Risks Are Increasing, but the Foundation is Solid

Outlook: October 2026

Executive Summary
The fundamentals driving this bull market are strong. However, the risks to the outlook have increased given persistent inflation, rising interest rates, the ongoing conflict with Iran, and the recent shift in the Federal Reserve’s policy. We maintain our positive view but acknowledge the range of outcomes has widened. 

A sustained economic expansion, fueled by an investment super-cycle in artificial intelligence infrastructure, consumer net worth at an all-time high, persistent consumer spending, and a stable labor market, has helped to sustain the bull market. At the same time, corporate earnings growth has been exceptionally strong, with consensus estimates currently calling for earnings to increase approximately 30 percent this year. Growth rates of that magnitude are unusual and typically occur after a recession. Looking forward, the growth in earnings is broad-based rather than being driven solely by select technology companies, paving the way for profits to continue to expand, and they are expected to rise more than 10 percent next year. 

We are closely monitoring the risks, but this bull market is driven by powerful trends that are likely to be enduring. Accordingly, we maintain our positive outlook while acknowledging the wider range of outcomes. Given the shifting dynamics, we believe this is a good time to review portfolio allocations and rebalance where appropriate, particularly in assets that have appreciated significantly and are now above long-term target weights.

We wish you all the best and encourage you to reach out if you want to discuss our outlook in more detail.

Economy

The economy continues to grow at a modest pace fueled by consumer spending and sustained investments in artificial intelligence infrastructure. The strong rise in stock prices has driven consumer net worth to a record level and the labor market continues to expand at a modest pace. Accordingly, consumers continue to spend and are helping to sustain this economic expansion.  

Investments in the artificial intelligence infrastructure have also become a driver of economic growth. In both the first and second quarters of this year, business investment contributed more than one percentage point of GDP growth. That rate far exceeds the long-term average; it also represents a large portion of the economy’s growth in the first half of the year. 

The federal government is also playing a part in the expansion. While the Federal Reserve is tightening its policy, the federal government continues to spend, providing its own form of stimulus. This year, the Congressional Budget Office forecasts the federal government will run a budget deficit of approximately six percent of GDP. Historically, deficits of that size are associated with periods of economic hardship or recession. In other words, the government is pursuing a stimulative spending policy during an economic expansion. That magnitude of the spending provides a tailwind to economic growth, but it is also a factor in today’s rising interest rates and persistent inflation. 

The economy’s growth drivers are well entrenched, but inflation remains above the Federal Reserve’s 2.0 percent target. The persistent rise in prices was a major factor in the Federal Reserve’s decision to raise interest rates in September. Notably, the central bank also provided guidance suggesting that an additional rate increase may be implemented before year-end. We will monitor inflation trends closely, as a couple of rate hikes are not likely to have a significant impact on the economy’s growth trajectory. However, if the inflationary pressure does not subside, our central bank may need to engage in a sustained series of rate hikes and that has the potential to slow economic growth and threaten the economic expansion.

While the resurgence in inflationary pressure increases uncertainty and widens the range of outcomes, our base case calls for a continuation of the economic expansion, but with modest growth of approximately 2.0 percent. We expect consumer spending to be resilient given the wealth effect from the rise in the stock market in recent years. Just as important, business investment should continue to act as a growth driver. Capital expenditures from the major hyperscalers are expected to rise dramatically this year and again in 2027. However, the persistence of inflationary pressure and the tightening of policy by the Federal Reserve are likely to act as headwinds to growth.

Inflation

The latest Consumer Price Index (CPI) report showed inflation is rising and remains well above the Federal Reserve’s target. As expected, oil and other energy-related commodity prices have increased significantly due to the supply chain constraints. 

Inflation is one of the primary swing factors in the outlook. If today’s high energy prices are sustained for an extended period, inflationary pressure is likely to expand to other segments of the economy given that oil and petroleum products are a source input in many goods and services. In addition, a sustained period of price increases may also lead to higher inflation expectations, which are often accompanied by rising savings rates, a reduction in consumer spending, less spending on discretionary items, and a slower pace of economic growth. 

In the coming months, we expect headline inflation readings to remain elevated, given today’s high energy prices. However, our base forecast calls for an eventual decline in oil prices and a moderation in the inflationary pressure. Based on that outlook our view for this year calls for headline inflation to be approximately 3.5 percent.

U.S. dollar

Last year, the U.S. dollar declined relative to many other currencies. The weakness was driven by expectations for a moderation in U.S. growth, improvements in the economic outlook for many foreign economies, uncertainty surrounding U.S. trade policies, and the sustained increase in U.S. debt levels. In contrast, the dollar has increased this year given the rise in interest rates, the shift in policy by the Federal Reserve, and heightened geopolitical risks.

