US markets and the economy are heading into uncharted territory

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is chief executive and chief investment officer of Richard Bernstein Advisors

Over the past several years it seems we’ve seen unprecedented use of the word “unprecedented”. Pundits and politicians now routinely claim that political and economic events have never before occurred.

Despite the widespread overuse of hyperbole, the US Federal Reserve in 2026 might truly be heading for uncharted territory by cutting rates despite a healthy economy and a weakening dollar. This combination of monetary and economic conditions has never happened in modern US economic history. Investors should prepare portfolios for what could be a very unfamiliar journey.

The US economy currently is quite strong. Nominal GDP in the latest reported quarter was more than 8 per cent, which is the strongest growth in 20 years apart from the post-pandemic period. This excludes the inflation adjustments in the headline economic growth figures. Using the Atlanta Federal Reserve’s estimates of current GDP and expectations of rising prices implied by one-year inflation-protected Treasury bonds, nominal GDP over the next quarter or two seems to be tracking above 7 per cent.

The Federal Reserve has cut rates only a handful of times when nominal growth was greater than 8 per cent and most of those instances were in the 1970s. Investors and economists would surely agree that today’s monetary policy should not emulate the policies of that inflation-prone period.

But the Fed might cut rates despite the dollar’s recent weakness. The dollar, as measured by the DXY Index, is down roughly 10 per cent over the past year. Although the Treasury has stated its intention to continue long-held strong dollar policies, lowering rates when the greenback is already depreciating would indicate a new “weak dollar” regime.

Some have suggested that productivity growth related to AI will negate inflation and support the dollar. However, these hopeful forecasts seem to ignore the inflationary effects of de-globalisation and of trade and labour restrictions. 

For example, some of the leading indicators of inflation, such as surveys of small business pricing intentions by the National Federation of Independent Business, continue to move upward. AI might already be replacing computer coders and lower level service employees, but it still can’t produce goods not manufactured in the US, the prices of which could rise as the dollar falls.

US investors haven’t had to worry about a persistently weak dollar in nearly two decades. Equity investors can use several different strategies to diversify portfolios to take advantage of the situation. International stocks immediately come to mind.

Currency can be a meaningful source of returns, but US investors are significantly underweight non-US stocks despite the potential risks to the dollar, far below their roughly 40 per cent weighting in the MSCI All-Country World Index.

In addition, non-US stocks now offer competitive earnings growth and, when comparing the MSCI ACWI ex US and MSCI US indices, they have double the dividend yield (2.5 per cent vs 1.2 per cent). They also have considerably cheaper valuations with price to trailing earnings multiples of 18 times versus 26 for American stocks.

“Shorter duration” equities are another area for investors to explore in the current environment. Duration is generally used as a term to describe fixed-income investments’ interest-rate sensitivity but it also can be important for equities. If inflation does turn out to be higher than current consensus, long-term interest rates could rise and bonds and stocks more sensitive to such moves — those considered longer duration — could underperform.

One of the simplest ways to measure equity duration is dividend yield. Stocks with no dividends tend to be more sensitive to changes in interest rates than dividend-paying ones. Investors caught up in the AI boom have largely ignored dividends to favour growth stocks, but the compounding of dividends has historically been one of the easiest ways to build wealth. Contrary to what growth stock enthusiasts might think, the S&P Dividend Aristocrat Index’s total return over the past 25 years is neck-and-neck with the tech-heavy Nasdaq index but with considerably less volatility.

In what could be a truly unprecedented economy, non-US and dividend-paying stocks seem the best suited for what could be a truly unprecedented economy.