Global Market Review and Outlook

Third Quarter 2026 Highlights

• The investment cycle is in full swing: AI, automation, infrastructure renewal, and national-security priorities continue to drive capital spending.
• Investors’ enthusiasm has not been unbridled: While investors are still focusing on momentum and technology, they are also starting to question the debt-funded expansion relative to expected future revenues and valuation multiples.
• Higher Treasury yields reflect several factors, but the largest driver is stronger growth: Tight credit spreads suggest that the move is not signaling a broader credit event, yet we are witnessing some wider spreads of companies increasing leverage for AI spend.
• Geopolitics increase uncertainty: Energy, shipping, and trade disruptions could keep inflation and market volatility elevated.
• Higher gas prices: Rising prices for gasoline and diesel are hurting affordability, lowering discretionary spending, and weighing on voters’ minds in the upcoming midterm elections.  

The Capex Boom Continues

It was once again evident in the third quarter that this is not a consumer cycle; it is still very much a capital investment (in plant, equipment, and machinery) investment cycle and corporate America is amid a major reindustrialization and capital stock upgrade. The spending is much needed, not only to renew aging infrastructure, plant, and equipment—where little investment has been made over the last couple of decades—but also to automate, which would help offset a shrinking labor force as baby boomers retire and where immigration has declined. Spending is also needed to take advantage of new innovation in AI and other related technology to better compete globally.

But Sentiment Around the Boom Is Turning More Cautious

Over the last quarter, the mood around this expansion has notably shifted. Both investors and the general public are now starting to ask, at what cost? The public is concerned about the environmental damage from too many data centers given the resources required to run them, in addition to rising costs of electricity and water. Investors, meanwhile, have become more concerned about the transition from funding the expansion by internally generated free cash flow to now staggering amounts of debt issuance and whether future revenue growth will be sufficient to justify that expense.

The public’s concerns are starting to manifest themselves in electoral polling ahead of the midterm elections, where the politicians stressing the need for more regulation and control around data center expansion and the use of AI, are gaining more ground compared to those who aren’t.

Equity investors, meanwhile, are no longer rewarding stunning revenue growth to the same degree they were previously. Nvidia, for example, saw its second-quarter revenue grow by a whopping 105.9% on the previous year, but its share price has only increased by 22% over that same period, and its P/E multiple has been contracting. Notably, the IPO for Oura (maker of the health tracking ring) was also pulled in the quarter as investors questioned growth expectations. None of these developments would normally be associated with excessive optimism.  

Nevertheless, through the third quarter, the market has continued to be bifurcated, whereby trend-following momentum stocks (those that have gone up the most) have continued to outperform quality ones (those with durable earnings, good managements, and strong balance sheets) and almost all other factor measures, for that matter (exhibit 1). 

Relative Performance of Quality vs. Momentum

S&P 500 Quality TR Index Relative to S&P 500 Momentum TR Index

 

Historically, this does not last. In the early 1960s through to the early 1970s, for example, investors bought the Nifty-50, which were 50 stocks viewed as “one decision names” that would only go up—companies such as Coca Cola, Xerox, Polaroid, McDonald’s, and IBM. While many of those companies are still around and performing well today, a combination of high valuations, rising interest rates, and a recession resulted in a sharp pullback and a change of leadership toward a more diversified basket of high-quality companies.

Rising Rates Reflect a Stronger Economy

The increase in Treasury yields has been another disconcerting factor for equity investors.As exhibit 2 shows, the drawdown in Treasurys has been painful, but well within historical parameters, and nothing like the extreme drawdown we witnessed in 2021.

Treasury Market Aggregate Drawdowns from 2-Year Highs

Daily data from March 1996 - October 2026, %

 

The proximate cause of the increase in yields has predominantly been due to the strengthening of real economic growth. Though there have been other contributory factors, such as: 1) the recognition that inflation is stickier and the economy is stuck in a slightly higher inflationary regime; 2) rising short rates as the Fed tightens policy; 3) higher government debt levels; 4) increased geopolitical concerns; and 5) greater competition for funding from the hyperscalers whose debt issuance (borrowing money in the bond market) has been rising significantly. Importantly, while interest rates for high-yield corporate debt have increased, the increase has been very much in line with the rise in Treasury debt; hence, the spread between high yield interest rates and T-note rates has remained very tight, indicating this has not been a major credit event.

Yet, as exhibit 3 shows, the current yield on the 10-year T-note is consistent with nominal GDP growth, which tends to act as an anchor for these yields. Quite simply, if nominal GDP (real output growth plus inflation) is growing faster, it is likely that returns to the corporate sector are also rising, and Treasury will find it difficult to continue to attract investors unless it too offers up a more attractive yield.

Nominal GDP vs 10-Year T-Note Yield, %

 

Geopolitics Remains a Wild Card

Geopolitical tension did not ease over the past quarter. Russia continues to provocatively badger NATO members; several terrorist attacks were attempted but thankfully thwarted; the Houthis have de facto blocked the Bab El Mandeb Strait; the Strait of Hormuz similarly remains de facto blocked; tariffs have increased against Canada with relations deteriorating; more populist politicians are winning elections across Europe as tensions around immigration, growth, and inflation have mounted; and the midterm elections are looming. Meanwhile, it is unclear how the current stand-off with Iran will end, though the president said he will not attack before the midterms.

These tensions are resulting in much higher global oil prices and, importantly, increased costs for both gasoline and diesel, where more limited refining capacity has exacerbated price increases. The average cost for a gallon of diesel rose from $4.84 per gallon to $6.49 per gallon at the end of the quarter, with unleaded gasoline briefly touching $4.50 per gallon. Longer trade routes, higher fuel costs, and reduced flow of water through the Panama Canal due to the latest Super El Niño have also significantly increased container shipping prices.

As we move into the last months of the year and look into 2027, the investment backdrop remains constructive, though the scale of spending is not going unnoticed by investors. Strong capital spending and resilient nominal growth continue to support corporate earnings, yet higher financing costs, stretched market leadership, and geopolitical risks should signal caution in chasing the most crowded winners. We look forward to our conversations and meetings together as we move into year-end and into 2027.

Thank you for your trust and confidence,

1935 Wealth Management Team

Total Returns
Source: FactSet