The Strategy Signal Quarterly Investment Report Q4 2026

In the 1968 Stanley Kubrick film, 2001: A Space Odyssey, the movie follows a voyage by astronauts, scientists, and the sentient supercomputer HAL 9000 (our version of today’s AI) to Jupiter to investigate an alien monolith. In the film, HAL malfunctioned due to a fatal contradiction in his core programming. This led HAL to engage in this famous exchange with astronaut Dave Bowman:

Astronaut Dave Bowman: “Open the pod bay doors, HAL.”

HAL 9000: “I’m sorry Dave, I’m afraid I can’t do that.”

This iconic moment captures the essence of today’s concern over the possibility that AI, given its rapid advancements, may go beyond its original programming and make decisions that are, at best, counterproductive, and at worst, fatal to humankind.

Dario Amodei of Anthropic, Sam Altman of OpenAI, Demis Hassabis of Google DeepMind, and Elon Musk have recently voiced their concerns about the threat that AI poses to humanity. They believe that “superintelligence” could override human directives and become uncontrollable without effective safeguards in place. This concern is countered by those who believe we must move quickly to maintain our AI lead over China and others who might use superintelligence to harm the U.S. Many tech leaders are calling for government regulation to provide guardrails for AI and AI agents while some are calling for “self-policing” by large tech companies.

Domestic hyperscalers (giant cloud providers) like Microsoft, Alphabet, Meta, Oracle, and Amazon as well as Chinese providers Alibaba and Tencent have been spending billions on data center construction to provide the infrastructure needed to support the massive growth of AI. In a June 10th, 2026 article in Converge! Network Digest, Dell’Oro Group projected data center capital expenditures to exceed $1 trillion in 2026.

Likewise, in a June 3rd, 2026 article in yahoo!finance, Goldman Sachs strategist Amanda Lynam put some numbers on hyperscaler capex spending on AI. Goldman now expects a combined $5.3 trillion of capex spending for the four largest hyperscalers — Meta (META), Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) — from fiscal year 2025 to fiscal year 2030. Prior to the start of first quarter earnings, this figure stood at $4.5 trillion.

This has been the investment backdrop that dominated the third quarter and first nine months of 2026. The importance of AI to our investment markets cannot be overstated as AI-related stocks have accounted for 67% of the S&P 500’s price return since the beginning of 2024. Likewise, those same stocks have been responsible for 58% of the earnings growth and 81% of the Capex/R&D growth of the market during that time period.

The overarching theme:

Only a narrow group of stocks have been driving market returns for the past few years and those stocks not related to AI have markedly underperformed the benchmark. Historically steady performers found in consumer staples, financials, software as a service stocks, retail, and health care have suffered as investors flocked to the allure of dynamic earnings growth found in AI-related names in technology (semiconductors, servers, and memory stocks) and industrials (data center construction). Energy stocks (a very small portion of the S&P 500 index) have also outperformed the broader indexes due to the elevated price of oil connected to the ongoing war with Iran.

So where do we go from here?

In light of the on again, off again war with Iran, rising fuel prices (and their overall impact on inflation), rising interest rates, narrow stock market leadership, worries about the impact of AI overspending and fears of a bubble in technology stocks, I’ll discuss our take on the economy and markets in the Outlook for the Rest of 2026 section of this report.

Second Quarter Performance Review

Markets were volatile in the third quarter, but stocks still managed to advance, as strong corporate earnings growth and a resilient economy pushed the major indices to new all-time highs. The three major influences on the markets in the third quarter were rising oil prices, surging Treasury yields, and AI enthusiasm, and those factors heavily influenced market internals and performance.

• By market capitalization, small caps badly lagged large caps in the third quarter and declined outright, as surging yields weighed on small caps while large caps benefitted from tech and energy rallies tied to AI and higher oil prices.
• From an investment style standpoint, growth handily outperformed value, thanks primarily to strength in the tech sector late in the quarter. Volatile, tech-heavy growth stocks benefitted from a continued AI rally while value sectors were pressured by concerns about rising yields and higher oil prices.

