The third quarter of 2026 delivered an unusual combination for investors.
- Energy prices rose,
- inflation worries returned and
- global bond yields climbed sharply.
Yet corporate earnings remained remarkably strong, helped by heavy investment in artificial intelligence and defence.
That resilience allowed equity markets to absorb a macroeconomic environment that would normally have been much more challenging. But heading into the final quarter of the year, the question is whether strong earnings can continue to offset the pressure from higher borrowing costs, expensive energy and increasingly restrictive financial conditions.
The answer may depend heavily on what lies beneath those impressive headline earnings numbers.
Strong earnings – but how broad is the strength?
US earnings have been exceptionally strong. By early August, FactSet estimated year-on-year S&P 500 earnings growth at more than 50% for the second quarter. But the headline number concealed significant concentration: excluding Alphabet and Amazon, growth dropped to 32%.
Unsurprisingly, artificial intelligence has become an increasingly important part of the corporate story. AI was mentioned on 67% of S&P 500 earnings calls during the second-quarter reporting season, far above historical averages.
This concentration is important, and there is more to it!
“NFG Partners' Glenn Coxon highlighted the difference between headline earnings growth and the underlying picture once some of the extraordinary gains associated with AI investment and these investments valuations are filtered out.”
As such, investors should distinguish between broad-based earnings strength and growth generated by a relatively narrow group of companies benefiting from enormous investment flows.
And this distinction becomes more important as the macroeconomic backdrop gets tougher.
The equity signal is becoming less comfortable
Several market indicators that were supportive earlier in the year have started to deteriorate.
- Interest rates and credit yields have risen,
- Market breadth has weakened, and
- Some market-based growth indicators have begun to roll over.
The US has continued to perform relatively well, but the global picture has become less convincing.
“Glenn Coxon's market models, which combine market breadth, volatility, rates, positioning, employment and other economic and market variables, have consequently turned more cautious on equities.”
This does not necessarily mean that a large equity correction is imminent. It means that the balance between potential return and risk is becoming less attractive.
There is nevertheless one important source of support: the economy. US growth remains robust, the labour market has proved resilient and investment linked to AI remains enormous. Government spending has also continued to provide support to economic activity.
The paradox is that these same forces are contributing to another major challenge for markets: higher bond yields.
Why bonds are not necessarily the obvious alternative
Normally, a more cautious equity outlook would make bonds increasingly attractive but the current environment is more complicated. Long-term US Treasury yields have risen above levels investors had become accustomed to over the past decade, yields have moved higher across most developed markets. Yet higher yields alone do not guarantee strong demand for bonds.
“The structural backdrop for the Treasury market has changed.”
On one hand, large fiscal deficits require substantial Treasury issuance. On the other hand, some traditional foreign buyers have become less reliable sources of incremental demand.
China has been gradually decreasing its US Treasuries exposure after Russia saw its US assets frozen following the invasion of Ukraine.
Japan is selling US Treasuries to prop up the yen
Euro area countries must also sell their holdings to meet their defence spending requirements.
As such, the once-reliable and price-insensitive buyers are being gradually replaced by smaller and increasingly price-sensitive investors to absorb that supply. That can translate into a higher term premium: investors demand greater compensation for committing capital to long-dated government bonds when fiscal, inflation and supply uncertainty are elevated.
Among government bonds, inflation-protected Treasuries (TIPS) may therefore look relatively attractive because they provide protection against persistent price pressures. But even there, conviction remains limited when real yields are moving rapidly.
Can higher rates actually cool this economy?
There is another unusual feature of the current cycle.
Higher interest rates are supposed to slow economic activity by making mortgages, corporate borrowing and investment more expensive, eventually reducing demand and inflation. But today's US economy is defined by large amount of debt, meaning that higher rates/yields turn into higher interest payments to holders of that debt. Meanwhile, fiscal spending continues to inject demand into the economy.
That does not mean rate hikes won’t matter. Monetary tightening still raises financing costs and restricts private-sector activity. But strong fiscal support and higher interest revenues could partially offset monetary tightening.
“Interest rates may need to remain higher for longer to achieve the same degree of demand destruction than a decade ago.”
And if an important part of the inflation impulse is coming from energy prices and fiscal demand, monetary policy becomes an even blunter instrument.
The two cornerstones of the current outlook are the Middle East and AI investment. As long as AI-related demand remains powerful and the energy shock remains manageable, the economy may be able to absorb somewhat higher interest rates. But a prolonged energy crunch combined with increasingly restrictive financial conditions would eventually put that resilience to the test.
A potential rotation rather than an exit from equities
A more cautious equity outlook does not necessarily imply abandoning equities altogether.
It could instead favour a change in leadership.
- Low-volatility and defensive equities – including consumer staples, pharmaceuticals and healthcare – have significantly underperformed the more fashionable parts of the market in recent years. Their relative appeal could improve if volatility rises and investors become more selective.
- Value stocks could also benefit. Financials, energy companies and other shorter-duration businesses tend to be less sensitive to changes in the discount rate than highly valued growth stocks whose expected profits lie further in the future. Also, companies in traditional industries that successfully implement AI to improve productivity, reduce costs or strengthen margins could eventually become beneficiaries of the same technological revolution that initially favoured semiconductor and technology companies.
For investors expecting a more difficult quarter, therefore, the question may become less about equities versus no equities and more about which equities.
Cash makes a comeback
One of the clearest consequences of higher interest rates is the return of cash as a genuine asset allocation choice.
For much of the post-global-financial-crisis era, holding cash carried a considerable opportunity cost because short-term interest rates were close to zero.
But with rising yields, money-market instruments and Treasury bills now offer meaningful yields without requiring investors to accept the duration risk of longer-term bonds or the volatility of equities.
