Market Sense: The CIO View

Peter Fitzgerald reflects on investment markets in the third quarter of 2026 and shares his outlook for the months ahead.

At a glance

• Higher bond yields are changing the investment outlook: Rising energy prices, higher interest rates and other market pressures have improved the outlook for bonds while making it harder for shares to deliver strong returns.
• Opportunities are becoming more selective: Areas linked to AI, higher-quality bonds, and selected investments outside the US, including energy, materials and real assets, remain attractive.
• Diversification remains important: Inflation, government borrowing and geopolitical tensions remain key risks, reinforcing the need to spread investments across different assets.

A shift in market conditions

The third quarter marked a clear shift in market conditions. Early signs that inflation was easing gave way to a more challenging backdrop of resilient activity, rising energy inflation and higher-for-longer interest rates.

July began with weaker US inflation and jobs data, which briefly supported bonds and weakened the dollar. Renewed disruption in the Middle East then pushed oil prices above $100 a barrel, with the impact spreading beyond oil into gas, fuel products and transport costs.

By September, central banks around the world were keeping pressure on inflation through higher interest rates and tighter policy, while government bond yields had reached their highest levels for several years. Investors were reassessing both the outlook for interest rates and whether elevated equity valuations remained justified.

The more significant change was the rise in real yields, driven by government borrowing, energy security spending and investment in AI infrastructure. This improved the outlook for bonds while making it harder for shares to keep delivering the strong returns seen in recent years.

US economy picked up again

The US economy finished the quarter on a stronger footing than early data suggested.

July jobs data initially appeared particularly weak, with employment falling by 23,000 and previous months' figures revised lower, supporting government bonds and weakening the US dollar. However, employment growth recovered in August and economic activity strengthened through September. The Federal Reserve responded with its first rate rise since 2023 and the dollar recovered.

Europe faced higher energy costs and slower growth

Europe faced a more difficult combination of rising energy costs and weaker economic growth. The European Central Bank continued to take steps to tackle inflation as energy-related price pressures returned. In France, political uncertainty and concerns about government finances weighed on investments, although markets may have reacted too strongly, too quickly.

UK economy stayed resilient despite borrowing costs

The UK economy proved more resilient than expected. The Bank of England kept rates at 3.75% but warned that ongoing energy inflation could eventually require further action.

UK government bonds, known as gilts, remained under pressure as bond yields rose around the world and concerns grew about government borrowing ahead of the Budget.

AI investment continues to support shares

Shares were supported by stronger company earnings and continued investment in AI, although market leadership became more varied.

The AI theme continued to be driven by company earnings rather than rising valuations alone, with many of the beneficiaries among semiconductor, memory, power and equipment suppliers rather than AI service providers themselves. Spending on AI infrastructure by the largest technology companies also increased demand for investment and kept pressure on interest rates.

Higher yields challenged share valuations

Higher bond yields put pressure on share valuations, even as company earnings continued to rise. This prompted investors to look beyond the US market and take a more selective approach, with growing interest in value stocks, energy, materials and infrastructure.

In Europe, opportunities became more selective too, with investors focusing on specific companies and sectors rather than the market as a whole, reflecting differences in energy exposure and political uncertainty in France.

Bonds played a more valuable role again

Bond prices fell as investors adjusted their expectations for inflation, interest rates and future returns, rather than because of problems in any single market.

While this created short-term pressure, higher bond yields have improved the outlook for bonds over the medium term. US government bond yields returned to more sustainable levels, offering more attractive income and making bonds look more appealing relative to expensive US shares.

Outlook

The investment opportunity set is broadening, but a more uncertain backdrop means diversification needs to work harder.

Higher yields have improved the outlook for higher-quality bonds, offering more attractive income and strengthening their role in diversified portfolios.

In shares, investment linked to AI continues to create opportunities in the infrastructure needed to support it, including semiconductors, memory, power and equipment. However, investors are likely to focus increasingly on whether this high level of spending can deliver the earnings growth and productivity improvements needed to justify it.

Higher interest rates reinforce the case for diversifying across different regions as economic conditions, policy decisions and valuations increasingly diverge. Selective exposure to energy and materials could benefit from continued investment in energy security, electrification and digital infrastructure, while real assets and inflation-aware strategies may help portfolios navigate a more volatile inflation environment.

The main risks to watch

Prolonged disruption to the Strait of Hormuz could push up energy and transport costs, keeping inflation higher for longer and increasing the likelihood of further interest-rate rises.

High levels of government borrowing could continue to create volatility in bond markets, while weaker-than-expected returns from AI-related investments could put pressure on companies whose share prices have benefited most from the AI theme. China's property slowdown remains a challenge for global demand, while new tariffs and political tensions could further disrupt trade, investment and supply chains.

What this could mean for investors

For a diversified investor, the key message is balance rather than making big reductions in risk. Bonds have become more useful again in portfolios, but periods of higher inflation can still cause shares and bonds to move in the same direction for a time. As a result, choosing the right investments is becoming increasingly important, rather than relying on broad market exposure alone.