OUTLOOK: Rising Rates, Impressive Resilience, Powerful Earnings Growth

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In This Outlook...

• Headlines suggest a bumpy road ahead, but opportunities are being presented for those looking past the headlines.
• Risks – persistent inflation, rising rates, stretched valuations, an appreciating U.S. dollar, difficult geopolitical backdrop, changing terms of global trade, and AI’s existential threat.
• What is driving economic and market resilience?
• Striking the balance between the risks and opportunities

Our July Outlook highlighted the underappreciated capital spending super cycle driving U.S. economic growth and equity markets to another year of positive returns. While our conviction in the beneficiaries of this super cycle remains intact, emerging growing economic and geopolitical risks have prompted us to adjust position sizes across several of our largest holdings.

Beyond escalating conflicts in the Middle East, Ukraine and Russia—which persist without a clear resolution in sight—we are observing several key risks: surging interest rates, an appreciating U.S. dollar, unexpected global election outcomes, persistent inflation, stretched valuations, and recent warnings from influential technology leaders regarding existential threats from AI. Despite these headwinds, global equity markets continue to flirt with all-time highs and have climbed since February when the war with Iran began (Chart 1). However, these risks demand investors be more circumspect in security selection as the combination of these forces will foster a period of higher interest rates that forces central banks to hike rates and make earnings growth all the more important.

Worrisome headlines aside, robust public and private sector spending continues to power the U.S. economy and push corporate profits toward new highs. Investors find themselves weighing the risks of AI disruption, entrenched inflation, and expanding sovereign debt against technology’s promise to deliver substantial productivity gains that offset price pressures. Productivity remains the structural antidote to inflation, and ARS continues to believe technological advances will play a pivotal role in resolving many economic pressures. However, a timing mismatch between today's capital spending and the realization of productivity gains demands active risk management, as elevated interest rates are already compressing price-to-earnings multiples. Second-quarter S&P 500 earnings grew more than 30% year over year while the index rose only about 22% over the same time frame, pulling the forward P/E from roughly 22x at the start of the year to just over 18x as the 10-year Treasury yield climbed to ~5.3%. Companies facing decelerating growth are the most exposed.

 Chart 1. Global Equity Markets Have Mostly Risen Since the Start of the Iran Conflict (as of 09/21/2026)

ARS continues to maintain high-conviction exposure across sectors aligned with non-discretionary capital deployment: industrials, energy, technology, select biopharma, financials, and basic materials. Within commodities, physical gold and silver remain key portfolio anchors given the persistent backdrop of sovereign deficit spending worldwide and critical industrial applications. Focusing exposure on non-negotiable, essential spending streams provides defensive ballast alongside asymmetric upside potential.

Rising Risks from Multiple Sources

“As technological powers increase, side effects and hazards escalate.”

–Alvin Toffler, Futurist

The global economy has experienced several well-documented crises over the past two decades. Today, the introduction of artificial intelligence (AI) brings extraordinary potential to reshape the world alongside unprecedented risks. Beyond acute disruptions to labor and cybersecurity, advanced frontier systems present existential concerns ranging from systemic loss of control to catastrophic economic and geopolitical destabilization. The concerns about energy prices, land use, tax treatment, and water are global, and local resistance to data center construction is on the rise as AI becomes a political issue.

Inflation Remains Elevated: Inflation has persisted above the Federal Reserve’s 2.0% target for over five years (see Chart 2). The global economy is absorbing triple supply-and-demand shocks from AI infrastructure demands, tariffs, and energy pressures. Due to the structural nature of these shocks, central banks have limited tools to resolve them solely through rate adjustments. Furthermore, the U.S. economy has remained—in the words of Fed Chair Kevin Warsh—"impressively resilient," with the Chair noting that broad conditions were "not restrictive" suggesting additional rate hikes ahead. While resolving geopolitical conflicts and reopening restricted trade corridors would relieve price pressures, near-term resolutions remain questionable at best.

 Chart 2. The Fed’s Preferred Measure of Inflation Has Been Above Target for 5 Years

Rising Rates from Growth, Debt and Deficits: As shown in Chart 3, interest rates are on the rise globally as the bill comes due from the fiscal policies employed to address the multiple crises experienced since 2008. Global debt has grown from $171 trillion in 2008 to $348 trillion following a decade and a half of zero-interest-rate policies, escalating investor concerns over net interest costs and fiscal deficits. These surging financing costs redirect capital away from critical economic priorities at a time when governments face more funding demands than tax receipts to support them. A continued rise in interest rates would push up debt-service costs and worsen the budget deficit outlook. As a result, bond investors would seek higher rates as governments would be forced to issue more debt and refinance at higher rates.

