The Good, the Bad, and the Ugly

In July we said the economy was stronger than the headlines, rates would stay higher for longer, and AI’s impact was real but uneven. All three held up. Here’s where things stand going into Election Day.

The Big Picture

• THE GOOD: Profits. Earnings are growing about 30%, faster than stock prices, so stocks got cheaper even as they set records.
• THE BAD: An energy shock driving inflation. Gas and diesel are driving higher costs, paychecks are falling behind, and households are hurting.
• THE UGLY: The price of money. The Fed has turned, and the AI boom is now a borrowing story.
• WHAT’S NEXT: Gridlock. A Democratic House and a divided government is the likely result on Tuesday. It limits surprises, but it also limits fixes to the debt.

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The Numbers: 2026 so far

The Good: stronger than the headlines, again

• Growth sped up. In July, forecasts called for about 2%. The economy grew at a 3.4% annual rate in Q3, its fastest in a year (BEA). 

• Profits beat even our July numbers. Earnings growth topped 50% in Q2 (helped by one-time investment gains at Alphabet and Amazon) and is near 30% in Q3 (FactSet). 

• Stocks got cheaper while setting records. The S&P 500 hit its 28th record close of the year on Oct 6, yet its forward P/E fell from about 22 to 18.7. Earnings grew faster than prices (FactSet). 

• But growth is concentrated. Without Micron and NVIDIA, Q3 earnings growth drops from 29% to about 20%. Energy profits more than doubled on higher oil (FactSet). 

Why stocks hold up when prices rise. Inflation lifts what companies charge as well as what they pay, so revenues and profits rise with prices. That’s a big reason stocks have historically outpaced inflation over long periods while cash loses ground. This year companies did better than keep pace: profit margins widened to 14.9% from 13.0% a year ago (FactSet). The caveat: inflation shocks can hurt stocks in the short run, as in 2022. 

The Bad: an energy shock, and households are paying for it

• It’s an energy shock. Oil, which had eased in July, is back near $100 a barrel. Consumer prices rose 3.7% in the year to September, up from 2.4% in January, while “core” inflation (excluding food and energy) held at 2.6%. Gasoline alone drove more than half of September’s increase (First Trust). 

• Diesel is a tax on everything. It hit a record of about $6.53 a gallon in September, and freight costs rose with it (AAA). 

• Housing is stuck. Mortgage rates are above 7%, and home sales are running under 4 million a year, about 10% below average (NAR). 

• Households are feeling it. Card spending per household is up 6.2% from a year ago (Bank of America Institute), but we think that reflects higher prices more than a healthy consumer. 

• Paychecks are falling behind. After inflation, average hourly earnings are down 0.7% over the past year (First Trust). 

• The data say fine. Households say otherwise, and they’re right. Consumer sentiment is 48.0, near a record low, even with GDP growing 3.4% and unemployment at 4.2%. The gap isn’t in people’s heads: gas costs more, borrowing costs are up, and paychecks buy less. The averages look strong because the companies selling energy, chips and AI are doing well, not because the typical household is.

The Ugly: higher for longer, confirmed

• The Fed turned. In July we said we were watching how Warsh would reshape the Fed. His answer: the first rate hike in three years in September. On Oct 28 the Fed held rates at 3.75% to 4%, but the market is expecting another 0.25% hike in December. That’s a reversal from the rate cuts many expected coming into 2026. 

• Long rates followed. The 10-year Treasury hit 5.3% in October, its highest since 2007, as we warned in July (U.S. Treasury). 

• AI’s funding is tightening. In July, half of all investment-grade bonds were funding AI. The cloud giants still get money, but at higher rates and tougher terms. More than 30 dealmakers told Bloomberg that raising cash for data centers has gotten much harder in just a few months (Bloomberg). 

• That’s healthy, not a crash. Lenders are pushing back early and in public. In 2008, lending kept loosening until the system broke. AI demand is still strong; the question is how fast revenue catches up with spending. 

What’s Next: gridlock is the base case

Divided government is the most likely result on Tuesday

• Congress: forecasters strongly favor Democrats to win the House (80% at Decision Desk HQ, above 90% in prediction markets). The Senate is closer: most models lean Democratic, while academic forecasters lean Republican (Political Science Now). 

• Either way: the White House stays Republican. The only path to one-party control is a Republican sweep of both chambers, which models give roughly a 1-in-10 to 1-in-5 chance. 

What gridlock looks like

• Vetoes: partisan bills would likely be vetoed, and overrides need two-thirds of both chambers. 

• A new House agenda: affordability, health care and tariffs, plus more oversight of AI, crypto and prediction markets (per David Rubenstein, Carlyle). 

• Your taxes: the 2025 tax law is very unlikely to change. 

• Deadlines: government funding and the 2027 debt ceiling become leverage. Expect shutdown threats and some volatility around them (though actual default is never a real option as it would cause America’s credit rating to plunge, rates to rise, and trigger a recession – something no politician or party can tolerate). 

Gridlock and markets: usually good, but not always

• Markets like gridlock because it means fewer surprises.  

The catch: gridlock prevents bad surprises, but it also prevents fixes 

• Debt: $40.6 trillion.  

• Interest: net interest topped $1 trillion in FY2026, more than we spend on defense (U.S. Treasury). 

• Deficit: $2.0 trillion in FY2026 (AAF). As we noted in July, the CBO sees debt reaching 175% of GDP by 2056. 

• The fix: closing the gap means both parties agreeing on spending and revenue. In divided government that is unlikely, so the bond market is doing the disciplining, with the 10-year near 5%. 

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What This Means for You

1. Stress-test your spending & borrowing.  Assume 3% to 4% inflation and high fuel costs.  Expect floating-rate debt (e.g. credit cards, lines of credit) to be up 1% over the next 6-12 months.   
2. Plan around current tax law. Gridlock makes it unlikely to change, so year-end moves can be made with confidence. Talk them through with your CPA. 
3. Discernment still matters. As we said in July, a passive index is a concentrated bet on a handful of companies. Own AI through companies with real earnings. 
4. Stay invested and stick to your plan. Stocks have historically outpaced inflation over long periods, and your plan was built for a range of outcomes, including this one. 

If anything here raises questions about your business, your portfolio, or anything else, reach out ([email protected]) and we’ll find time to talk it over.