We certainly are living in interesting times. There are numerous variables and cross-currents that are conspiring to reshape the macro environment, and the near-to-medium term may be quite different from the one that investors have grown accustomed to in recent years. Although the situation is dynamic and even murky at times, we believe investors should be prepared for a higher interest rate regime as our new normal. If true, there could be important implications in structuring both equity and fixed incomeportfolios.

Fiscal and Monetary Headwinds?

For starters, let’s step back and consider how a few factors appear to be fundamentally reshaping financial markets. Geopolitical tensions continue to run high, particularly in the Mideast, and that’s been reflected in energy price volatility. Not surprisingly, inflation has been running hot. The year-over-year consumer price index (CPI) has climbed to 3.4%, as of August 2026, according to the most recent release from the U.S. Bureau of Labor Statistics. That remains markedly above the Federal Reserve’s stated 2.0% target, and new Fed leadership has articulated that it is intent on controlling prices and bringing inflation down to target. No surprise, markets have priced in tighter monetary conditions, and this has shifted the yield curve higher in 2026.

It’s not just monetary policy that has caught the attention of financial markets. Further complicating matters is the fiscal side of the equation (in the U.S. as well as in other developed economies).

The cumulative federal budget deficit for fiscal year 2026 is projected to be roughly $1.9 trillion, or roughly 5.8% of GDP, according to the Congressional Budget Office. Large and persistent budget deficits have pushed the U.S. government's total accumulated debt to more than $40 trillion, according to the Treasury Department. This eye-popping number casts doubt on the sustainability of any strong fiscal tailwind for financial markets. Given this fiscal backdrop, we should not be surprised that Treasury yields at the long end have surged. This makes borrowing more expensive for consumers and corporations, to say nothing of what it does to the government’s own interest expense.

Nevertheless, equities have been remarkably resilient in the face of all the uncomfortable news. After a steep drawdown at the start of U.S. military action in the Mideast early this year, equities rebounded and forged ever higher (with some bouts of volatility) as we approached year-end.

A Word about the Midterms

As if investors don’t have enough on their minds, U.S. midterm elections are right around the corner. Nobody has a crystal ball, but our base case is for a divided government, and it’s unlikely (though far from impossible) that we will see continued unified Republican control of both houses of Congress and the executive branch. With respect to markets, our research of the historical record suggests that divided government has been the most constructive backdrop for equities, while fixed income has performed best when legislative gridlock disciplines fiscal policy. The U.S. dollar (USD), conversely, has tended to strengthen most under unified Republican rule. For the moment, however, we expect limited direct equity market impact across scenarios, but potentially more meaningful implications for rates and the USD depending on the composition of Congress in January 2027.

Portfolio Implications for Equities

Of course, the shifting macro backdrop, domestic politics, and geopolitical turmoil will continue to influence equities. Although some portfolio shifts may be appropriate (depending on each investor’s specific situation, goals and risk-tolerance), it’s important to reiterate that focusing on the long term and not acting impulsively is paramount across all macro environments.

That said, we do believe that a higher-rate regime is the new normal given the confluence of factors outlined above. In this likelihood (in our view), valuation discipline for equities may be coming back into vogue. In the era of cheap money post-Global Financial Crisis and again post-pandemic, it seemed like valuations mattered less to investors. That mindset appears to be shifting.

Why? One key reason is that a higher yield curve also pushes up the discount rate, which is typically used to value future cash flows. This mechanically lowers the present value of earnings expected far in the future, even if a company's business hasn't changed. One result could be broad, correlated equity volatility, since every stock's valuation depends on that same discount rate at the same time. "Long duration" stocks (i.e., those companies whose value depends on earnings many years out rather than cash generated today) are likely to be more vulnerable to repricing, similar to how a long-maturity bond is more rate-sensitive than a short one.

As a result, we think that today's AI-driven market concentration, particularly among some of the large-cap indexes, bears watching. This is where the risk is amplified, in our view. We believe that a large share of the S&P® 500’s value (among other indexes) continues to sit in a handful of mega-cap names priced on future AI monetization. We think that it might behoove investors to embrace greater diversification and potentially consider more actively managed approaches, which may be able to better manage the risks away from this cohort.

What about Fixed Income?

Fixed income investors may also want to shift their focus if we are entering a new higher-rate regime. Certainly, we are not expecting Treasury yields to revisit their 15+% peak (not a typo) as they did in the early 1980s. However, the historical context is a good reminder when 10-year Treasuries are moving above 5% and feel impossibly high. In this new era, it’s also important to remember that fixed income actually provides a potentially attractive real yield return—the yield after subtracting the effect of inflation. That has not always been the case, and thus bonds appear to offer a decent risk-return alternative to equities, in our view.

In addition, targeting shorter- to intermediate-term Treasuries may be more attractive at present. And emphasizing higher-quality, shorter-duration securities within corporate credit, with an emphasis on diversified securitized credit exposure and sufficient liquidity, could allow investors flexibility if conditions turn more turbulent.

As with the equities market, we believe an active approach to fixed income may be a better approach versus passively allocating to large bond index funds. Some passive bond funds may carry more exposure to unwanted areas of the fixed income world, and thus we believe they may be set up to underperform in today’s new normal.