Winter is coming

Markets Weakened by the Cost of Capital, Yet Supported by Growth

On 7 October 2026, Ms Georgieva, Managing Director of the International Monetary Fund (IMF), stated that the global economic situation “requires a comprehensive package of urgent policy measures” and that “fiscal policy space is in dire need of replenishment”. Indeed, public debt is increasing in most countries and is expected to reach 100% of global GDP, the highest level since the Second World War.

This development comes at a time when the global economy is facing US tariffs at their highest level in decades, the war in Iran and its repercussions on oil markets, as well as the ongoing Russia-Ukraine conflict.

In this context, rising interest rates are increasing the cost of debt and raising questions about governments’ ability to repay it. Yet equity markets remain close to their all-time highs (see charts on the previous page), while the International Monetary Fund (IMF) has revised its global growth forecast for 2027 upwards from 3.2% to 3.4%.

How can this paradox be explained? And what does it tell us about the future?

The Bond Market Takes Back Control

One of the most striking developments in financial markets has been the rapid rise in long-term interest rates (10 years and above), reaching levels not seen for two decades (see chart on the previous page). As a result, bond investments have generally delivered slightly negative total returns since the beginning of the year: bond prices fall when yields rise. A similar pattern can be observed in gold, whose net performance in euro terms has been virtually flat since the start of the year.

This increase in yields can be explained by two factors:

1. Persistent inflation, which is prompting central banks to maintain restrictive policies, or even raise rates further. In the United States, Europe, the United Kingdom and Japan, among others, central banks have recently increased their policy rates. Markets must now factor in the risk of a prolonged period of tighter monetary policy.

   
   

2. Higher compensation demanded by investors. When a borrower, whether a government or a company, widens its deficit or increases investment spending, it must borrow more by issuing additional bonds. This greater supply of securities must attract enough buyers, who may therefore demand higher returns in exchange for lending their money. In short, when borrowing needs grow faster than investor demand, financing costs tend to rise.

The two charts opposite and below illustrate this phenomenon:

• The first chart shows the evolution of the yield premium required by investors to lend to four European sovereign states relative to Germany, measured in basis points. For example, France currently pays 1.60% per year more than Germany to borrow over a ten-year period.

  
  

• The second chart illustrates the evolution of the risk premium required on the debt of Oracle, the American technology company investing heavily in the data centres required to support artificial intelligence.

  
  

In both cases, these premiums have risen sharply within a short period of time, fuelling concerns about a potential debt spiral: as borrowing costs increase, debt becomes more difficult to service, which in turn further raises the cost of financing.

All else being equal, higher interest rates tend to weigh on equities for four reasons:

1. They increase companies’ financing costs.

2. They reduce the present value of future cash flows.

3. They make bonds more attractive relative to equities.

4. They may force governments to adopt austerity measures, to the detriment of economic activity.

Strong Earnings, but High Expectations

How, then, can we explain the strong performance of equity markets since the beginning of the year: +15.6% for the MSCI World Index (in euro terms), +8.2% for the Euro Stoxx 50, +36.0% for the Nikkei, and +25.5% for the MSCI Emerging Markets Index? The CAC 40 stands out as a notable exception, having declined by 2.3%.

The explanation can be summed up in a few words: the spectacular growth in corporate earnings. As illustrated in the chart opposite, the earnings of US companies are expected to increase by 52% in 2026 (or 35% excluding exceptional items), compared with only 22% anticipated at the beginning of the year. (Source: J.P. Morgan Asset Management).

This market rally is nevertheless driven by a limited number of stocks. The ten largest companies in the S&P 500 now account for 37% of the index, having significantly outperformed the rest of the market. By way of illustration, just 42 AI-related companies out of the 500 constituents of the S&P 500 have generated 60% of the index’s gain since the beginning of the year.

This concentration suggests that not all sectors of the economy are benefiting equally from the rise of artificial intelligence. Some major consumer-oriented companies, such as McDonald’s and Home Depot, have posted declines of 23% and 16% respectively since the start of the year.

This situation is reminiscent of the dot-com bubble of 2000, when enthusiasm for new technologies also concentrated market gains in a relatively small number of stocks, leaving large parts of the economy behind.

The next challenge, therefore, will be managing a slowdown. Earnings growth moderating from 30% to 10% would still be impressive, but it could disappoint markets that have come to expect more. Indeed, share prices react less to the absolute level of results than to the gap between reported earnings and investors’ expectations.

Artificial Intelligence: A Growth Engine and a Source of Fragility

The investments required to develop artificial intelligence are considerable, and their ultimate profitability remains uncertain. To justify current spending levels, companies will need to translate anticipated productivity gains into measurable revenues and profits within a reasonable timeframe. Rising demand for computing power alone does not guarantee an adequate return on every dollar invested.

Three Risks to Watch

1. The trajectory of US long-term interest rates. A further sustained increase would suggest that investors are demanding higher compensation to absorb growing financing needs.

2. Inflation, particularly energy-related inflation, and the response of central banks.

3. The quality of earnings. Investors will need to distinguish between profits that have actually been realised and expectations that remain dependent on future investments.

Other factors also warrant close attention, including public deficits, credit conditions, and the evolution of corporate bond risk premiums. A deterioration in credit markets would indicate that the rising cost of capital is beginning to affect the broader economy. Finally, geopolitical risks remain a reminder that unexpected events can quickly disrupt an equilibrium that markets had previously considered robust.

Conclusion: Stay Invested, but Demand Greater Discipline

The rise in the risk premiums demanded by investors raises a central question: can financial markets continue to absorb the growing volumes of debt issued by governments and corporations, particularly to finance artificial intelligence investments?

In the months ahead, portfolio performance is likely to depend less on the ability to anticipate every market movement than on disciplined portfolio construction. Growth remains an ally, but it never removes the need to consider the price paid to achieve it.

The Return of the Herd by Pieter Bruegel the Elder, 1565

The Return of the Herd does not derive its origins from the Flemish calendar tradition. Perhaps Bruegel the Elder combined here his experience of Alpine landscapes with the compositional ambition of depicting a mountain scene in autumn. The approaching storm appears all the more threatening as it descends from the mountains, from which the herd itself seems to be returning.

The author of these lines had the pleasure of attending a traditional désalpe in a remote Swiss village at the beginning of October. This centuries-old family custom marks the return of herds and shepherds from the mountain pastures, welcomed joyfully by those who remained in the village, with the sound of bells ringing throughout the valley as they come back to shelter for the winter.

At a time marked by climate uncertainty and when artificial intelligence is widely expected to transform profoundly the way we live and work, is it not reassuring to observe that nature continues to follow its own enduring rhythm?