High Altitudes

Michael Grant

The past quarter has confirmed the story of 2026: a maturing equity bull market revitalized by an America-centric technology and profitability boom. The principal difficulty is altitude—corporate assets are now climbing where the air is thin. Everyone has understood that the AI mania is the rejuvenator; valuations of the beneficiaries are elevated. Meanwhile, a different climb has been underway in the bond market.

Since late 2025, investor sentiment toward global government bonds has become increasingly negative. The yield of the 30-year Treasury has risen to its highest level since 2007, and the 10Y–10Y forward rate¹ has climbed above its 2008 peak to 5.9%. This synchronized move across developed markets—driven by higher real yields rather than a deterioration in inflation expectations—is generating alarmist commentary.²

The array of influences pointing to higher yields is impressive: persistent inflation, a higher term premium, firmer expectations for world growth, new leadership at the Fed, fiscal sustainability, and competition for capital. The context is so hostile to fixed nominal claims that one might ask why yields are not already higher.³ For many, the classic 60/40 portfolio is obsolete in a post-Covid, higher-for-longer world.

US economic data have signaled a resilience that mirrors this orthodoxy, testimony to the extended effects of the corporate capex upswing. Estimates of the scale of the AI buildout continue to move higher, as do Q3 earnings projections. Accordingly, investors have concluded that the equilibrium US real rate of interest needs to be 50 to 100 basis points higher. Under its new chair, the Fed has had no credible choice but to acquiesce to this line of thinking.

Earlier in 2026, we assumed the 10-year US Treasury yield would not rise beyond 5%. That assumption was too reasonable for the exceptional scale of the AI shock, at least amid oil supply disruption. The 2007 top of 5.35% is the new reference and likely a climax given negative sentiment and shrinking institutional exposure. We suspect that climax was reached by the end of September, though this may not be apparent until after the midterm elections.

Two perspectives suggest greater value in global bonds than most perceive. First, the AI boom is a form of corporate reflation that mitigates the need for a conventional monetary cycle. The labor insecurity at its core is the very opposite of a wage-price cycle: workers fearing displacement do not bargain for higher pay. AI spend is producing a modest but temporary degree of restriction until its productivity potential becomes apparent.

Second, the two-tier consumer economy is tenacious: household employment and incomes are not robust enough to withstand genuine monetary restriction. Even amid the AI boom, it is hard to see why US growth should accelerate in 2027, while the trajectory of core inflation will ease as the effects of the higher price of oil and tariffs fall out of the annual comparison. In sum, the higher-rate trajectory discounted through 2027 is too aggressive.

For the first time in the post-GFC era, high-quality fixed income is becoming a viable, low-risk portfolio ballast. In July, we noted that a break above 4.65% would signal the return to fixed income—that signal has arrived. Long-dated yields at their highest since 2007, set against the compressed earning yields of equities, have restored the value of bonds in portfolios. This implies interest rates will be less problematic in the months and quarters ahead.

Q4 Outlook: Acclimatizing Where the Air Is Thin

At high altitudes, it is easy to appear wise by counseling caution. The relentless rise in yields through September has generated alarm, and early autumn is notoriously perilous for risk assets, especially in a midterm election year amid an oil shock. Yet the playbook this year has been different: 2026 is the year when the significance of AI has been broadly recognized. How else can reasonable people believe that machine learning is an existential threat to humanity?

We distinguish between higher yields that constrain financial valuations and those that constrain economic activity. The climb toward 5% on the 10-year is a valuation story. It raises the hurdle for equity multiples and weighs hardest on long-duration assets. In contrast, yields that constrain the US economy are probably closer to 6%, and with capex compounding and private balance sheets strong, we are not near that threshold. Today’s duration pressures fall on prices rather than profits.

Equities have thus absorbed the twin bond-oil mini shocks without serious damage, albeit with considerable internal rotation. Single-stock volatility has risen as breadth has narrowed, but benchmark volatility remains subdued. US large-cap growth stocks are comparatively defensive versus their international peers. For October, the robust earnings setting should continue, allowing the S&P 500 Index to bide its time and possibly extend toward 8,000 by the midterms.

Beyond that, we do not assume the typical post-election rally that many expect. Should the GOP lose both houses of Congress, the market could react poorly—the Trump Administration is unusually protective of Wall Street—and the 2018 midterm was not good for equities. Absent an oil price collapse, upside into the new year looks pedestrian. The principal constraint is valuation and positioning: equities are a crowded trade, and any upside acceleration will require a new positive shock.

Powerful narratives are buffeting markets: AI as both profit engine and existential threat, the definitive end of the rate-suppression era, and an oil weapon aimed at the midterms. Such gusts might pass unnoticed at normal altitudes. Where the air is thin, they unsettle even seasoned climbers—particularly when the “two-tier” diagnosis applies as much to corporates as to consumers. High altitude demands diversification—and, for the first time in years, that includes bonds.