In the second half of October, the financial chattering class seized onto what seemed like a throwaway comment by OpenAI head Sam Altman during an interview. Responding to a question, Altman acknowledged that the AI space in the stock market was probably in bubble territory, though adding that while the space would probably go through some short-term pain, as generally happens with new technologies, the long-term use case remained extremely robust (it would be hard to imagine Altman, arguably the world’s leading evangelist for the bright shiny future of AI, to say otherwise).

In any event, financial pundits seized onto the “bubble” idea and ran with it. Investors for their part mostly ignored the bubble hype, though, and by the end of the month both the S&P 500 and the S&P Small Cap Growth index (where a number of the up and coming names in the space exist while they try to establish proof of concept) had reached their year-to-date highs. Shortly thereafter, however, the small cap index started to take a pronounced tumble. Yesterday the S&P 500 followed suit, and if today’s market open is any indication of how things end (which may or may not be the case, because even the future six hours ahead is unknowable), the blue chip index will end up down for the week.

Bad Vibes Take Charge

AI-related stocks (in both their large cap and small cap manifestations) have certainly taken much of the brunt for this week’s pullback, but the story is broader than that. The economic news – the data points that remain available during this prolonged absence of input from government agencies – has skewed to the downside. A weekly payroll estimates report from ADP reported an average decrease of 11,250 jobs per week during the four weeks up to October 25, adding support to last week’s job cuts report by Challenger, Gray and Christmas noting October’s large number of losses. Then the NFIB Small Business Optimism index came in at 98.2, below expectations and far below the almost giddy optimism small business owners reflected in the period immediately following last year’s presidential election. Small business owners have a great deal to worry about, from labor market concerns to tariffs and the lack of sufficient capital to pony up in today’s increasingly pay-to-play business-government nexus.

There has been a great deal of Fedspeak this week as well, with a number of FOMC voting members opining about the upcoming December meeting, and the market takeaway from much of the Fed commentary has tilted hawkish. The likelihood of a December rate cut, which a couple weeks ago was seen as a very high probability, is now more or less a coin flip. Along with the diminishing chances for a rate cut, the divergence of views among Committee members, resulting in a string of dissents at recent FOMC meetings, continues to be a subject of concern. Even with the government reopening this week, the question of when data from the BLS and BEA will become available remains unknown. Economic spokespersons from the White House do not seem at all eager to release a full set of data any time soon, leading to questions about what that data might tell us about the key issues of jobs and inflation.

Seasonality Still a Plus

For all the drama of Thursday’s big price moves on the major markets (with the potential for more today), the pullback thus far remains well short of a bull market correction (ten percent drop from the last peak) or even the five percent fall that we chronicle internally as a notable sentiment shift. We are still in the thick of what is frequently the most benevolent period of the year for stocks, with the holiday shopping season well underway (shouldn’t we just admit that now every day in November is Black Friday?) and window dressing as investment managers spruce up their portfolios before year end. That may still be enough to keep the headwinds of the purported AI bubble, downbeat macro data points and hawkish Fedspeak at bay. But there is plenty of volatility out there, and we have to be prepared for more twists and turns ahead as we head into 2026. For portfolios with long term objectives, this is a time to remain disciplined and unswayed by the day-to-day noise.

This has been a week, one full of news related to politics, the economy and much else in between. But it is also a week in which absences loom large. Today is supposed to be Jobs Friday, when the Bureau of Labor Statistics publishes its monthly report on the state of the US labor market, and we get to chew over the raw total of nonfarm payrolls created, the unemployment rate, labor force participation, number of people with part-time jobs who would rather work full time…all the fun stuff that helps us figure out where the economy is today and prognosticate about where it might be headed.

No Workers, No Data

But no, for the second month in a row, Jobs Friday is not to be. The halls of the BLS are empty and the desks where analysts would be beavering away on the many tasks leading to publication on the first Friday of the month are unoccupied. Those same analysts should also be getting their numbers together ahead of next week’s scheduled Consumer Price Index report, but it is far likelier than not that next Thursday will come and go with no new insights about consumer prices. This marathon government shutdown remains in effect.