Expectations of sustained inflationary pressures, the recent rise in interest rates, the ebbs and flows of geopolitical risks, and another rate hike by the Federal Reserve, are expected to keep the U.S. dollar range bound in the coming months. However, on a long-term basis, the dollar is at risk of further depreciation if our government debt levels continue to increase at their current pace. 

Asset class

Cash/Money Market Instruments

We expect money market yields to remain attractive in the coming months, supported by persistent inflation, the Federal Reserve’s recent rate increase, and expectations for an additional rate hike prior to the end of the year. With economic growth remaining resilient and inflation still above target, money market yields are likely to remain near current levels or increase slightly through year-end as policymakers may move short-term rates modestly higher.

Intermediate Government/Credit Bonds

We expect high-quality intermediate government and corporate bonds to offer attractive income over the next three to six months, with yields now at some of their most compelling levels in recent years. For investors building individual bond portfolios, the recent rise in rates allows maturing securities and new cash to be reinvested at higher yields, gradually increasing portfolio income. Although yields could move somewhat higher, a diversified portfolio held to maturity should benefit from today’s improved income and return profile.

Tax-Exempt Municipal Bonds

Municipal bonds should remain appealing over the next three to six months, particularly for investors in higher tax brackets, as recent yield increases have improved their value relative to taxable alternatives. State and local government finances remain generally healthy, providing a supportive credit backdrop for high-quality issuers. Elevated new issuance may create periodic price pressure, but it should also provide opportunities to add attractive tax-exempt income across a well-diversified municipal bond ladder.

U.S. Equity

The equity market has generated solid returns this year, but the leadership has changed. In a reversal of the long-term trend, international equities, as well as those in the value and small/mid cap styles, have outperformed the growth segment year to date. While earnings continue to rise rapidly in the technology sector, stocks across other equity styles are now participating in this trend, with strong earnings growth and a positive outlook for profits in the coming quarters.

We see two catalysts supporting a continuation of the current bull market. Earnings growth has been exceptionally strong, with increases of at least ten percent in each of the last two years. That trend is poised to continue, with exceptional growth this year and expectations for a sustained increase in 2027. 

Investment in artificial intelligence is another driver of equity prices, with hyperscalers like Microsoft, Meta, and Amazon spending hundreds of billions of dollars per year on the infrastructure needed to deliver artificial intelligence services. This investment boom is driving strong demand for products and services ranging from construction and energy-generation equipment to semiconductors and network connectivity components. 

These drivers of the bull market are critically important as the risks to the outlook have increased given the upward trajectory of interest rates, the ongoing conflict with Iran, and the persistence of inflationary pressure. To contain inflationary pressure, the Federal Reserve raised interest rates in September and provided guidance that suggests they will raise rates again before the end of the year. Historically, a couple of rate hikes, in isolation, have not had a significant impact on equity prices, but a sustained series of rate hikes would create a meaningful headwind for this bull market. 

Given the combination of strong earnings growth, rising interest rates, and an uptick in the risks to the outlook, equity valuations have declined from historically high levels. As it stands, the S&P 500 Index is trading at 19x forward earnings, which represents a premium to the long-term average, but is far from extremes or levels that are worrisome. 

In aggregate, we maintain our positive outlook but are monitoring the risks closely.

International Equity

Foreign stocks have generated strong returns, driven by improving earnings growth, targeted stimulus programs in some parts of the world, the ongoing economic expansion, and attractive valuations. Within this segment, stocks in emerging markets outperformed those in developed countries, driven by strong returns in the emerging Asia region. Asia is home to many technology companies in the artificial intelligence supply chain, and their stocks have performed well. 

The recent drivers of international equity returns remain supportive, but much like the U.S., there has been a slight deterioration in the outlook. Interest rates are rising worldwide, and the European Central Bank recently increased its policy rate. In Japan, the government is pursuing opposing policies with the central bank raising interest rates and the federal government cutting taxes. However, earnings growth remains strong, and valuations are attractive in foreign markets. Accordingly, we maintain our positive view and continue to expect greater symmetry in the long-term returns between U.S. and foreign stocks.

Commodity

Commodity prices have increased this year, led by the energy segment, but industrial metals and agricultural products have also moved higher. After several years of large increases, gold has posted modest year-to-date losses. 

We maintain our positive long-term view on commodities but anticipate volatility within the group. In the coming months, oil is likely to remain elevated even if there is a resolution in the conflict with Iran as the supply chain will take time to normalize. We also expect upward pressure on prices for other commodities, as the disruption in energy markets affects the cost of food, transportation, and other items. In terms of precious metals, we anticipate sustained long-term demand amid rising government debt across major economies and subsequent efforts to diversify away from fiat currencies.

Potential opportunities & risks

OPPORTUNITIES

The emergence of artificial intelligence and other innovative technologies—the convergence of cloud computing, significant increases in computing power, and the smartphone—has created a connected world in which new technologies are changing how we live. This convergence has created investment opportunities centered around long-term themes such as the growth of artificial intelligence, Big Data, and quantum technologies.

