Market perspectives

Vanguard’s outlook for financial markets

Our annualized nominal return and volatility forecasts are based on the June 30, 2026, running of the Vanguard Capital Markets Model® (VCMM).

IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of June 30, 2026. Results from the model may vary with each use and over time. For more information, please see the Notes section below.

Source: Vanguard Investment Strategy Group.

Notes: These return assumptions depend on current market conditions and, as such, may change over time. We make our updated forecasts available at least quarterly.

Earnings carry the weight as rates are the watch item

Despite busy headlines—including conflict in the Middle East, rising global yields, and AI safety risks—the main driver of the U.S. equity market remains earnings, increasingly shaped by the pace of AI capital investment and its prospects for monetization. The result is a market that appears calm on the surface but carries unease beneath it, reflecting uncertainty about the durability of those earnings and their concentration in a single theme: the AI complex, which represents roughly 40% of U.S. equity market capitalization from hyperscalers through the broader AI supply chain.

The tension shows up in two ways. First, the market's earnings yield has gone up this year (and its valuation—the inverse of earnings yield—has gone down), even as earnings growth has accelerated to historic highs. This contrasts with prior years when prodigious earnings growth was rewarded by multiple expansion.

Earnings yield and 10-year Treasury yield moving in tandem

Sources: Vanguard calculations, based on data from Bloomberg, as of September 15, 2026.

Note: This chart compares the S&P 500 Index earnings yield and 10-year U.S. Treasury yield from the first quarter of 2023 to the third quarter of 2026, along with the S&P 500 Index year-over-year earnings growth from the first quarter of 2023 to the second quarter of 2026.

Second, a great deal of repricing has been taking place under the placid index-level volatility, where return dispersion across individual stocks has climbed to levels normally associated with drawdown periods.

A benign effect of rising yields?

Against the backdrop of rising U.S. Treasury yields, the key question looking forward is what additional impact this might have on U.S. equities. If the rising yield is driven by an anticipated pickup in real economic growth, the yield increase could be benign—or even supportive—for equity valuation. But another important factor may be contributing to the rise in yields. It's likely that part of the increase reflects fiscal-sustainability concerns and uncertainty around a new approach from the Federal Reserve.

More time will be needed to understand whether the joint increases in earnings yield and Treasury yield over last few months are connected or entirely coincidental. But one thing is clear—if rates settle structurally higher, it would become another factor that eventually weighs on U.S. equities. For instance, rising funding costs could impact the pace and/or cost of AI capital expenditure investment and create headwinds for more debt-dependent small- and mid-cap companies.

For the next few quarters, what earnings and IPO filing documents tell the market about the emerging economics of AI and AI capex sustainability will likely remain the dominant driver of U.S. equities—but these rate channels, and whether they stay dormant or begin to bite, are worth monitoring closely.

United States: Refining the monetary policy stance

Growth continues to demonstrate resilience, with activity tracking at a pace consistent with an economy expanding above 2%. Business investment remains a notable source of strength. Investment ran at a 9.6% pace through the second quarter, exceeding our strong expectations coming into the year by over two percentage points. We expect this capital expenditure cycle to remain an important contributor to growth through 2027. Consumer spending is also evolving broadly in line with expectations, supported by tax policy tailwinds and the continued benefits of elevated household wealth. Softer real income growth presents a potential headwind to consumption during the second half of the year.

The labor market remains fundamentally stable, with a broad range of indicators suggesting conditions remain close to neutral and consistent with overall health. We believe that the August employment report of 162,000 jobs created was stronger than underlying conditions suggest, but it did reinforce our view that cyclical labor conditions have improved modestly over the last few months. We have revised our year-end unemployment rate forecast down from 4.6% to 4.4%. We attribute about half the decline in the unemployment rate since November 2025 to the noncitizen labor force, a group that represents about 10% of the overall U.S. labor force. Immigration policy and declining noncitizen survey response rates are among the reasons for the drop.

Inflation continues to be distorted by measurement issues and temporary factors; however, underlying price pressures appear to be stuck in a range just below 3%. The Federal Reserve raised its policy rate by a quarter percentage point at its September 16 meeting. We anticipate another rate hike by year-end, which we view as a recalibration of policy and the removal of prior accommodation rather than the start of a more sustained tightening cycle at this point.

Region-by-region outlook

Source: Vanguard.

Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December for each year. For Canada, core inflation is the year-over-year change in the Consumer Price Index (CPI), excluding volatile food and energy prices, as of December for each year. Monetary policy is the Bank of Canada's year-end target for the overnight rate. For China, core inflation is the year-over-year change in the CPI, excluding volatile food and energy prices, as of December for each year. Monetary policy is the People's Bank of China's seven-day reverse repo rate at year-end. For the euro area, core inflation is the year-over-year change in the Harmonized Indexes of Consumer Prices, excluding volatile energy, food, alcohol, and tobacco prices, based on the fourth-quarter average for each year. Monetary policy is the European Central Bank's deposit facility rate at year-end. For Japan, core inflation is the year-over-year change in the CPI, excluding volatile fresh food prices, as of December for each year. Monetary policy is the Bank of Japan's year-end target for the overnight rate. For Mexico, core inflation is the year-over-year change in the CPI, excluding volatile food and energy prices, as of December for each year. Monetary policy is the Bank of Mexico's year-end target for the overnight interbank rate. For the United Kingdom, core inflation is the year-over-year change in the CPI, excluding volatile food, energy, alcohol, and tobacco prices, based on the fourth-quarter average for each year. Monetary policy is the Bank of England's bank rate at year-end. For the United States, core inflation is the year-over-year percentage change in the Personal Consumption Expenditures price index, excluding volatile food and energy prices, as of December for each year. Monetary policy is the rounded midpoint of the Federal Reserve's target range for the federal funds rate at year-end.