Now, earlier this week there were at least a few vibes emanating from the Capitol suggesting that a solution might be at hand, with little bipartisan clusters of Senators hashing out this and that to see if there could be a path to reopening. Then Tuesday night happened. In electoral contests everywhere, from the marquee races in Virginia, New Jersey and New York City to public utility boards in Georgia, county executive seats in Pennsylvania and legislative seats in Mississippi (go figure), Democrats pulled off wins by in many cases substantially bigger margins than expected. The political fallout is still being processed by both sides, but in the meantime, any progress on ending the shutdown seems to be stymied.

No Data, No Dot Plots?

We’re just a little over a month away from the next Fed meeting on interest rates, one replete with the much-anticipated Summary Economic Projections – the “dot plots” in market vernacular – and one wonders what purpose those dots are going to serve if not derived from up-to-data data on the two most important macroeconomic insights for the Fed: jobs and prices. The data fog has already had an impact on the central bank’s customarily smooth decision-making process, with noted dissents from the majority vote in each of the last three FOMC sessions (in the last session, those dissents went both ways).

The division is likely to intensify for as long as the fog remains. In the absence of government analysis from the BLS and its sister agency, the Bureau of Economic Analysis (which is responsible for quarterly GDP and productivity data as well as the monthly Personal Consumption Expenditure index that is the Fed’s preferred inflation gauge), data from various private sources takes on outsize importance. Interpreting these is very much a matter of individual preference, which can lead to decidedly different views. For example, this week we got one report – the ADP survey – noting that job growth was modest but still positive and better in October than September. But then a separate report from the firm Challenger, Gray & Christmas reported more than 150,000 job cuts in October, the highest number of cuts for the month of October in 22 years and bringing the total year-to-date tally of job cuts to its highest point since the pandemic in 2020. What’s your takeaway, if you are a FOMC member trying to weigh the balance of factors for and against another rate cut at the December meeting?

SCOTUS Throws a Curve

As if that were not enough, the Supreme Court weighed in this week with what appeared to be a rather caustic take on the Trump administration’s legal authority for the barrage of tariffs it has unleashed on the world since taking office. Over this period the average tariff on goods coming into the US has gone up from 2.4 percent to 17.9 percent, and that translates to something like $200 billion coming into government coffers by the time the calendar turns on New Year’s Eve.

Now, a great many people in the business and finance world, ourselves included, would be perfectly happy to see this very confusing and taxing (both fiscally and mentally) tariff regime done away with, so if that is what the Supreme Court’s eventual decision ultimately leads to, then great. But that decision is not going to be forthcoming today or next week or maybe even not before the end of the year. And it is anybody’s guess how the administration, for which tariffs seem to have the authority of revealed Scripture, will react if the Court strikes its arguments down. In the meantime, it just creates more confusion. More fog, when thick gray sheets of fog befitting a New England harbor town on a cold November morning already hang over the economy.

Maybe we will have clarity on all these matters sooner rather than later. The government shutdown, now the longest on record, is starting to have a real impact on real people. Hopefully at some point it will remind our government leaders that they actually have to…well, govern. And allow sunlight to penetrate the thick fog.

Well, it’s the last day of October (Happy Halloween!), and unless something really freaky and ghoulish happens between now and 4:00 pm today Eastern daylight time (don’t forget to turn the clocks back on Sunday), we will have managed yet again to avoid an October Scare, that creepy phantasm given to showing up every now and then in years otherwise unconnected – 1929, 1987, 2008 to name a few – with a bag full of tricks and no treats. This year, despite the inescapable return of bubble banter among the financial chattering class, the S&P 500 has added 2.3 percent to its year to date price performance since the end of September.

Second Half Surge

In fact, much of the market’s giddiness in recent weeks has happened in that very same segment of mega cap AI-themed stocks that has generated the lion’s share of the bubble chatter. It was not always thus. For the first half of the year, the so-called Magnificent Seven and its posse of AI fellow travelers didn’t stand out in any meaningful way from the rest of the market. The chart below shows the year to date relative performance of the S&P 500 benchmark index, which is weighted by market capitalization and thus influenced in an outsize manner by the movements of the largest companies, and the S&P 500 equal weighted index (which, as the name suggests, takes away the influence of the market cap factor).

