2nd Quarter, 2026
Global conflicts continue to put upward pressure on interest rates.
The Markets
Global markets finished the quarter significantly higher, supported by easing geopolitical tensions in the Middle East and the continued resilience of the U.S. economy. While the ceasefire between the U.S., Israel and Iran remains fragile, increased shipping activity through the Persian Gulf has contributed to lower energy prices, helping to temper near-term inflationary pressures. Nevertheless, meaningful damage to regional energy infrastructure underscores that geopolitical risks remain elevated and could re-emerge quickly.
Equity markets remain heavily concentrated in companies leading the artificial intelligence revolution. While the long-term potential of AI is substantial, the extraordinary level of capital investment required is beginning to outpace internally generated cash flow for many participants. As a result, companies are increasingly turning to debt and equity financing. Given the strong balance sheets of many industry leaders, this is not inherently concerning, but it does introduce an additional layer of financial risk should growth expectations moderate.
Government finances also continue to warrant attention. Elevated debt levels have made investors increasingly sensitive to risks involved with longer-term bonds, contributing to higher Treasury yields and greater reliance on shorter-term government financing. This dynamic bears watching, particularly if inflation or fiscal deficits persist.
Overall, financial markets continue to price in a favorable economic outcome. While that optimism may prove justified, today's elevated valuations leave less room for disappointment, whether from geopolitics, inflation, interest rates or slowing corporate earnings growth.
The Economy
Domestically, the economy continues to demonstrate surprising durability. Employment growth remains positive, layoffs are modest, and inflation has generally moderated. Looking ahead, however, the path toward sustained price stability may require interest rates to remain higher for longer. Several major central banks have already begun adjusting policy in response to similar inflationary dynamics.
Consensus forecasts call for U.S. GDP growth of approximately 1.8% to 2.0% in 2026, with modest improvement expected in 2027. Consumer confidence weakened during the escalation of tensions with Iran but has recently stabilized as energy prices have eased and the risk of broader regional conflict has temporarily diminished.
Business investment remains a bright spot, driven primarily by unprecedented spending on AI infrastructure. This investment is helping support economic growth, although AI-related capital assets generally have shorter useful lives than traditional industrial investments, requiring ongoing reinvestment that will need to be financed over many years.
The consumer remains the backbone of the U.S. economy, but financial conditions have become more challenging. Pandemic-era savings have largely been exhausted, the personal savings rate remains historically low, and consumer credit balances continue to rise. Higher fuel prices earlier this year also weighed disproportionately on lower and middle-income households, reinforcing the uneven nature of the current expansion.
Housing affordability remains another structural challenge. For decades, affordable homeownership has been a key driver of household wealth creation and consumer spending. Today, elevated home prices and financing costs continue to limit affordability for many first-time buyers, reducing one of the traditional engines of long-term economic growth.
Globally, geopolitical uncertainty remains an important economic consideration. The situation in the Middle East remains fluid, while the war in Ukraine continues to reshape defense priorities around the world. Increased defense spending across Europe and other allied nations is likely to remain a significant source of long-term government investment for years to come.
Investment Strategy
The strong advance in equity markets has pushed valuation multiples toward historically elevated levels. The Cyclically Adjusted Price-to-Earnings (CAPE) ratio at 42x now approaches levels last seen during the technology bubble, while the S&P 500's free cash flow yield of just 2.7% remains well below its long-term average of 4.7%. These metrics do not predict market turning points, but they do suggest that future returns may increasingly depend on earnings growth rather than expanding valuations.
Today's market leadership remains highly concentrated among a relatively small number of AI-related companies. While enthusiasm has broadened into sectors expected to benefit from AI adoption, current valuations leave little margin for error should investor expectations become more measured.
We also continue to monitor areas of the financial system where higher interest rates are creating pressure, particularly within private equity and private credit markets. Reduced liquidity has complicated valuations and slowed new investment activity.
Our investment approach remains unchanged. We continue to rebalance portfolios thoughtfully, harvesting gains where appropriate while maintaining equity allocations consistent with each client's long-term objectives and risk tolerance. We also continue to view U.S. Treasury securities as an attractive source of liquidity, income and portfolio stability in the current environment.
Most importantly, we remain committed to owning high-quality businesses with durable competitive advantages, strong balance sheets, and the ability to generate sustainable cash flow across varying economic conditions. While short-term volatility is inevitable, history has consistently rewarded disciplined, long-term investors.
Some Thoughts on AI Growth and Financing
Artificial intelligence has evolved from an emerging technology into one of the most significant drivers of the U.S. economy. Its contribution to economic growth has expanded rapidly, supported by unprecedented investment from many of America's largest technology companies.
The scale of this investment is extraordinary. Increasingly, spending commitments exceed internally generated cash flow, leading companies to access debt markets, issue equity, and utilize off-balance-sheet financing structures to fund continued expansion. While these financing strategies are manageable for many industry leaders today, they introduce leverage that investors should not ignore.
A recent report from the Bank for International Settlements observed that while the broader financial stability risks associated with the AI boom remain manageable, its long-term sustainability depends on companies ultimately delivering the earnings growth that current valuations imply. We believe this is an important observation.
We remain enthusiastic about AI's transformative potential and expect it to remain a powerful force in economic growth for many years. At the same time, prudent investing requires distinguishing between long-term opportunity and short-term market expectations. Maintaining diversification, disciplined valuation standards, and appropriate risk management remains the most effective way to participate in this innovation while protecting capital.
As for China, it is becoming increasingly clear that the main purpose of the high-powered robotics engineering program is being driven by the government’s view that it will need to replace an aging workforce. This appears to be their solution to the shortcomings of China’s one child policy of the 1970’s. The development of large-scale humanoid robots does have ancillary potential for dominance in global industrial and defense applications.
Thank you for your continued confidence and trust. We appreciate the opportunity to steward your assets and remain committed to helping you navigate changing markets with discipline, perspective and a long-term focus.