Three additional factors pushing U.S. interest rates higher are the volume of Treasuries requiring refinancing and new treasury issuance required to finance the large and growing federal deficit. In addition, domestic requirements to fund AI development are being satisfied by additional borrowing in the bond market. Sustained domestic economic strength is also contributing to the demand for borrowed money. The consequence of these factors is putting upward pressure on long term interest rates in the face of persistent inflation and a Federal Reserve that is likely to increase interest rates at least once more.

Chart 3. Rising Yields and Uncertainty Have Increased the Cost of Capital

AI Spending Slows Materially: Estimates vary but the U.S. hyperscalers are forecast to spend roughly $750 billion this year on capital expenditures with much of that spend becoming the revenues for manufacturing, infrastructure, construction and non-tech businesses. A meaningful slowdown in AI spending would slow earnings growth, possibly triggering a broad market pullback. However, because the race for technological supremacy between the U.S. and China significantly raises the strategic stakes, and technological leadership confers distinct economic, technological, and national security leverage we do not expect a slowdown in spending for technological advancement. Regardless of intermittent public backlash against data centers and power usage, we expect high-level capital deployment to continue unabated, even as operational and regulatory risks expand.

Messy Politics: International conflicts and the weakening of the Western Alliance continue to have an important impact on global stability, making trade, food, energy, and many other products more expensive. It also increases the importance of national defense spending, while pushing electorates toward political extremes.

Furthermore, ongoing economic shocks from AI disruption, tariffs, and energy transitions will pressure governments to offer additional fiscal support—which most cannot afford without risking electoral defeat, a dynamic visible across Germany, France, the UK, and in U.S. mid-term primaries. Given worsening sovereign fiscal positions, orthodox policy demands cuts to spending and tax increases — measures that rarely win elections or attract donor capital. In our base-case scenario where conflicts persist, ARS expects governments will avoid addressing these structural imbalances, attempt to defer recessions at all costs, and pass the burden onto future administrations unless the markets rebel, forcing governments to make hard decisions.

Changing Terms of Global Trade: The terms of global trade have shifted dramatically since the pandemic, accelerated by President Trump's tariffs, geopolitical conflicts in Ukraine and the Middle East, as well as the global realignment of the U.S. and NATO which is resulting in an increase in military spending for the Western Alliance and also increasing deficit spending. To protect economic and national security, companies are reorienting supply chains and nearshoring manufacturing. This transition is being impacted by a global energy shock that is suppressing growth and raising the cost of living.

What is Driving the Market Resilience?

The last Outlook focused on the capital spending super cycle.  Capital spending has grown 88% since the pandemic (see Chart 4), and in turn, resulted in a doubling of earnings for U.S. companies. In addition to record capital expenditures, three other forces are driving the economic and market resilience: historic debt-financed support from the past four administrations, strong consumer spending, and continued foreign direct investment flows.

Chart 4. U.S. Total Capital Expenditures Up 88% Since the 2020 Low

Record outlays and deficits for governments: John Maynard Keynes once said, “the political problem of mankind is to combine three things: economic efficiency, social justice and individual liberty."  Politicians around the world are being forced to make hard choices as strained public finances limit their ability to address current and future problems. At the same time, politicians cannot stay in office or get elected by promoting raising taxes and cutting social spending or benefits to give their governments greater flexibility. Further complicating the challenges is the need to increase defense, energy and cyber security spending, reskilling and training workers displaced by AI, and continued reindustrialization. As a result, politicians will likely keep conditions accommodative, while avoiding the hard economic choices.

Chart 5. Debt Has Been Rising from $8 Trillion to $40 Trillion Under the Past 4 Administrations

Baby Boomers Driving Spending: Owners of U.S. equities and real estate have been big winners, and the biggest beneficiaries are the 10,000 baby boomers turning sixty-five each day. They have both time and money. In their retirement, boomers benefit from higher interest rates on their savings and are less exposed to AI-driven labor disruption. With net worths of an estimated $90 trillion, boomer spending could continue to provide support to the U.S. economy.