The acceleration of the Big Tech-concentrated second-half surge was on prominent view this week. On Tuesday, the S&P 500 finished in positive territory largely thanks to just two names – Nvidia and Microsoft – while 75 percent of the companies in the index finished lower on the day, as did eight of the 11 main industry sectors. On Thursday, shares of Alphabet (Google’s parent company) jumped three percent even while the index itself lost nearly one percent as investors responded to a more hawkish than expected report from the Federal Open Market Committee the day before. This morning (Friday), Amazon is up nearly 12 percent on the day following a blockbuster earnings report delivered after yesterday’s market close. Amazon’s strength, which has little to do with Prime shipments of Halloween tchotchkes and lots to do with robust demand for AI and cloud services from its AWS business segment, seems to be giving the AI optimist crowd an argument against the many recent concerns expressed about the apparent circularity of the AI ecosystem.

The End Is Nigh…Near…Never…

It’s one thing to observe a bubble and proclaim its existence; it’s another thing entirely to predict how much longer the animal spirits have to run. After all, Alan Greenspan made his “irrational exuberance” comments about the building tech bubble in 1996, several years before the thing finally imploded in March 2000. The AI infrastructure bonanza does not appear to be on track to end any time soon. Among the tidbits to take away from this week’s earnings reports was the tidy sum of $80 billion in capital expenditures on AI-related items by just three companies – Microsoft, Alphabet and Meta – with much more than that promised for the year ahead. The build-out of data centers to power the large language models for AI software is increasingly a must-have component for GDP growth. According to a recent analysis by Harvard economist Jason Furman, investment in data centers and information processing technology accounted for virtually all the GDP growth for the first half of this year. As long as this multibillion dollar spending frenzy occurs, it seems, the economy has a pretty solid cushion against falling into negative growth. Of course, when and if all this spending turns into real productivity across the economy is the question that will keep us all guessing for the foreseeable future.

Meanwhile, the bubble talk won’t be fading away any time soon. Keep an eye on that relative performance trend between the market cap and equal cap indexes, which is likely to look quite different on the other side of a bursting bubble.

It has been a strange year in so many ways, but one of this year’s odder bedfellows has been the tandem duo of US stocks and gold. These two asset classes don’t normally tango together. In 1979, gold was just about the only thing that was working for portfolios, while the S&P 500 was in the dumps and bond markets were roiled by the Volcker shock of ultra-tight monetary policy. Two decades later, 1999 was a go-go year for any stock with even the flimsiest connection to the Internet, while gold had nothing to offer other than being pretty to look at.

This year, the precious metal and the blue chip stock index have been at the forefront of a giddy general melt-up for financial assets. Gold, in particular, has been on a tear since late summer, shooting up by more than 30 percent from the middle of August to the end of last week. But this week, suddenly, things went south and the price of gold dropped by nearly seven percent in just two days, no doubt to the chagrin of those coming late to the party.

To Hedge or Not to Hedge

The timing of this pullback was a little odd. As we wrote about in our column last week, all the talk of the town in recent days has been about a stock market bubble. Bubble talk, in general, gets people to start thinking about hedging. Gold, of course, has long been thought of as a go-to hedge asset – witness that start turn during the stagflation miasma of the late 1970s. One might have thought, rationally, that this week would kick off with a big pullback in stocks while gold rose some more. But rationality has precious little to do with the ways of the markets in these times of ours. Stocks have continued blithely to ignore anyone waving wildly at stratospheric valuation levels, surging to yet another record high by the end of the week.

It is entirely possible, of course, that gold’s performance this year doesn’t actually have all that much to do with hedging. There are other, potentially cheaper ways to offset exposure to US stocks if one is so inclined, including simple S&P 500 put options. Capital markets are starting to look a lot more like prop bets than anything else, where you can take a position for or against just about any movement large or small in just about any corner of the globe using an ever-expanding arsenal of easy-to-obtain assets. Maybe there’s nothing more to the post-August rally in gold than the simple fact of all that liquidity coursing around the world has to go somewhere, so a good chunk of it might as well go to something that has been around for thousands of years.

