across the curve, creating the opportunity to achieve yields of more than 5% in core bond allocations. At the meeting, Fed Chair Warsh continued to emphasize the Federal Reserve’s commitment to maintaining price stability and achieving a 2% rate of inflation. The credibility of this commitment is important to the value of the US Dollar and the Dollar strengthened in the weeks following the hike.

The economic environment that contributed to the Fed’s decision remains strong. The labor market strengthened in August, with payroll growth significantly exceeding expectations and the unemployment rate remaining stable at a low level of 4.1%. Consumer spending also continues to demonstrate surprising resilience despite elevated energy prices and higher borrowing costs. Retail sales advanced broadly during August. Together, these data points supported the Fed’s decision to raise interest rates while simultaneously reducing concerns that tighter monetary policy could meaningfully derail economic growth.

Artificial intelligence remains central to this story. Entering the year, consensus expectations called for around 15% earnings growth for S&P 500 companies for 2026. Today, earnings growth expectations have increased substantially, approaching 32%. Stronger-than-anticipated profits have supported equity market performance while also creating tangible benefits throughout the economy, enabling hiring activity, investment spending, and continued business expansion. While concerns surrounding the long-term disruptive potential of AI persist, the immediate economic impact has been overwhelmingly supportive of growth.

Beyond AI, geopolitical developments remain an important source of uncertainty. The ongoing conflict in Iran has kept oil prices and inflation expectations in flux. With midterm elections on the horizon the Trump administration has every incentive to minimize negative headlines and manage the economic consequences of higher energy prices. Midterm elections have historically been challenging for the party in power and prediction markets anticipate divided government after the midterms. Periods of divided government have often been associated with lower policy uncertainty and fewer sweeping legislative changes. Developments in the Middle East and domestic politics will likely continue to garner headlines but history has shown that markets have demonstrated an ability to adapt to a wide range of outcomes. As we have noted in election cycles past, it remains prudent to vote with your ballot and not your portfolio and to remain committed to your thoughtfully constructed financial plan.

As we take inventory of the first three quarters of 2026, results have been consistent with an economic regime experiencing high-growth, high-inflation surprises. Equity markets have been relatively volatile, but upward trending. Global equities have returned around 13% with US small caps and emerging markets leading. Commodities, specifically those with supply shortages associated with the war in Iran, have had a strong – albeit volatile – three quarters. Fixed income has trailed based on prevailing sentiment towards inflation with core bonds down about 1.5%. All things considered, the performance of a 60% stock and 40% bond portfolio held up well, returning about 7%, despite the noise in the market.

Looking forward to 2027, consensus expectations continue to call for a relatively constructive backdrop. Corporate earnings for S&P 500 companies next year are expected to grow at roughly 15%, a material increase from expectations entering 2026. Inflation is expected to come in at 2.3%, following the moderation of energy prices that are being priced in by futures markets. Economists project a stable labor market as well, with 68,000 new jobs expected monthly in 2027. Finally, markets are pricing in one additional interest rate hike in 2026 and two to three in 2027 from the Federal Reserve.

The primary takeaway from the first three quarters of 2026 is that resilience often emerges even when headlines predict disruption. Whether navigating the transformative momentum of artificial intelligence, shifting geopolitics, or a recalibrating Federal Reserve, markets have once again rewarded discipline over reactivity. The outlook will undoubtedly continue to evolve, and volatility remains an unavoidable element of investing. Yet the fundamental lesson remains unchanged: maintaining discipline, diversification, and a long-term perspective is the most effective response to uncertainty. Above all, we remain deeply grateful for your continued confidence and the privilege of managing your capital.