Credit remains another possibility, although spreads and the economic outlook need to be watched carefully.
And for sophisticated investors, inverse ETFs can provide short-term hedging opportunities. But they are usuitable as long-term holdings because daily rebalancing and compounding can cause their performance to diverge significantly from the simple inverse of an index over longer periods.
A stronger US dollar enters the equation
The foreign-exchange picture also points toward a more defensive environment.
The US dollar has strengthened as Federal Reserve (Fed) expectations have become significantly more hawkish and US yields have risen.
“The rate-of-change in interest-rate differentials remains supportive of the greenback.”
The euro and sterling face a less straightforward environment. Both Europe and the UK are dealing with elevated inflation while economic growth remains comparatively fragile. Higher energy prices make that trade-off even more uncomfortable.
The Japanese yen is perhaps more interesting. After an extraordinary period of weakness and volatility, the possibility that the worst is behind the currency deserves attention, particularly as Japanese monetary policy normalises. But the path is unlikely to be smooth.
For the dollar, the yield curve could eventually become important. If aggressive Fed tightening expectations pushed the US curve into inversion and investors began to conclude that monetary tightening had gone too far, expectations could reverse and remove some support from the dollar.
Until then, higher US rates remain supportive. And Coxon doesn’t see the US yield curve invert anytime soon.
And before we move further, note that a stronger dollar also feeds back into the equity outlook. For US multinationals, foreign revenues become less valuable when translated back into dollars, creating another potential headwind for earnings.
Gold faces an unusual competitor
A riskier market environment would normally sound constructive for gold. But gold currently faces a powerful competitor: yield. As such, gold is facing very tough competition from Treasury yields, while a stronger dollar adds another headwind.
That creates an unusual situation in which gold could struggle even during periods of market stress.
The longer-term argument for gold remains different, however. Persistent fiscal deficits, geopolitical fragmentation and concerns about fiat currencies could continue to support its strategic role in portfolios over a much longer horizon. Gold outlook remains positive for longer term investors, who lose confidence in fiat currencies.
There may be an interesting exception among currencies: the Swiss franc. Switzerland's political stability, comparatively disciplined public finances and lower structural inflation give the franc characteristics that could become increasingly valuable in a more fragmented global environment.
Commodities and Bitcoin remain exceptions
The outlook for industrial commodities looks more constructive as inflation remains elevated.
Oil and copper are supported by a combination of geopolitical risk, infrastructure investment, constrained supply and continuing demand. Energy and broader commodity exposure could therefore remain interesting even if the outlook for traditional risk assets becomes more cautious.
Bitcoin is another notable exception. After speculative capital migrated heavily toward the AI theme, some of the excess positioning in cryptocurrencies has been cleared, according to Coxon. A reduction in potential sellers, improving technical momentum and declining volatility could create a more supportive setup.
That does not suddenly turn Bitcoin into a defensive asset. It remains volatile and sits at the higher-risk end of a portfolio. But the volatility is gradually weakening and its improved momentum looks noteworthy.
The final quarter of 2026 begins with a striking contradiction.
On one hand, economic growth remains strong, corporate earnings are impressive and investment in AI and defence continues at an extraordinary pace.
On the other hand, the same resilience, combined with energy and inflation outlook keep interest rates (and interest rate outlook) elevated.
This challenging environement makes the Q4 outlook less about chasing broad market performance and more about selectivity.
- Defensive and low-volatility equities could regain appeal.
- Energy and industrial commodities remain supported by the macroeconomic backdrop.
- Cash and short-term government paper once again offer meaningful returns.
- And the US dollar continues to benefit from favourable rate differentials.
The two major pillars holding the current market structure together remain AI investment and economic resilience. If they persist, markets may continue to digest surprisingly high yields.
If either begins to crack, however, the combination of stretched valuations, elevated borrowing costs and geopolitical uncertainty could make the final quarter of 2026 much more volatile than the previous one.
Frequently Asked Questions
What is the Q4 2026 market outlook for equities?
The Q4 2026 equity outlook is becoming more selective. Strong corporate earnings and resilient US economic growth remain supportive, but higher bond yields, expensive energy and tighter financial conditions could make broad equity gains harder to sustain.
Why are higher bond yields important for the 2026 stock market outlook?
Higher bond yields can increase borrowing costs and raise the discount rate applied to future company earnings. This can put pressure on highly valued growth stocks and make cash or short-term government securities relatively more attractive.
Which sectors could benefit if stock market volatility rises in Q4 2026?
Defensive and lower-volatility sectors such as consumer staples, pharmaceuticals and healthcare could regain relative appeal. Value-oriented areas including financials and energy may also become more attractive in a higher-rate, more selective market environment.
Is cash becoming more attractive for investors in 2026?
Higher short-term interest rates have made cash, money-market instruments and Treasury bills more relevant again. They can offer meaningful yields without the duration risk of longer-term bonds or the volatility associated with equities.
What is the US dollar outlook for Q4 2026?
The US dollar remains supported by relatively high US yields and a more hawkish Federal Reserve outlook. However, if monetary tightening expectations eventually reverse, some of that support could weaken.
What is the outlook for gold, commodities and Bitcoin in Q4 2026?
Gold faces short-term competition from higher yields and a stronger US dollar, although fiscal and geopolitical concerns may continue to support its longer-term role. Oil and copper remain influenced by supply constraints, infrastructure investment and geopolitical risk, while Bitcoin continues to offer a higher-risk and more volatile exposure.
The views and opinions expressed in this article are solely those of the external asset manager and do not necessarily reflect the views, opinions or investment approach of Swissquote. This content is provided for informational purposes only and does not constitute investment advice or a personal recommendation.
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