Just a Pretty Hunk of Meta

The other thing to remember about gold is that it has no other source of value than price appreciation. No interest coupons, no dividend payments, nothing other than a belief that the price will be higher tomorrow than it is today. Yes, it is a scarce asset with a finite supply, and over long periods of time the scarcity factor delivers value. But not always. Gold rose, for understandable reasons, during and after the stock market crash in 2008, reaching a then-peak in 2011. But prices fell after that, and didn’t regain that 2011 peak price until the middle of 2020. In the post-pandemic period through 2023 gold’s performance was mostly flat. It was no help to investors looking for a hedge during the equity bear market of 2022, with prices falling around 15 percent from April to October of that year (the sharp rise of interest rates during this period made gold, as a non-interest bearing asset, less attractive).

What happens next remains to be seen, of course. Today, stocks are up, gold is down and a belated inflation report (delayed due to the government shutdown) delivered no surprises versus expectations. In the wake of that powerful surge in gold prices from August to last week, though, a more protracted pullback would not be out of the question.

Is it going to be one of “those” Octobers? If you tuned into pretty much any financial media this week, you would have heard “bubble” spout forth from the mouths of many a money pundit. Luminaries from JPMorgan Chase head Jamie Dimon to OpenAI maven Sam Altman have weighed in on the frothy state of the market. It’s not a hard call to make – the US stock market is undoubtedly expensive. According to Yale economist Robert Shiller’s vaunted CAPE  (cyclically adjusted price to earnings) ratio, the S&P 500 is more expensive today than at any time in the history of modern markets apart from the height of the tech bubble before it blew up in 2000. And it’s only a few points off of that – 39.5 today versus the dot-com peak of 44.2 set in December 1999. For a nice historical reference to coincide with the release this week of Andrew Ross Sorkin’s book “1929” – the CAPE peak just ahead of that epic calamity was 32.6.

That’s rare air we’re breathing here. And investors have noticed, and gotten a bit jumpy. The CBOE VIX index, Wall Street’s so-called “fear gauge,” has spiked in recent days after being quiescent for most of the summer. The VIX currently trades around 25, which is above the rule-of-thumb fear threshold of 20, though still well below where it shot up to after the “Liberation Day” tariff announcement of April 2. Much of the market commentary, naturally, has focused on the AI narrative as the driving force behind the market’s gains this year. But the headline story told by those Brady Bunch panels of talking heads on the networks is not exactly seamless – and there are some important distinctions to be made when thinking about today’s market relative to the late 1990s or other bubble periods.

The Mag Seven’s Mixed Results

Let’s start with a closer look at the so-called “Magnificent Seven” – that small group of mega-cap stocks that became a byword for “AI narrative” back in 2023. This group collectively has not packed quite the same punch this year as it did back then.

As the chart shows, only four of the Mag Seven names are ahead of the benchmark index so far this year – Nvidia, Alphabet, Meta and Microsoft. The other three – Apple, Amazon and Tesla – are lagging the index. Now, it’s true that other names have shouldered their way into the story. Palantir, a provider of data and AI services to defense and other government services, currently trades at a logic-defying forward price-earnings ratio of around 225 times. That’s not exactly a screaming buy unless you assume that everything that could possibly go right in the most optimistic AI scenario actually comes to pass. But the frothiness of this bubble, in general, seems like it might be a bit more selective than the one that consumed the market 25 years ago.

Spreading the Wealth

It’s also notable that while the AI hype is concentrated on US stocks, the performance of global equity assets this year has been more evenly distributed. In fact, the S&P 500 and even the tech-concentrated Nasdaq Composite are still lagging most of the rest of the world. As of Thursday’s market close, the S&P 500 was up 13.9 percent for the year to date and Nasdaq was ahead by 17.4 percent; meanwhile, the MSCI EAFE index was posting a 27.4 percent gain while the MSCI Emerging Markets index, on the back of a stonking performance by China shares, was ahead 31.4 percent. So there must be other factors driving markets apart from the AI story, and the blowing up of AI-themed shares, were it to happen, would arguably not have the same deep impact everywhere at the same time. This underscores the importance of diversification, in favor now after many years in the wilderness, as a strategy for long term performance.

