As we move into the final quarter of 2026, investors face an unusual combination of economic resilience in several major markets, sticky inflation and sharply rising government bond yields. In addition to these macro factors, there are a wide range of complex external risks present, including high energy costs, geopolitical uncertainty, and questions about the pace and governance of artificial intelligence (AI) development. Despite this, equity markets have uncharacteristically adopted the mantra of ‘keep calm and carry on’.
The most notable market event over the summer months, and now pushing into the autumn, has been within bond markets. Over the past 20 years, governments across the developed world have borrowed habitually at scale. The chickens have, however, come home to roost as several converging factors – including persistent inflation and increasing competition for debt from corporations – push yields sharply higher and prices lower.
Rising government debt is understandably concerning, particularly when the cost of servicing debt as existing borrowing is refinanced absorbs tax revenue that could otherwise be used for public services or investment. However, debt levels alone do not necessarily point to an imminent crisis. The more relevant questions are whether governments can maintain the confidence of the bond markets, and whether economies can grow quickly enough to prevent debt servicing costs becoming progressively less manageable.
For investors, higher yields create both risks and opportunities. Government bond prices can fall further if inflation remains persistent or if markets demand additional compensation for lending to heavily indebted governments. However, yields now provide a useful cushion for investors that did not exist when rates were close to zero following Covid. In simple terms, this means that if yields remain broadly unchanged, investors are being paid a good level of income; if economic growth weakens and interest rate expectations fall, longer-dated government bonds could also provide useful capital gains and portfolio protection.
This dynamic is what the traditional asset allocation and diversification methodology was built around. When economies are strong, equities produce good returns and bonds produce a predictable, but not exciting, income. When economic shocks occur, equity prices fall, but as central banks respond by cutting interest rates, bond prices can rise. The adjustment to rising yields and falling bond prices has been uncomfortable for investors already holding a significant weighting to the sector. However, the relationship between interest rates and bond prices means that higher-quality bonds have the potential to provide meaningful protection during a growth-led slowdown, a role that was largely missing from the toolbox during the era of ultra-low interest rates.
The other dominant theme remains artificial intelligence. Whilst the headlines focus on the companies developing the AI models that can help us sort our emails and plan our holidays, investor enthusiasm has focused largely on the companies building the infrastructure behind the technology. This ranges from semiconductor manufacturers to data centre operators and cloud providers. The long-term opportunity is substantial, but so too is the scale of investment required to support it and to maintain the speed of development that this competitive market requires and, increasingly, that investment is being financed through debt markets rather than existing cash flows.
This has also made the valuation debate more nuanced than many headlines suggest. Strong earnings growth has allowed several leading technology businesses to grow into valuations that previously looked stretched, meaning some now appear less expensive on conventional price-to-earnings measures than they did a year ago. That said, this ratio of share price relative to current or future earnings should not be used to establish whether a company represents good value in isolation. Many of the businesses at the centre of the AI investment cycle are cyclical and capital intensive, while the wider infrastructure build out is becoming increasingly reliant on continued borrowing and spending. These are factors that cannot be assessed simply by dividing a share price by earnings. Strong profitability and growing earnings can justify high share prices, but it can also create a temptation to assume that today’s exceptional growth is a permanent trend and not subject to cyclical corrections.
When managing portfolios, the greater concern is therefore concentration rather than valuation alone. Market-capitalisation weighted indices have become increasingly dependent on a relatively small number of companies and on the continued success of a single dominant theme, with the ten largest holdings now accounting for approximately a 28% of the MSCI World Index[1]. And this is not solely a US problem. Technology and semiconductor businesses also represent a significant proportion of several emerging market indices[2], meaning geographic diversification may provide less true diversification than investors assume.