Chart 6. Household Net Worth Has Increased Over 80% Since 2020 to $185 Trillion

Continued foreign direct investment flows to U.S. with a shift to more equities than bonds: There have been several headlines discussing foreigners selling U.S. Treasuries with China and Japan reducing their holdings and, most recently, Norway’s sovereign wealth fund (Norges) selling $80 billion of Treasuries. However, these stories often miss key facts. Norges is reducing its allocation to government bonds globally due to debt and deficit concerns, but it is not reducing its U.S. exposure meaningfully as it will be buying other U.S. fixed income securities. While the headlines have been quiet on foreigners buying more stocks than bonds, the data clearly shows strong foreign demand for U.S. equities as shown in Chart 7. The U.S. for all its flaws remains a magnet for capital.

Chart 7. Foreigners Have Been Selling U.S. Treasuries and Buying Equities

Striking the Balance Between Risk and Reward

“The American economy is going to do fine. But it won’t do fine every year, every week, and every month.”

–Warren Buffett, Legendary Investor

Chart 8. Finding Opportunities in the Areas of Required Spending

ARS is a high-conviction manager that first identifies the secular themes expected to drive capital flows, then invests in the businesses best positioned to benefit. Chart 8 illustrates where ARS is finding opportunities today. Rather than replicating the S&P 500’s sector weights, ARS targets sectors, industries, and companies aligned with these themes while avoiding areas facing headwinds or where popularity has stretched valuations. We are also avoiding companies with weak balance sheets and companies whose perceived earning power lies well in the future.  ARS portfolios are positioned differently from the S&P 500 as we have been underweighting (relative to the index) the technology, communications, discretionary, staples and financial sectors, though we do hold high-conviction positions in select names in some of these sectors. Among the sectors of the S&P 500 that ARS favors, three of these – energy, materials, and industrials – are significantly underrepresented in the index. Yet, these sectors are absolutely essential to addressing the challenges facing the world today.

ARS has been actively managing risk exposures due to the unusual nature of today’s markets. The market's measure of volatility, the VIX, has been low by historical standards over the past two years, but conditions beneath the surface are far less calm. Individual stock volatility has been extreme, with large and mega-cap companies seeing almost unprecedented daily moves (Micron is up ~550% in the past year), and participation has narrowed sharply since July: as of late September, 79% of S&P 500 stocks traded below their 50-day moving averages even as the index sat near record highs. While the business outlook remains exceptionally positive, ARS has been actively risk-managing the position sizes in our memory chipmaker positions to reduce concentration risk and lock in gains for clients while maintaining meaningful weights in portfolios. Conversely, ARS has initiated new positions this year in areas of focus such as energy, technology, materials, and industrials including several that had presented particularly attractive buying opportunities.  This presented an opportunity to swap one business that ARS already owned for another selling at a more attractive valuation with similar or better earnings characteristics.

We expect continued market volatility and remain vigilant in balancing the rising risks to the economy and to portfolios against the opportunities presented by one of the greatest technological revolutions in history.  ARS favors equities in this environment as the best defense against inflation and a rising cost of living. The team continues to be aggressive when important opportunities present themselves, and defensive when valuations are stretched or earnings are set to disappoint the market for the intermediate term.  It is worth remembering that as interest rates rise, a dollar today becomes more valuable relative to a dollar received in the future. Because common stock valuations are based on expected future earnings, higher rates reduce the present value of those earnings and make stocks, particularly those priced for distant growth, a riskier investment. As a result, we are mindful that great companies do not always make great stocks, and price discipline remains central to our process. Popularity and value are often at odds. The best values are typically found in out-of-favor stocks, and by the time a stock becomes popular, much of its opportunity has already been priced in.

ARS is pleased to announce four recent additions to the firm:

• Anthony Young has joined the firm as a Portfolio Manager
• Emiliana Torres has joined the firm as a Business Development Associate
• Lauren Haburjak-Taplin has joined the firm as a Client Services Associate
• Doug Kowlessar has joined the firm as an Accounting Manager

Published by the ARS Investment Policy Committee: Stephen Burke, Sean Lawless, Anthony Young, Greg Kops ,Andrew Schmeidler, Arnold Schmeidler, P. Ross Taylor, Tom Winnick.

The information and opinions in this report were prepared by ARS Investment Partners, LLC (“ARS”). Information, opinions and estimates contained in this report reflect a judgment at its original date and are subject to change. This report may contain forward-looking statements and projections that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable. However, such statements necessarily involve risks, uncertainties and assumptions, and prospective investors may not put undue reliance on any of these statements.

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