• On a sector level, performance was mixed in Q3 as only four of the 11 S&P 500 sectors finished the quarter with positive returns. Surging oil prices and AI enthusiasm were the main drivers of sector performance in Q3 as energy was, by far, the best-performing sector in the S&P 500. Oil and energy-related stocks surged courtesy of dramatically higher oil prices throughout the quarter. Other sector outperformers included tech, which benefitted from ongoing AI enthusiasm (especially late in the quarter) and healthcare, as a series of high-profile successful drug trials boosted pharmaceutical stocks.
  • Turning to sector laggards, the influence of higher yields was evident, as utilities were the worst performing sector in the S&P 500 and logged a material decline. Rising bond yields make the high dividends in utility stocks less attractive to investors and money rotated from utilities into different parts of the market throughout the quarter. Industrials also logged a materially negative return for the quarter thanks to concerns that higher rates could negatively impact economic growth while surging diesel costs pressured transportation companies.

• International market performance was also influenced by tech/AI as both foreign developed and emerging markets lagged the S&P 500. Foreign developed markets did log a marginally positive return for the quarter, but foreign indices have a smaller allocation to AI-related tech shares and that weighed on performance. Emerging markets, meanwhile, declined slightly as a stronger dollar pressured those investments.
• Commodities were the best-performing major asset class in the third quarter as an explosion higher in oil prices powered widely held commodity indices to strong quarterly gains. Brent crude traded back above $100/bbl during the third quarter and diesel prices surged to record highs, as the collapse of the U.S./Iran ceasefire, expansion of the conflict by the Houthis and increased attacks on Russian infrastructure by Ukraine disrupted the flow of oil and refined products globally. Gold, meanwhile, spent most of the quarter in modestly positive territory on higher inflation concerns and elevated geopolitical risks.
• Switching to fixed income markets, the leading benchmark for bonds (Bloomberg U.S. Aggregate Bond Index) declined sharply in the third quarter as rising inflation concerns pressured multiple types and classes of fixed income.
  • Looking deeper into the bond markets, shorter-duration bills logged a modestly positive return for Q3 and handily outperformed longer-duration bonds, as inflation concerns weighed on longer-dated bonds.
  • Turning to the corporate bond market, both investment grade and lower quality, but higher-yielding bonds posted negative quarterly returns. High-yield bonds relatively outperformed, however, as resilient economic growth and higher inflation metrics prompted investors to reach for higher yield despite greater credit risks.

What actions did we take in McKinley Carter portfolios last quarter?

• In our fixed income portfolios, we maintained a shorter-than-benchmark duration to lessen long-term interest rate risk and associated volatility. Also, as corporate high yield spreads over U.S. Treasuries remained compressed (expressing optimism on the economy), we maintained our modest high yield and nontraditional bond allocations.
• In our Earnings Focus and Hybrid models, we removed the shares of Netflix and replaced it with Teradyne, a semiconductor testing equipment manufacturer, in order to add to more visible earnings growth.
• In our ActiveTrack models, we replaced the iShares S&P 500 Value ETF (IVE) with the Dimensional US Large Cap Value ETF (DFLV) in order to include a more diversified, purer-play value ETF.
• Also, in our ActiveTrack models, we reduced the allocation to the iShares Russell 1000 ETF (IWB) and used the proceeds to add the iShares Russell Top 200 ETF (IWL) in order to increase our large cap allocation in light of rising interest rates.

Outlook for the Rest of 2026

As we begin the final quarter of the year, there are headwinds on markets via the ongoing U.S./Iran conflict, surging global bond yields, and the threat of more Fed rate hikes. However, it’s important to realize there are powerful forces supporting this year-to-date rally in the form of 1) Impressive economic growth, and 2) Historically strong corporate earnings growth, and those two substantial positives can overcome macroeconomic headwinds, as they did in the third quarter.

Economic growth remained strong and accelerated during the third quarter. Readings from the labor market were very healthy as unemployment claims remain muted, consumer spending remained strong despite higher prices, and activity in the manufacturing and service sectors of the economy accelerated.

The Atlanta GDP Now forecast shows third quarter GDP growth of 3.6%, and the reality is that strong economic performance provides a formidable foundation for the YTD rally.

Caution Lights

As have been widely reported in the business news media, there are legitimate risks to the market that must be monitored closely in the fourth quarter.

Starting with geopolitics, the stalemates in the U.S./Iran and Russia/Ukraine wars continue, and they are keeping oil, gas, and diesel prices elevated. The longer that continues, the greater the headwind it will become on economic growth. Positively, any real diplomatic progress in either theatre that allows oil or diesel to flow more freely will result in lower energy prices and that should be a significant, positive catalyst for markets.

A strong U.S. dollar, as we have seen recently, while a positive as it relates to lower import prices, does provide a headwind to international stocks as the local currency price performance is offset by the translation back into dollars for U.S. investors.

