Growth with Friction: Rethinking Portfolio Positioning in a Recalibrating World
Recent economic data continues to support our view that markets are in transition rather than at the cusp of a classic recessionary downturn. Inflation has moderated into a more manageable range, while recent nonfarm payroll data released on 2/11 came in better than expected rather than signaling meaningful labor deterioration. This appears less like an early-warning recession environment and more like an economy recalibrating as policy, growth expectations, and capital flows adjust to a new equilibrium. That distinction matters for how portfolios are constructed and experienced.
The AI-driven capital expenditure cycle remains a powerful structural force, and the recent valuation rationalization among AI leaders strikes us as constructive rather than concerning. We were not surprised to see consolidation in the first half of 2026, particularly as investor focus rotated toward earnings durability and return on capital rather than narrative momentum. Early enthusiasm priced in near-perfection (which we define as high valuations that would require extremely optimistic earnings growth); a period of recalibration is expected to broaden participation and improve long-term sustainability. Importantly, we believe the investment wave tied to infrastructure, power demand, industrial buildout, and services capacity increasingly benefits the real economy, not just equity indices. That diffusion may support growth, but it also suggests a more rotational and dispersion-driven equity landscape.
What makes this cycle different is that volatility has remained elevated and wider range-bound even within a growth-supportive environment. Since early 2022, the VIX has spent considerable time above the sub-15 levels1 that characterized much of the prior expansion, with repeated moves into the 20 to 30+ range1 even as equity indices approached all-time highs.1 Markets are pricing a wider distribution of policy, geopolitical, fiscal, and growth outcomes simultaneously. This is not a crisis regime, but it is not a low-volatility expansion either. We believe it is a structurally wider-range environment.
The evolution of the U.S. yield curve reinforces this transition narrative. After spending much of 2023 and 2024 inverted, the 2-year to 10-year Treasury spread has steepened meaningfully since the third quarter of last year, moving back toward positive territory and widening substantially relative to prior inversion extremes. This progression reflects shifting growth expectations, evolving term premium dynamics, and a market reassessing the path of policy rather than pricing imminent contraction. A curve that has grown steep from a long period of inversion historically aligns more with normalization than with the onset of recession.
We remain skeptical that a sustainably flat yield curve will be easily engineered in this cycle. Supported domestic growth, persistent global fiscal financing needs, evolving policy dynamics in Japan, and ongoing geopolitical uncertainty all argue for continued term premium pressure and rate volatility. That is a challenging environment for those hoping long bonds will provide diversification. In such an environment, institutions that provide liquidity and risk-transfer services, including global banks, broker-dealers, structured credit providers, and other well-capitalized intermediaries, become increasingly important. As an investor, being a source of liquidity may gain value relative to being purely a return seeker. When markets are actively repricing policy, growth, and geopolitical risk, balance sheet capacity becomes more valuable. Elevated issuance, wider spreads, and increased hedging activity can structurally advantage those positioned to provide as well as intermediate capital flows.
Structurally higher volatility changes portfolio math. When volatility persists above prior-cycle norms and produces wider return ranges, simply dampening exposure may not be sufficient. Strategies that can actively engage the range of volatility, adjusting beta, responding to dispersion, and positioning dynamically as correlations shift, may be better suited to this environment than static volatility dampeners. Because correlations tend to shift most meaningfully at volatility extremes, often when investors need diversification most, traditional asset allocation faces greater alignment challenges.
At the core of our philosophy is a simple belief: long-term success is not defined solely by headline return, but by the quality of the ride taken to achieve it. The path matters, and alignment among all parties in the investment process is vital. Drawdown depth, recovery time, and behavioral sustainability all influence real-world outcomes. In an environment defined less by crisis and more by persistent uncertainty, we believe resilience, alignment, and adaptability deserve as much attention as raw performance. We welcome the opportunity to thoughtfully discuss the implications of these realities with our clients and partners.
1 Volatility Index data; Source: Bloomberg
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