2026 U.S. Equity Outlook

Growth Stocks

Can Profit Growth Offset Inflation and Rising Interest Rates?

This seems an ideal time to invoke former President Harry Truman’s famous lament about the lack of a “one-handed economist.” All he wanted was a clear, unambiguous take on the economy, but his advisors kept highlighting the opportunities he faced on one hand and the risks on the other.

We face a similar situation today, with the markets and the economy poised between competing forces. On the one hand, corporate profits are robust, the economy is growing, and innovation and opportunity abound. On the other hand, war, debt, trade disruptions, interest rates, inflation and demographics pose serious challenges. First, the good news.

What Do Record Corporate Profits Mean for U.S. Stocks?

After-tax corporate profits stand at an all-time high as a percentage of gross domestic product (GDP) as of June 2026.¹ Of course, technology spending and investment are partly responsible for these historic gains. According to FactSet, profits for Big Tech companies and semiconductor firms more than doubled over the last 12 months.

Looking at the companies in the S&P 500^® Index, the broadest measure of U.S. corporate performance, earnings growth for the 12 months ended in June was roughly 50%.²

That's an impressive statistic. The only previous times earnings growth was this high were during the economic recoveries from the Great Financial Crisis and the COVID recession — both historic rebounds. Today, we see this growth rate alongside already strong profits and solid economic expansion.

What’s Behind Current Growth Stock Valuations?

Because the “E” in the price-to-earnings (P/E) ratio has been rising, growth stocks now appear to be much more compelling values relative to the broader market and to value stocks.

In terms of valuation, the Russell 1000^® Growth Index is trading below its 10-year historical average forward earnings multiple relative to both the S&P 500 and Russell 1000^® Value indexes.

What tends to happen is that analysts look at the recent past and assume the same trends will continue. So, coming out of a quarter of excellent earnings growth, they’ve naturally forecast more of the same for both the Russell 1000 Growth and the S&P 500 going forward.

However, we’re skeptical that such stellar profit growth can be sustained, particularly given the inflation and interest-rate environment.

Why Inflation and Interest Rates Matter for Growth Stocks

Growth stocks are oriented toward future earnings growth. Their appeal lies in their future cash flows. But higher interest rates today increase the opportunity cost and reduce the appeal of expected future cash flows.

Inflation erodes the purchasing power of future dollars. When inflation is rising, the Federal Reserve and bond investors react by pushing up interest rates. Today, key measures of inflation are at their highest levels in several years.

Pushed by economic growth, inflation and massive federal borrowing, U.S. long-term bond yields just hit the highest level since before the Great Financial Crisis.

Interest rates are also relevant here because AI-related companies are borrowing heavily to fund data center and infrastructure buildouts. By some estimates, the four largest AI cloud providers and Meta have doubled their debt to $350 billion over the past five years. Last year alone, they issued an estimated $120 billion in bonds.³

Higher rates directly increase financing costs and raise the hurdle rate for future AI economics and profitability.

Could AI Infrastructure Spending Produce an Economic Payoff?

We don’t agree with the “AI bubble” argument. These companies are spending in anticipation of securing a significant competitive advantage as enablers and providers of a potential AI computing revolution.

We firmly believe that investing in AI infrastructure today may yield massive economic rewards in the future. Go back two decades or so, and investors were fretting as Amazon, Microsoft and Alphabet invested heavily to develop their cloud businesses. Those costly investments have paid off massively over time.

We believe this round of capital expenditures (CapEx) will likely be beneficial. Demand for AI compute far exceeds the capacity of existing technology infrastructure, making it difficult to view this as a bubble or overinvestment. While future overcapacity cannot be entirely ruled out, it’s clear we’re not near that point now or in the near future.

The consulting firm Gartner estimates that global IT spending will approach $6.5 trillion in 2026.⁴ Additionally, AI spending could draw from part of corporate payroll budgets. The point is that there is a massive amount of capital available for enterprise AI model providers like Anthropic, OpenAI and SpaceX to capture, provided they can demonstrate their value.

While we maintain this perspective, we recognize that the current spending levels are unprecedented and are affecting short-term profits. Naturally, past successes don’t guarantee future outcomes, and while previous cloud investments were fruitful, that doesn't mean the same success will follow. Therefore, it’s understandable that investors may remain skeptical about the eventual returns.

It’s true that not all companies will succeed or derive the same benefit from their spending. In June, we shared our view on AI spending and on potential winners and losers.

How We Assess Financial Risks in AI Companies

It’s crucial to underscore that we don’t view AI as a single trade. Rather, it is a web of connected yet highly differentiated companies. Each of these companies has a unique competitive and financial profile and faces specific risks and opportunities.

We conduct in-depth fundamental research to gain a clear picture of each firm’s competitive position and financial health. In the AI context, this means we’re closely scrutinizing regulatory filings to develop a comprehensive understanding of a company's risks. We place particular emphasis on their off-balance-sheet liabilities.

That’s crucial because the massive demand for capital to finance the AI buildout has led companies to make long-term financial commitments that don’t appear in their headline earnings. These include backing debt issued by other companies and committing to spend on energy, infrastructure or other services far into the future.

The strictest, most conservative accounting treatment would be to record all such guarantees and long-term commitments on the parent company’s balance sheet.

But the reality is that many companies simply don’t do that. These firms create separate corporate entities to capture such transactions. As a result, these commitments aren’t reflected in the headline financial statements at all but are buried in footnotes and other disclosures.

To be clear, we’re not calling shenanigans on these companies. These transactions carry a significant presumed benefit, including future access to services and financial returns.

Our primary aim in research is to uncover a company’s true financial condition, enabling us to make the most informed investment decisions. We strive to ensure our investments are backed by strong balance sheets and sufficient capital to support their growth plans. Achieving this requires not only a thorough examination of key financial metrics but also a meticulous review of regulatory findings.

We believe this is a key differentiator between active and passive index-based strategies and is part of the value we provide to clients.

What Could an Uncertain Rate Outlook Mean for Growth Stocks?

Rising rates and inflation may continue to create uncertainty for growth equities. Even so, we remain confident in our disciplined investment process and the fundamental strength of our portfolio holdings.

We recognize the risks and potential volatility in the current environment and continue to closely monitor the fundamentals of each investment.

At the same time, we believe remarkable technological change and innovation may create attractive opportunities for long-term investors. Realizing that potential, however, may require patience through periods of volatility.

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^{¹U.S. Bureau of Economic Analysis, "Corporate Profits After Tax (without IVA and CCAdj) [CP]," retrieved from FRED, Federal Reserve Bank of St. Louis, September 14, 2026.
²Jonathan Bauman and Bernard Chua, “Earnings Watch: Q2 Earnings Strength Extends Beyond Mega-Cap Tech,” American Century Investments, September 9, 2026.
³Christen da Costa, “Big Tech Doubled Its Debt to $350 Billion. The AI Bill Is Coming Due,” Gadget Review, July 10, 2026.
⁴Gartner, “Gartner Forecasts Worldwide IT Spending to Grow 14.2% in 2026, Totaling $6.37 Trillion,” Press Release, July 27, 2026.}