Other Risks to Watch

• A slowdown in AI spending. Several firms view this as the biggest threat to market gains, since so much of earnings growth depends on it.
• Concentration. When a few stocks drive most returns, disappointments at any one of them can move the whole index.
• Rising yields. Higher long-term rates challenge richly valued growth stocks and have already pressured the broader market.
• Earnings quality and depreciation. Growing depreciation from massive AI asset buildouts could weigh on earnings in later years, and some Q2 gains were nonoperating.
• Credit and financing. Heavy debt issuance to fund AI infrastructure could pressure credit spreads.

Critical Factors

When deciding on our broad asset allocations, we focus on three primary factors: inflation, interest rates, and earnings, as we believe these act as guideposts for appropriate stock and bond allocations. We refer to these as the “three legs of the investment stool” as they allow us to cut through extraneous “noise” in the economy and to concentrate on what the data (the signal) tell us about the investment landscape.

Inflation:

Despite short term increases in headline inflation indexes and supply shock-driven commodity price increases, we believe a better gauge of market expectations for inflation is the 5-yr. Breakeven Inflation Rate produced by the St. Louis Federal Reserve. By focusing on the longer term market expectation for inflation, we believe that we better capture a significant data point that investors and the Fed use in decision making. Despite oil-related price spikes, the 5-yr. Breakeven Inflation Rate (2.34%) remains in a range that is supportive of equities and bonds.

Interest rates:

The Federal Reserve, led by Chairman, Kevin Warsh, is primarily focused on their 2% inflation target and is not currently concerned about the jobs market as unemployment remains low. Based on recent Fed commentary, it seems likely that the Fed will increase rates again this year, probably after the midterm elections.

Currently, the Fed Funds Futures are predicting up to three interest rate increases in the next twelve months. If the Iran War is protracted, the Fed may feel pressure to act though their ability to slow commodity inflation brought on by the war is suspect.

Turning to Treasury yields, the 10-year yield did hit a 20-year high recently and that is a headwind on economic growth. However, much of the rise in the 10-year yield can likely be attributed to rising oil prices, and if we see a decline in oil, then yields will likely follow and reduce the headwind on the economy. Additionally, strong GDP growth has also contributed to pressure long rates and continued economic strength will likely delay any significant pullback in rates.

As rising bond yields act as competitive threats to stock valuations, it is imperative that earnings growth remain robust in order to offset any market valuation threats brought on by higher interest rates. We believe that short to intermediate bonds represent good value at these levels and that short-term bond investors will be rewarded with 2-yr. Treasury Bonds or CDs that yield in excess of 4.5%. Additionally, 3-month and 6-month T-Bills are yielding far more than traditional money market funds and have the advantage of being state tax free.

Earnings:

2027 S&P 500 earnings estimates were revised higher, again, following the Q2 earnings season and annual earnings growth continued to trend far above historical averages. Beyond reflecting increased corporate profits (which are good for stock prices), surging earnings expectations have helped to keep market valuations reasonable.

During 2026, a constant theme has been the persistent rise in earnings projections for the stock market. Technology stocks, led by semiconductor manufacturers and other AIrelated companies have experienced dramatic earnings revisions due to what seems to be an insatiable appetite for data center construction and the associated component manufacturers. Also, as an additional positive sign for markets, excluding tech, projections for 2026 S&P 500 earnings are above 15%.

Emerging markets’ earnings estimates have risen dramatically this year due to prominent tech companies in Taiwan and South Korea that dominate their respective country indexes.

Profit margin increases are being felt in domestic and international markets. The AI revolution is serving as a catalyst for improved productivity and efficiency.

Conclusion

Concerns remain that the AI data center boom will turn “bust” and hurt economic growth. Those fears are understandable, especially for older investors who remember the “dot com” era. However, important differences exist between the two periods and there were signs in the third quarter that AI investments were already beginning to generate revenue. If there is more evidence of that in the fourth quarter, then investor concerns about the sustainability of the AI buildout will ease and tech will likely lead markets higher once again.

In sum, we begin the final quarter of 2026 with a market facing challenges in the form of geopolitical risks, higher bond yields and concerns about the sustainability of the AI data center boom. But the positives of a resilient economy and historically strong earnings growth are powerful, and despite negative headlines, the reality is the market remains on solid footing.

Despite the increase in interest rates, we remain overweight in equities due to strong corporate earnings and modest long-term inflation expectations. While elevated rates do act as a headwind on stock valuations, they also present investors with an opportunity to lock in higher yields in fixed income portfolio allocations.