A productivity boom—The advancements in technology noted above, coupled with rising costs and a persistent shortage of skilled labor, are leading companies to invest in new technologies to automate processes and boost productivity. Higher productivity enables faster economic growth without a sustained rise in inflation.

Rising demand for power—Power demand is poised to expand for the first time in a generation. The proliferation of artificial intelligence and the increasing number of data centers are catalysts for this trend, along with industrial reshoring and the rising use of electricity as a substitute for fossil fuels. The increase in demand marks a pivotal shift for the electrical equipment and grid infrastructure industry, which provides the hardware, software, and services that enable modern power systems. The industry is poised to benefit from rising electricity demand and a second-order effect in the transformation of how energy is generated, transmitted, and managed.

The evolution of finance—Technological advancements are disrupting the financial services industry. We are experiencing a global shift from paper currency to electronic payments, driven by the growing popularity of credit cards, debit cards, stablecoins, and cryptocurrencies. Online payment systems facilitating money transfers, e-commerce, and electronic bill-paying services are also experiencing strong demand. This shift is still in its early stages and has a long runway as it is occurring across both developed and emerging economies. In the coming years, blockchain technology may become a significant disruptor in the finance industry, creating opportunities for new entrants and risks for the firms currently dominating this space.

Expansion of robotics—5G communications, sensors, and artificial intelligence are facilitating technological innovations that are advancing robotics in healthcare, restaurants, construction, and other industries. 

Personalized healthcare—Advancements in technology support tailoring treatments to each patient, streamlining the drug discovery process, providing continuous data analysis in real-time, and improving clinical trials through digitization. Investment opportunities across the healthcare spectrum will be enhanced as artificial intelligence and machine learning increasingly result in better healthcare experiences.

RISKS

Geopolitical risks—We are closely monitoring developments in the conflict with Iran and the trajectory of energy prices. In addition, conflicts in many other parts of the world have escalated or have catalysts that may result in a change in dynamics, including the war in Ukraine. In international relations, we are also closely following developments in the relationship between the West and China.

A Pullback in Investments in Artificial Intelligence (AI)—Last year, the major hyperscalers (Alphabet, Amazon, Meta, Microsoft, and Oracle) invested more than $400 billion in data centers and infrastructure supporting AI and cloud computing. In 2026, they are expected to invest almost twice as much. These investments have been a significant driver of corporate earnings growth in recent years, and that trend is expected to continue.  

Advancements in technology can also help boost the economy’s productivity, resulting in a faster pace of growth without inflationary pressure. A pullback in AI investment, if that occurs, is likely to lead to disappointing results for corporate profits and economic growth. Accordingly, we are closely monitoring the amount of investment in AI as well as the productivity data. 

Inflation—Given the near-term impact of the conflict with Iran, coupled with persistent federal budget deficits, a high level of government debt, reduced investment in production capacity for some commodities, the trend towards deglobalization, and a shortage of labor, there is a risk that inflation may be in a sustained upward trend and remain above the average of the last thirty years.

Peak globalization/protectionism—The trend toward globalization that has been in place since the fall of the Berlin Wall is now being reversed. A renewed priority to ensure independence by securing access to commodities, promoting domestic manufacturing, and a race to establish global dominance in certain technologies have led to a reversal of the free trade movement. We expect this development to be accompanied by sustained increases in geopolitical tensions, upward pressure on inflation, rising costs in some industries, and the potential for a moderation in economic growth.

Rising government debt—Sovereign debt levels were rising before the outbreak of COVID-19. However, in the wake of the virus, they increased significantly. In the U.S., government debt outstanding has increased 83 percent since the end of 2019. While the short-term implications of higher debt levels are manageable, the long-term impact may be substantial as rising interest costs burden taxpayers.

Originally posted on October 15, 2026.

Disclosure: This material is provided for informational purposes only and reflects the opinions and market outlook of Badgley Phelps Wealth Managers, LLC as of the date indicated. It is not intended as investment, tax, legal, or accounting advice or as a recommendation or solicitation to buy or sell any security, investment product, or investment strategy.

This material contains forward-looking statements, including forecasts, projections, and expectations regarding future economic conditions, markets, interest rates, inflation, corporate earnings, and asset-class performance. Forward-looking statements are inherently uncertain and are based on assumptions and information available as of the date of this publication. Actual results may differ materially, and there can be no assurance that any forecast or projection will be realized.

Past performance is not indicative of future results. All investments involve risk, including the possible loss of principal. References to indexes are provided for informational purposes only. Index performance does not reflect the deduction of fees, expenses, or taxes, and investors cannot invest directly in an index.

Information has been obtained from sources believed to be reliable, but Badgley Phelps Wealth Managers, LLC does not guarantee its accuracy or completeness. Opinions and expectations are subject to change without notice. Investors should consider their individual circumstances, investment objectives, risk tolerance, and tax situation when making investment decisions.