The temptation is to crowd around these index funds where returns have been strong for several years now, and costs are low. There is a long-running narrative that doing so also means that you are avoiding manager risk, removing biases from the portfolio and allowing market forces to provide you with long-term growth. In many ways, this has been true, and there are a number of sectors where we feel that taking a low-cost passive approach is the right decision. However, the current composition of some of these indices is such that investors may have greater exposure to a small number of large technology-related companies than they may realise
It is also worth remembering that being positive on the prospects for AI does not mean backing only the big companies that are developing the technology. Just as previous technological advances ultimately created value far beyond their original developers, AI has the potential to improve productivity, efficiency and profitability across a wide range of industries. Whether that is direct efficiency gains in medical research, supply chain improvements for manufacturers, cost reductions for capital intensive financial institutions or allowing consumer businesses to reach new markets, there are many parts of the broader economy that could benefit as the technology continues to be more widely adopted.
We believe that this supports maintaining exposure to US equities and tech whilst remaining disciplined on position sizing and diversification. The US remains home to many of the world’s most innovative and profitable companies, but it is also an expensive and unusually concentrated market. We see little reason either to chase performance aggressively or to avoid the market altogether. Instead, we believe investors are best served by cautiously participating in the opportunity whilst recognising that the ultimate winners from the AI revolution may prove to be far more diverse than current market leadership suggests.
The UK market plays a useful diversifying role in portfolio construction because its sector composition is very different to the US and parts of Asia, with greater exposure to financials, healthcare, consumer staples, energy, utilities and materials. This can support portfolios during periods when highly valued technology shares are under pressure. Domestic growth remains subdued and the market’s relatively limited exposure to large listed technology companies means that the index will lag as the tech theme rises, however, the UK market’s defensive characteristics and, within large cap, global sources of return mean that the case for retaining exposure is broader than a view on the UK economy alone.
Elsewhere, opportunities remain selective. Japan has been a standout performer driven by a combination of macro factors, corporate governance reforms, and exposure to a number of strong tech companies. Whilst there may be further to go, recent gains mean that valuations are no longer as attractive as they were, making stock selection increasingly important.
Europe offers diversification and pockets of value, but weaker growth, developing macroeconomic risks in France and political risks in Germany mean that selectivity remains important. As with the UK, however, investors should not be guided by politics alone, and some of these concerns appear to be reflected in valuations. The European market provides exposure to a broad mix of industrial, healthcare, consumer and specialist manufacturing businesses, many of which are world-leading companies that could benefit as new technologies are adopted. While it is not currently our base case, an improvement in Chinese consumer confidence would also support many of Europe’s leading luxury businesses.
Investing feels uncomfortable when the outlook is uncertain and, with all that is happening in the world, uncertainty is abundant. Headlines continue to focus on rising debt levels, geopolitical tensions, inflation pressures and the rapid pace of technological change. However, in many ways, today’s investment landscape seems healthier than it has done for several years. Investors now have access to a broader range of credible options and no longer need to rely solely on a handful of technology companies or hope that interest rates remain close to zero to achieve attractive returns. Bonds can once again offer meaningful income and diversification, whilst equities continue to offer exposure to innovation, productivity and long-term economic growth.
The investment landscape will continue to evolve through shifting interest rate expectations, changing geopolitical relationships and transformative technologies such as artificial intelligence. Whilst it is impossible to know exactly how these themes will develop, we remain confident that investors are best served by maintaining a diversified portfolio, participating in long-term opportunities and avoiding excessive reliance on any single outcome or theme. Importantly, in an environment where both equities and bonds once again have a meaningful role to play, we believe a balanced approach remains as relevant as ever.
This note is intended as a general market update and should not be regarded as specific advice or treated as a recommendation to invest in any particular fund or asset class. Stock market investments can fall as well as rise. If you would like to discuss the implications for your own portfolio, please do get in touch.
[1] Source: MSCI World Index Factsheet (September 2026). The ten largest holdings represented approximately 27.85% of the index. These companies are; Nvidia, Apple, Microsoft, Amazon, Alphabet (A & C), Meta, Broadcom, Micron Technology and Tesla.
[2] Source: MSCI Emerging Markets Index Factsheet (September 2026). Technology related companies make up 9 of the 10 largest holdings in the index representing 38.17% of the index. Taiwan Semiconductor is the largest holding at 15.63% of the index.