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MORE INTEREST RATE HIKES MAY NOT BE NECESSARY
The Federal Reserve raised short-term interest rates by a quarter of a percentage point in September. While this decision made sense to us, we are less convinced the Fed needs to keep raising rates in the coming months.
This is because Iran War-related energy costs are the key inflation driver –higher short-term rates will do little to address these costs. Another reason is that a sharp increase in long-term bond yields to above 5 percent, which is already making borrowing more expensive.
Lifting interest rates too high risks an economic slowdown or even could even trigger a recession. As a result, we believe the Fed will be cautious and not increase rates more than the economy can handle.
AI CONTINUES TO PROPEL THE GLOBAL ECONOMY
U.S. GDP is currently projected to grow by 3.5 percent in the third quarter – this would be a significant upswing from the first two quarters of 2026.
Consumer spending is the largest contributor to the expanding economy, but the AI infrastructure buildout remains the most dynamic growth driver in the U.S. and in much of the rest of the world. Globally, AI-related spending is expected to exceed one trillion dollars in 2026 and climb even higher in 2027.
Data-center construction is facing some public pushback over environmental impact and electricity usage. We view this as a short-term obstacle that will be overcome rather than as a serious long-term threat to AI’s future.
STELLAR EARNINGS GROWTH IS POWERING U.S. STOCKS
The current bull market for U.S. stocks had its fourth birthday in mid-October – over those four years, the S&P 500’s annual return has averaged 21.5 percent. So far in 2026, the S&P is up about 13 percent, still well above the long-term average.
Earnings growth has been the main catalyst for stocks, and that looks to continue at least through year-end. AI and energy are the top drivers, but most of the S&P’s sectors are also contributing.
Higher interest rates have recently hurt small caps and a stronger dollar has pressured international stocks. We believe rates and the dollar are both near their peak, and that these headwinds will ease.
OUR OUTLOOK
We believe higher bond yields are doing a lot of the Fed’s inflation fighting by tightening monetary conditions. These higher yields also offer investors an opportunity to lock in higher income. AI will remain a powerful economic driver, as will consumers who are grumpy about prices but keep spending. The midterm election results may stir up markets temporarily but could also add policy certainty for businesses. History suggests markets usually perform well the year after a midterm election.
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