The AI of It All

So how worried should we be? Clearly, there are pockets of extreme frothiness in the market today. A number of the really head-scratching cases can be found in the private markets, perhaps none more so than OpenAI, the company trying to position itself as the Everything AI shop, which sports a valuation of around a half-trillion dollars even while delivering just $4.3 billion in sales in the first half of the year while burning through $2.5 billion in cash. OpenAI’s rampage around the tech universe, making spending commitments amounting to $1 trillion in the next five years, has also raised eyebrows among Silicon Valley observers concerned about the circular logic of infrastructure spend and valuations.

Whether one is prepared to take a few bumps along the way in pursuit of long term performance simply comes down to one’s own views on what AI can eventually deliver. To paraphrase an old joke, if you put ten tech-savvy investors in a room to talk about AI’s future, you’re going to come away with fifteen opinions. There is just too much that we don’t know today. If AI becomes the most significant paradigm shift in economic productivity since the achievements of the early Information Age, then the risk is worth taking. If, however, it never makes much headway beyond that circular universe of companies at the center of AI infrastructure and model building, then it’s more likely to be an epic bust.

The good news is that, as an investors, it is not necessary to stake your entire portfolio on either side of that binary outcome. Diversification among alternative risk asset classes still works, and you can scale the AI-themed component of that up or down accordingly as part of a diversified portfolio across geographies, industrial segments and macro themes. We believe it would be wise to not ignore the longer term potential of AI. Remember that not all dot-com companies perished in the crash of 2000, and many of those that survived have delivered handsomely for those who stuck it out.

Japan jumped into an already frothy geopolitical moment last weekend when the Liberal Democratic Party, the country’s ruling party for all but a very brief time since the end of the Second World War, selected Sanae Takaichi as the new head of the party and thus the person likely to succeed outgoing prime minister Shigeru Ishiba. Takaichi, who would thus become Japan’s first female prime minister, is known as a hardline conservative with an economic agenda modeled on the pro-stimulus policies of Shinzo Abe, the former prime minister whose “Abenomics” plan was all the rage back in the mid-2010s.

Deer in the Headlights

The news of Takaichi’s appointment caught markets flat-footed. The Japanese yen has been up against the dollar for most of this year, while the Nikkei 225 stock index mostly meandered along with modest gains. But the prospect of intense political pressure on the Bank of Japan to lower interest rates and pump up the economy had an immediate effect on both stocks (sending them soaring) and the yen (which promptly nosedived on the news).

On Monday morning traders were quick to dub the weekend’s developments as the “Takaichi trade,” with the Nikkei index ending the day nearly five percent higher. Observers noted the particular attractiveness of shares in the defense, energy and cybersecurity sectors given Takaichi’s hawkish bent on strengthening Japan’s military capabilities. Meanwhile, a bond market expecting to see another interest rate hike when the Bank of Japan meets in a couple weeks had a deer in the headlights moment, with Takaichi vowing in public statements to put pressure on the BoJ to keep rates low in service of new rounds of economic stimulus.

Coalition Problems

But the market gyrations were far from over as the week wore on. The fortunes of the Liberal Democratic Party have been poor of late, with the party losing its majority in both the upper and lower houses of parliament during the troubled rule of Ishida, the outgoing PM. The party has been able to continue governing thanks to its coalition with the Komeito party. But that came apart earlier today when Komeito’s leader Tetsuo Saito pulled the junior party out of the coalition. Lacking an outright majority, Takaishi will now have to obtain support from other minority parties in order to form a governing coalition. That could potentially pull Japan even further to the right, joining what appears to be a global trend gathering steam.

Despite the Komeito setback, Takaichi is likely to be sworn in as prime minister following parliamentary voting next week. Traders with itchy fingers may want to wait for awhile to see what the make-up of the new governing coalition looks like, though, before diving head-first into the “Takaichi trade.” Japan is in a different place today than it was in 2012 when then-PM Abe kicked off his “Abenomics” agenda. The new prime minister and her government are going to have to adapt their policies to address concerns about higher consumer prices, a rapidly ageing demographic landscape and the regional challenges facing all countries residing in the neighborhood dominated by China. We will be paying close attention to developments in Japan as we proceed with our own geographic diversification strategy. But for now, our take on Japan is very much wait and see.

