Markets have a way of testing conviction right when it matters most. Rate hike risk is back on the table, and the 10-year Treasury yield has pushed toward its highest level in a year. A growing share of investors are reading that combination as a signal to trim exposure broadly ahead of further uncertainty.
We're seeing this caution take hold more widely than expected, with a defensive tone creeping into positioning discussions across the industry. We understand the instinct and, in some areas, we share it. But we think the more useful response is recalibration, not retreat; narrowing where we lean in rather than abandoning risk assets wholesale.
The starting point is the underlying economy. Federal Reserve Chair Warsh's own recent commentary pointed to fundamental strengthening beneath the surface, and we'd echo that view: the resiliency, as evidenced by recently released data, argues against wholesale derisking. That said, we don't think this strength supports uniform enthusiasm across every corner of the market, either. Our conviction here is selective rather than broad-based, and that distinction matters more than the headline risk-on or risk-off label.
Not All Exposure Is Created Equal
This isn't a call for unlimited risk-taking everywhere. Smaller companies carry meaningfully higher sensitivity to financing costs, and floating-rate funding exposure, combined with housing-related softness and moderating earnings estimates, argues for a more balanced stance there after a strong multiyear run. We think that's a sensible, targeted adjustment, distinct from the broader case for equities. Selectivity within the asset class is not the same as retreating from it, and it shouldn't be read as a loss of conviction in equities more generally.
The Earnings Case Still Holds
Start with the numbers. The S&P 500 Index’s blended earnings growth for the second quarter came in at 52%, more than double the roughly 23% analysts had penciled in before results season began. That is not a rounding error; earnings blew past already lofty expectations. And the momentum hasn't stalled: third-quarter growth is tracking around 27%, with fourth-quarter estimates above 24%. Encouragingly, this strength is broadening beyond mega-cap technology into infrastructure-linked sectors, though the index's concentration still leaves it exposed to multiple compression if capital expenditure decelerates.
Valuations deserve continued scrutiny given how much of this earnings strength has been tied to a relatively narrow group of large technology names. Multiples have compressed meaningfully over the past year even as earnings surged, which should make us somewhat more comfortable with current pricing, though careful not to become complacent about how quickly that could reverse.
AI Spending: A Genuine Tailwind, With Real Limits
We'd push back on the instinct to grow uniformly defensive on U.S. large-cap equities, where earnings resilience and continued conviction in the AI capital expenditure cycle still argue for holding exposure. A rotation toward historically expensive defensive sectors doesn't, on its own, square with the strength we're still seeing in results.
That said, we're more cautious than we've been about extending this enthusiasm indiscriminately. The AI capital expenditure cycle is large by any measure, with spending among the largest hyperscalers expected to approach roughly $733 billion in 2026, nearly double 2025 levels, according to sell-side consensus estimates.
A moderation in that spending, should it occur, isn't the unambiguous negative it's often portrayed as; it would ease pressure on chipmakers while improving the supply-demand balance for companies deploying AI tools to lift productivity and margins elsewhere. That argues for staying invested through the transition, not stepping to the sidelines ahead of it. This same tension shows up outside the U.S., where a genuine opportunity in China sits alongside recent strength in markets like Korea, where already-depressed multiples could face further pressure if AI capex moderates.
Risks to Watch
Conviction shouldn't mean ignoring the risks.
The first is the interest rate path itself. Markets are digesting scenarios ranging from a modest 50 – 75 basis points of further tightening to a much more aggressive 150- to 200-basis-point cycle. History is fairly unambiguous that sharp, sustained hiking cycles, not gradual tightening, tend to choke off bull markets. If the more aggressive scenario materializes, we’d need to further reduce the risk in portfolios.
Second, the narrative underpinning our conviction matters as much as the positioning itself. If AI enthusiasm is the primary driver of our confidence, that story needs to remain consistent across every part of the portfolio it touches, domestic and international alike. Where the case for caution is legitimate, we think the more honest narrative is a quality focus: continued economic momentum and strong earnings for several more quarters, weighed against real overhangs from restrictive policy, inflation and capex slowdown risk.
Third, the earnings strength we've seen has been narrower than headline numbers suggest, concentrated in a few mega-cap names. Broader participation would make this rally, and our confidence in it, considerably more durable.
Selective Conviction
None of this changes our overall lean toward risk assets, but it does temper how broadly we're willing to apply it. We remain constructive on U.S. large caps and on Japan and China specifically, while taking a more measured stance on smaller companies, broader developed non-U.S. markets, and undifferentiated emerging-market exposure. That's a deliberate recalibration, not a retreat, and it reflects real earnings strength weighed against genuine, specific risks rather than a uniform view in either direction. We'll be watching the pace of hikes, the breadth of earnings, and the concentration risk building in AI-linked names closely, and we'll adjust further the moment the data tells us to.
What to Watch For
Tuesday 09/29:
- U.S.: CB Consumer Confidence
- U.S.: JOLTS Job Openings
- China: Manufacturing Purchasing Managers’ Index
Wednesday 09/30:
- U.S.: ADP Nonfarm Employment Change
- U.S.: Core PCE Price Index
- U.S.: GDP
- U.S.: Chicago Purchasing Managers’ Index
- U.K.: GDP
- Germany: Consumer Price Index
Thursday 10/01:
- U.S.: Initial Jobless Claims
- U.S.: Manufacturing Purchasing Managers’ Index
- U.S.: Manufacturing Prices
Friday 10/02:
- U.S.: Average Hourly Earnings
- U.S.: Nonfarm Payrolls
- U.S.: Unemployment Rate
- Eurozone: Consumer Price Inflation
