Market Commentary Q3 2026
A Rising Cost of Capital
Rising interest rates are reasserting themselves as a major theme in capital markets, altering both the risk premium afforded to equities and the returns available to bond investors. The 10-year Treasury yield recently reached its highest level since 2007, rising from 4.4% to 5.3% during the third quarter alone.
We believe there are both positive and negative explanations for higher rates. Persistent fiscal deficits and increased corporate debt issuance to finance artificial intelligence infrastructure are contributing to greater bond supply, while inflation remains above the Federal Reserve’s 2% target. At the same time, economic activity has accelerated, with nominal GDP growing at an annualized rate of 8.5% during the second quarter. Stronger economic growth typically coincides with higher interest rates, making the recent increase in yields at least partially a reflection of better-than-expected economic fundamentals, in our view.
Sticky inflation and healthy economic conditions have also led to a dramatic shift in expectations for Federal Reserve policy. At this point last year, the bond market was pricing in several rate cuts during 2026. Instead, the Fed raised rates in September for the first time in more than three years, and implied market expectations now assume additional tightening through 2027. While recent inflation data offered some early evidence of moderation, monetary policy is likely to remain highly dependent on incoming data.
Business investment has been the engine of that acceleration, helping fuel corporate earnings that continue to exceed expectations. Entering 2026, consensus estimates called for approximately 15% earnings growth for the S&P 500, nearly twice the historical average. Those estimates have since risen to more than 30%, a remarkable increase given that they build on record earnings in 2025. These upward revisions have provided an important counterweight to rising rates and helped support equity markets even as valuation multiples have compressed. The S&P 500’s forward price-to-earnings multiple has declined from 23x to 19x over the past year.
Artificial intelligence spending remains at the core of that earnings strength. Accelerating cloud revenues among the hyperscalers continue to support further investment in AI infrastructure. Meanwhile, the market’s response to AI disruption risk has become more nuanced. Cybersecurity stocks and other businesses demonstrating accelerating growth or durable competitive advantages have begun to differentiate themselves following what we viewed as indiscriminate selling in software and other AI-exposed sectors earlier this year.
Dispersion extends beyond the technology sector. Earnings growth has broadened to include small-cap, mid-cap and international businesses, but performance remains uneven and highly correlated with exposure to the AI buildout. Rate-sensitive areas such as housing have faced pressure from higher borrowing costs, while persistent inflation has weighed more heavily on the lower-income consumer. By contrast, the higher-income consumer has remained relatively resilient, supported in part by the wealth effect of a strong equity market.
The combination of exceptionally strong index-level earnings growth and higher interest rates is also changing how investors value growth. Multiples have contracted meaningfully for many companies even where underlying fundamentals and long-term growth expectations remain stable. In our view, this reflects both higher rates and the perceived opportunity cost of short-term growth available elsewhere. For patient long-term investors, we believe this is creating opportunities among durable growth businesses, particularly if growth becomes less abundant over time.
Even so, the valuation assigned to many businesses is likely to look fundamentally different in a more normalized interest-rate environment. Higher discount rates raise the hurdle for long-duration assets, placing greater importance on the quality and durability of future cash flows, in our view.
The other side of a higher cost of capital is a more attractive starting point for fixed income, which is coming off an exceptionally difficult decade of inflation-adjusted returns. As of the end of August, the Bloomberg U.S. Aggregate Bond Index had generated annualized real returns of -4.3% over the past five years and -1.9% over the past ten years, a difficult stretch that partly reflects the historically low starting point for rates and rising inflation. By comparison, the S&P 500 generated 8.3% and 11.6% annualized real returns over the same five- and ten-year periods.
While higher yields have improved prospective bond returns, equities retain an important long-term advantage: businesses have the ability to grow revenues, earnings and cash flows alongside, and potentially faster than, inflation. That ability to compound remains a powerful source of long-term purchasing-power growth and is a primary reason we maintain a bias toward equities for clients with long-term time horizons.
Authored by: Jack Holmes, Chief Investment Officer
As of October 8, 2026.
Thank you for your continued confidence. If you have questions regarding this commentary or our investment perspectives, we welcome the opportunity to speak with you. Please contact us at Bridges Trust.
This is a marketing communication and is not personal advice. We do not take account of your individual circumstances. You should consider whether any investment is suitable for you and seek professional advice if needed. The views, opinions, and commentary expressed herein are for informational purposes only and do not constitute investment advice or a recommendation, offer, or solicitation to buy or sell any security or investment strategy. Such views are subject to change without notice, and no representation is made as to their accuracy or completeness. Investing involves risk, including possible loss of principal. Estimates, forecasts, and forward-looking statements are not guarantees of future results.
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