On Wall Street, traders and other denizens of the market have their own way of processing the daily news feed. Generally, every news item gets processed through the prism of what it might mean for interest rates, taxes and (maybe) one or two other things that markets care about. When you wonder why the pundits on CNBC are all excited about a bad jobs report, it means that the Street is abuzz with hopes for a looming Fed funds rate cut. Bad news is good news, in other words. Throw in a few bad macroeconomic reports, and there might be a pony out back in the form of another tax cut.

Catch the Drift

The news today – the first Friday of the month and therefore by all rights Jobs Friday – is neither good nor bad. It just isn’t. Over at the Bureau of Labor Statistics, the September employment report probably exists somewhere, in somebody’s desk drawer. But it won’t be coming out today, because the lights are off at the BLS due to the government shutdown that started on Wednesday and appears likely to continue at least into the early part of next week. What is the latest unemployment rate? Did nonfarm payrolls increase or decrease last month, and by how much? Presumably we will find out sometime after the shutdown ends, but that will not be today.

In the absence of this key piece of economic data, markets are likely to drift. That’s not such a bad thing, necessarily, because the trend of late has been upwards, and in the absence of a catalyst to force a change of direction, it would be a rational assumption that the drift will continue to bear prices aloft. US stock markets open in about 10 minutes, and premarket indicators are showing small moves to the upside. Nature may abhor a vacuum, but markets are happy to drift in the absence of hard data.

Earnings Season, Shopping Season

We don’t know, of course, how much more government data will be delayed on account of the shutdown. The next big items – meaning the ones that matter most to the Fed in its interest rate deliberations – are due to come out in a couple weeks when the BLS releases its Consumer Price Index report (October 15) and Producer Price Index report (October 16). That’s the same week that corporate earnings season kicks off in earnest, so at least there will be plenty to chew over as management teams present their third quarter results and provide guidance for the year ahead. That could be another excuse for traders to push stock prices higher. The current analyst consensus for Q3, according to data research company FactSet, is for sales to grow a bit more than six percent and net earnings to increase by nearly eight percent. Those estimates are higher now than they were three months ago, with the general sentiment seeming to be that, at least for now, the worst-case scenarios around tariffs and stagflation haven’t materialized.

Towards the end of October the Federal Open Market Committee will meet again (with or without updated data about jobs and inflation). Markets are betting on another rate cut to follow from the 0.25 percent cut in September. That brings us into the holiday season, where expectations are for modest growth as shoppers continue to spend, though at a slower pace. Our current expectation is that these developments will be supportive of ongoing strength in equity markets, though we will be interested to see what happens in the year’s final weeks. Sometimes, the holiday season giddiness loses steam as Christmas comes and goes, and points towards a reversal of sentiment come January. Time will tell. Hopefully, by then we will at least have more hard data to peruse.

Stop us if you’ve heard this one before. The US government shuts down for some defined span of time, markets barely notice, and for everyone who doesn’t work for the federal government, life goes on more or less as normal. Well, there might be some disgruntled folks at closed national parks, if it gets that far. But that’s about it. So it looks like the government will be shutting down again next week, on September 30, unless some completely unexpected series of talks emerge between the parties, where currently none exist. So, more of the same, right? Or is this time different and markets should be paying more attention?

Dysfunctional In Their Own Unique Ways

Government shutdowns are like the unhappy families of Tolstoy’s opening line in “Anna Karenina” – each one is dysfunctional in its own special way. The government has actually shut down a number of times over the previous few decades, of which three stand out in particular. In November 1995, then-President Clinton refused to sign off on a slew of budget cuts demanded by Newt Gingrich’s Republicans, the latter of whom also threatened to refuse to raise the debt ceiling limit (familiar, no?). The shutdown – actually two shutdowns with a brief interlude between them – lasted from November 14, 1994 to January 6, 1996. During that time the S&P 500 gained 4.7 percent amid an otherwise perky period of economic growth.

