Two market signals, one story

Rapidly rising earnings forecasts and higher government bond yields might seem hard to reconcile. Both trends can pull markets in opposing directions, as higher long-term rates tend to dampen earnings growth. Yet five years after the last economic downturn, consensus earnings forecasts for 2026 are still being revised higher, not lower. See the chart. We see this as evidence of structural forces at play. In our CMAs, we see strong earnings growth as durable. We expect U.S. corporate earnings to grow by 11.6% a year over the next five years — a pace seen in only about 15% of historical five-year periods. This outcome is not guaranteed and is conditional on AI adoption boosting productivity and profit margins. But the fact that it is plausible underscores why we cannot apply a typical business cycle playbook to long-term portfolios in this environment.

The same forces supporting corporate earnings are also driving the global bond reset that has lifted government bond yields since 2021. That aligns with our long-held view of a world shaped by supply scarcity, where investors demand more compensation for holding long-term government debt. Rising public borrowing, greater inflation uncertainty and more volatile bond markets have reinforced that trend. Yet we remain strategically underweight developed market government bonds. This is an active call because we think long-term yields have more room to run. Governments, AI hyperscalers and companies across the economy are competing ever more intensely for capital, keeping upward pressure on long-term government bond yields — even in our AI productivity boom scenario. We’ve argued that this environment calls for a different approach to portfolio construction as long-standing macro anchors investors have come to rely upon, such as stable inflation expectations, become less reliable. The industry’s growing focus on a total portfolio approach reflects that shift.

For us, this means focusing more on the underlying drivers of risk and return across the portfolio and less on asset class labels. We remain underweight global investment-grade credit because today’s tight spreads offer little compensation for additional duration risk. Instead, we like selected private credit, including direct lending, where resilient cash flows, stronger lender protections and recovery value can provide durable income. Rising dispersion — the widening gap between stronger- and weaker-performing managers and borrowers — also reinforces the importance of manager selection.

We prefer growth exposure through equities and private infrastructure equity over high yield credit. Tighter spreads prompted our new strategic underweight in high yield this quarter and reinforce our view that equities are better positioned if earnings strength persists. We see valuations falling as earnings growth outpaces share price gains, allowing multiples to decline over time. We favor targeted exposures, such as in technology and healthcare, where structural shifts support earnings growth. We also see opportunities in infrastructure equity through investment in power, grids and data centers.

The same structural changes supporting stronger earnings are also pushing bond yields higher. We reflect that through our preference for equities, durable income and limiting duration risk on a strategic horizon of five years or more.

This is our final edition before our summer publishing pause. The Weekly commentary will return on Monday, Aug. 31.

The S&P 500 and Nasdaq notched their biggest weekly gains in three months on hopes of a Middle East peace deal and solid earnings. U.S. Treasury yields fell after July payrolls unexpectedly declined. The gap between two- and 30-year yields has widened by roughly 20 basis points since the last Fed meeting. That leaves our investment view unchanged: the softer jobs report likely gives the Federal Reserve more flexibility but does not materially alter our longer-term inflation outlook.

July inflation will show whether softer hiring and wage growth are starting to feed through to prices. We think much of June’s inflation softness reflected normalization in a handful of categories and is likely to reverse. The key watch is services inflation: sustained moderation there would strengthen the case for policy easing more than a single weak payroll reading.