Q3 2026 Commentary: Resilience with Less Room for Error
Corrado Tiralongo - Oct 15, 2026
Markets have shown remarkable resilience, but risks are building. Corrado Tiralongo explores AI, inflation, interest rates and portfolio positioning in a changing environment.
Since my last commentary, the tension facing investors has become clearer. The economy continues to absorb higher energy costs and trade uncertainty, while the AI investment cycle supports spending and earnings. Yet the cost of capital is rising, several major central banks are tightening again, and markets depend heavily on continued strength in a relatively narrow group of businesses.
These forces are connected. AI investment supports growth but also adds to demand for power, equipment and financing. Rising equity prices support household spending, helping sustain activity even as inflation erodes purchasing power. That resilience gives central banks less room to ease. The multi-asset portfolios managed by our team continue to participate in these opportunities, but we are increasingly concerned that the AI boom is approaching its later stages.
The Limits of Resilience
Industrial production outside the Middle East and global trade have remained firm, supported partly by the international supply chains behind AI investment. Spending on semiconductors, servers and data centres has provided an important offset to higher energy costs.
Recent U.S. data reinforce that picture. Retail sales excluding autos, gasoline, building materials and food services rose 1.4%1 in August from July. This measure, known as the retail sales control group, feeds into estimates of consumer spending on goods. It measures spending in dollar terms, so the increase should not be interpreted as equivalent growth in the volume of goods purchased.
The sources of that spending also matter. The U.S. household saving rate fell to 2.8%2 in the second quarter as rising wealth helped consumers maintain spending despite pressure on real incomes. Households have less room to keep saving a smaller share of income, and a reversal in equity prices could weaken that support.
Energy remains the most immediate complication. The Middle East conflict and constraints on regional export routes continue to disrupt supplies. Inventory drawdowns, government assistance and reduced household saving have cushioned the economic impact but have also delayed the adjustment in demand. Unless supply recovers sufficiently, elevated fuel prices may have to do more of the work of restraining consumption. Refinery disruptions add another complication: gasoline and diesel prices can remain elevated even when crude oil prices ease.
Interest Rates and the Price of Credibility
The U.S. Federal Reserve (“Fed”) raised its target range by a quarter percentage point to 3.75%–4.00%3 on September 16. The median projection among Fed officials pointed to another increase this year and a more persistent period of elevated rates4. These projections are conditional, but the direction of policy has already changed.
Central banks face a difficult balance. Higher energy prices raise living costs while reducing households’ spending power. Interest-rate increases cannot restore oil supplies. Policymakers may nevertheless respond if repeated shocks spread into broader pricing, wages or inflation expectations, particularly after an extended period of above-target inflation.
The bond market response illustrates why policy rates and long-term yields need not move together. Immediately after the Fed meeting, short-term yields rose while long-term yields declined, with lower oil prices also contributing. A credible commitment to controlling inflation can reduce the compensation investors demand for holding longer bonds, even as the central bank raises borrowing costs today.
That relief has been limited. In early trading on September 21, the ten-year Treasury yield edged above 5%5. There is no automatic breaking point at that number. What matters is why yields are rising. Stronger growth can support earnings and government revenues. Higher yields driven by inflation uncertainty or doubts about fiscal sustainability are more troublesome. Higher debt-service costs can deepen fiscal concerns, prompting investors to demand still greater compensation.
AI Raises the Stakes for Earnings
AI remains central to both the opportunity and the risk. The investment boom is producing tangible economic activity, and growth in expected technology earnings has helped markets withstand higher bond yields. Many of the businesses driving this cycle have substantial profits and financial resources.
Several indicators nevertheless underpin our growing caution. Analysts’ long-term earnings growth expectations for the S&P 500 have reached the highest levels in the historical series examined, with expected gains heavily concentrated in technology6. Those forecasts also make forward valuations look more forgiving than measures based on historical earnings, including earnings averaged over the economic cycle. A lower price-to-earnings ratio offers limited reassurance if the earnings estimate proves too optimistic.
Concentration compounds that vulnerability. When a few dominant companies account for a large share of index value and expected earnings growth, disappointment among them can affect the broader market disproportionately.
Corporate financing provides another warning. Capital spending is absorbing more operating cash flow, and net debt issuance by five major U.S. cloud and AI infrastructure companies exceeded US$200 billion7 over the twelve months ending in the second quarter. Some of these companies’ credit spreads, the extra yield investors demand over comparable government bonds, widened during the summer even as broader investment-grade spreads narrowed. Most retain considerable financial capacity but rising borrowing and increasingly complex funding arrangements raise the stakes for future investment returns.
Rising equity issuance adds to the evidence of a more mature cycle. Strong share prices and receptive investors make it easier for companies to raise capital through initial public offerings and additional share sales. Net equity issuance by U.S. nonfinancial companies turned positive in the first quarter8, meaning that new issuance exceeded the equity retired through share repurchases and other transactions. Historically, surges in fundraising have accompanied the later stages of market booms, including the dot-com period and 2021.
New shares increase the supply that investors must absorb, potentially making further gains harder to sustain if demand weakens. Issuance can finance productive investment, so an increase is not inherently negative. However, when it coincides with demanding earnings expectations and concentrated market leadership, it adds to concerns that investor enthusiasm is already well advanced. For us, this reinforces the importance of assessing whether the capital being raised can generate sustainable earnings and cash flow. It strengthens the case for diversification and preparation, without providing a reliable timetable for a correction.