During the administration of Barack Obama, one of the most perennially contentious issues was the Affordable Care Act, which galvanized Republican opposition like nothing else. In October 2013 the ACA was the key issue in a failure by Congress to either appropriate funds for the following fiscal year or to rig up a continuing resolution for interim funding. A shutdown ensued, lasting for seventeen days during which all but the most critical government functions were curtailed, 800,000 federal workers were furloughed and another 1.3 million continued to work in some form without knowing when they would next be paid. The shutdown generated major daily news headlines during this period. Again, though, the stock market barely paid attention. The S&P 500 rose 1.6 percent from October 1 to October 17.

The longest shutdown to date lasted for 35 days from December 22, 2018 to January 25, 2019. The Congressional Budget Office estimated that this prolonged shutdown cost the US economy $11 billion, as about a third of all government operations were completely non-functional for this period. This time, the main point of dispute was disagreement over $5.7 billion in funding for Trump’s border wall between the US and Mexico. After a great amount of fudging and performative Kabuki drama on all sides, the shutdown fizzled out and life went on. Meanwhile, the S&P 500 actually rose 10.5 percent over this 35-day period (the stock market’s movements during this time actually had almost nothing to do with the shutdown and everything to do with the Fed, near the end of a period of monetary tightening).

Health Care, Rescissions and Mass Firings

So what can we expect next week, when the government appears poised to shut down again? Well, the issues on the table would appear to be intractable. Messaging on the Democratic side appears to have settled around the issue of health insurance subsidies which are due to expire, with House minority leader Jeffries insisting on a measure to protect these subsidies and related health care benefits in the form of “ironclad” legislation. More generally, the Democrats are trying to figure out how to stop a repeat of the last budget go-around earlier this year, when they agreed to a continuation in funding only to have some elements of that funding yanked away by the Republicans in the Recissions Act of 2025 (recission being the technical term for “we said you could have this but we’re taking it away now, and you can’t stop us”).

None of this appears to be ruffling any feathers on the Republican side, and in fact the White House has threatened to use the shutdown as an excuse to implement mass federal firings throughout the swath of government agencies. The strategic logic on the Republican side appears to be that the pain caused by such broad-based evisceration of agency personnel will be too much for the Democrats (who, they assume, would bear the brunt of the blame), causing them to fold. A veritable game of chicken is at hand.

The markets, as usual, are not paying attention to much or any of this. History would seem to be on their side: a government shutdown becomes a real, economically consequential event if it goes on indefinitely, but eventually something will give and some messy compromise will get the funds flowing again. That’s how it has always worked, and the S&P 500 has the receipts.

The problem this time is that the general creditability of the US system is not exactly riding high these days, either here or elsewhere in the world among dollar-denominated asset holders. We don’t expect this looming shutdown to last indefinitely or even that it will break that prior record of 35 days. But the dysfunction is just one more indication that things are not working as they should, and this concern will be very much on our minds as we start to plan our allocation strategy for 2026.

Pick a number, any number. That was, more or less, how Fed chairman Jay Powell responded to a question posed by a journalist in this week’s post-FOMC press conference about the current state of the labor market. Specifically, the journalist was asking about the breakeven rate – the number of jobs employers have to create every month to keep the unemployment rate from going up as new job seekers come into the market.

NFP Roulette

“If you said between zero and 50,000 you’d be right” was Powell’s wry response to the question, referring to the quantity of nonfarm payroll (NFP) gains needed. Meaning: it’s really anybody’s guess what that breakeven number is, because the jobs market today is full of confusion and misdirection. The unemployment rate is rising and NFP gains have declined significantly from their levels a few years ago. The chart below illustrates this trend.

It is clear from this chart that the demand for labor is cooling: the monthly change in nonfarm payrolls is well below where it was a couple years ago, and the latest revisions showed that the number actually declined for the month of June. Meanwhile, the unemployment rate has ticked up, slowly but steadily, to its highest level since the immediate aftermath of the pandemic in 2020-21. Now, while the latest NFP number of 22,000 payroll gains technically falls within that “zero to 50K” quip of Powell, it would seem to be coming in somewhere short of the breakeven rate. Anecdotal evidence suggests that demand for labor is weakening in just about every sector of the economy except for healthcare. Manufacturing employment, to name one, is down by 78,000 for the year to date. Other areas including retail, professional and business services, construction and hospitality have shown little change in this period. And conditions are particularly tough for younger job seekers, especially – in a striking reversal from the normal trend – for young college graduates.