Volatility across individual stocks remains below dot-com extremes in aggregate, but semiconductor shares and the Korean market have experienced much larger swings. Margin debt, or borrowing to invest in shares, remains comparatively low relative to market value, yet that ratio has been rising despite the rally9. It also excludes exposures through options and leveraged exchange-traded funds. We monitor these measures alongside foreign ownership and other corporate fundamentals to assess how vulnerabilities are evolving.
These indicators cannot identify a precise turning point. Valuation warnings can persist while earnings continue to grow, and strong results can support further gains. That is why participation and preparation can coexist. The size and composition of an exposure can reflect increasing risk well before the investment outlook becomes uniformly negative.
An AI-led correction could also reach beyond financial markets. Falling household wealth could encourage greater saving, while disappointing investment returns could lead businesses to reduce capital spending. Together, those responses could weaken two important supports for growth. A substantial market correction does not require a recession, although its economic consequences would depend on how broadly weaker spending and investment spread.
Canada’s Competing Pressures
Canada faces a different balance of forces. Higher oil prices support national income and energy producers, while higher fuel costs and borrowing rates pressure households and housing. Trade uncertainty continues to complicate investment decisions.
The US import ban scheduled for September 29th10 targets roughly US$1 billion of Canadian goods, with alcohol and cheese among the products most affected. Using 2025 trade values, these goods represent about 0.25% of Canada’s annual goods exports to the United States. They already face 50% tariffs, so the additional economy-wide impact is likely to be limited, although individual businesses could face serious disruption.
The greater concern is the shift from tariffs to prohibiting imports outright. If existing tariffs and uncertainty around the Canada-United States-Mexico Agreement (CUSMA) persist, businesses beyond the targeted industries may delay investment and hiring as they reassess access to the US market.
Ottawa’s announced expansion of investment deductions would allow most new capital investments to be expensed immediately, bringing the tax benefit forward and improving the economics of new spending. But tax incentives cannot fully offset uncertainty over Canada’s largest export market. Closer European ties may help over time, although Europe cannot quickly replace the scale of U.S. demand.
Higher borrowing costs provide another constraint. Rising government bond yields can feed into fixed mortgage rates before the Bank of Canada changes its policy rate, weakening housing affordability and demand. The Bank must therefore weigh inflation risks against financial conditions that may already be tightening. Whether energy inflation spreads more broadly will be important, making the US policy experience an imperfect guide.
Diversification as Leadership Evolves
Europe illustrates the difference between an economic outlook and an investment opportunity. Its economy faces a larger energy import bill and stronger competition from Chinese manufacturers. Yet its equity market has less exposure to the AI cycle and lower valuations than the U.S., even after allowing for sector differences. That could provide relative resilience if U.S. technology leadership weakens, although it would not insulate European equities from a global decline.
Geographic diversification still requires attention to underlying exposures. Markets such as Taiwan and Korea have substantial links to the same semiconductor and AI investment cycle. Holding investments outside the United States does not necessarily reduce dependence on that cycle.
Currency adds another consideration. A firmer U.S. economy and a hawkish U.S. Federal Reserve can support the US dollar. An AI-led correction that weakens growth expectations and capital flows could change those dynamics. The implications for the Canadian dollar would also depend on Canada’s trade and energy outlook. Currency exposure can therefore add to or subtract from foreign investment returns; its protective role should not be assumed.
Canada Life Investment Management Portfolio Implications
The multi-asset portfolios managed by our team reflect both the opportunity in U.S. markets and our increasing concern about an AI-led correction. We have diversified our exposures to participate in U.S. growth and earnings while managing dependence on the continuation of the AI boom.
We maintain a modest preference for equities over fixed income, with less conviction than earlier in the year. Within equities, we favour the U.S. relative to Canada and maintain a neutral view on developed international markets. We also see opportunities in foreign fixed income relative to Canadian bonds. That measured stance is consistent with recognizing a more mature investment cycle.
We express our views through mandates, regional allocations, investment styles and factor exposures. Our diversification considers how holdings behave together. Different managers and sectors can share exposure to AI spending, including through industrials, utilities and credit. The number of holdings alone tells us little about the independence of their risks.
Growth-oriented strategies can participate in continued earnings strength, while complementary exposures help manage concentration and sensitivity to changing market leadership. Diversification cannot eliminate losses, but it can reduce reliance on a narrow set of outcomes.
Fixed income requires the same attention. Government bonds may provide support if growth weakens, although persistent inflation and fiscal concerns could limit the decline in yields. Corporate credit carries an additional risk: weaker earnings or financing conditions can cause credit spreads to widen, offsetting some benefit from falling government yields. Equity and corporate-credit exposures could therefore weaken together without a large government-bond offset.
Our decisions will reflect the combined evidence from valuations, concentration, earnings, cash generation and financing conditions. We do not need to identify the market peak to recognize that the balance of risks is changing. Further deterioration could warrant adjusting the level or composition of portfolio risk, while continued earnings delivery could support participation. The discipline is to keep exposures proportionate to the opportunity and the consequences of being wrong.
Corrado Tiralongo
Vice President, Asset Allocation & Chief Investment Officer
Canada Life Investment Management Ltd.