The Supply Side

But the jobs numbers don’t just reflect the demand side. At the same time as demand has been weakening, so is supply. As Powell noted during Wednesday’s press conference, a big impact on the supply side has been immigration policy restricting the flow of new workers. Think again about the logic behind the breakeven rate. How many new jobs have to be created to keep unemployment in check depends on how many people are out there looking for jobs. If the number of new job seekers is lower, then the breakeven rate is also likely to be lower.

We know that the number of foreign-born workers – whether due to deportation or just not wanting to risk showing up at the local Home Depot parking lot in search of work – has declined significantly since the beginning of the year. As the chart below shows, that number fell from around 33.3 million in January to about 32.2 million in August.

So how bad are things, really, in the labor market? Nobody really knows, including the Fed, and that is why Powell described the 0.25 percent cut in the target Fed funds rate announced Wednesday as a “risk management” cut, rather than signaling a clear and decisive move towards monetary easing. An unemployment rate of 4.3 percent, where it stands today, is not unusually high – in fact, it is not too far away from what economists in the past have tended to regard as the “natural” rate of unemployment under conditions of economic stability. But the trend is in the wrong direction.

By referring to this rate cut as an exercise in risk management, Powell addressed both sides of the Fed’s dual mandate: taking steps to prevent unemployment from getting uncomfortably higher while at the same time acknowledging that the battle against inflation is far from over. The high degree of uncertainty in the economy makes it difficult to chart a clear path forward. Look no further than the Summary Economic Projections – the “dot plots” – that accompanied this week’s FOMC decision. One of the nineteen “dots” in the Fed funds rate projections for the rest of 2025 actually contemplated a rate hike before the end of the year, while another dot reflected expectations for five more rate cuts (the less said about that latter projection, the better). The truth is probably somewhere in between. Pick a number, any number.

If you had told anyone following financial market trends on April 2 this year that by September just about any asset class under the sun would be basking in positive returns for the year, they would have called you crazy. But the doom and gloom of the “liberation day” tariff announcement quickly dissipated, and since then the markets have learned to take each and every curve ball thrown their way in stride, shrugging off any longer-term implications while reveling in the joys of a short-term sugar rush. Everything from gold to emerging market and European equities to our own S&P 500 is up double digits, and even the once-jittery bond market has settled into a comfortable place with prices up low to mid-single digits across a spectrum of credit risk. It’s a year for the Pollyannas of the world. And that sugar rush may have a ways to go before it ends.

Party Like It’s 2021

It wasn’t all that long ago that we had a similar dynamic. 2021 was the year of the “everything rally,” the year when the punters of the world united to pump up the prices of dubious stocks like GameStop while loading up on all things crypto and outbidding each other for “unique” digital images of primates in various postures of ennui. The fun back then ended, of course, when the Fed took away the punchbowl of zero-level interest rates and began its extensive monetary tightening program in early 2022.

Interest rates are still high relative to where they were in 2021, but that may be about to change in a way that gives this year’s everything-goes rally another burst of upward movement. The Federal Open Market Committee will meet next week, and investors are all but certain that, come 2:00 pm Eastern time next Wednesday, the Fed funds target rate will drop by 0.25 percent. The FOMC has three more meetings this year (including next week’s), and prediction markets have pegged a rate cut for each of those meetings, having the Fed funds rate end the year 0.75 percent lower than where it is today. Couple that with the frequent impulse for markets to rise during the holiday season, and it’s not hard to see why pundits from a number of corners are furiously raising their estimates for risk-asset performance between now and New Year’s Eve.

Reality Bites Back (Sometime, Probably)

A rationally-minded person might ask why all this good cheer is happening at a time when there doesn’t seem to be much in the way of good news out there. The labor market is in a clear slowdown phase, and this week we learned that the BLS jobs numbers reported for the twelve months between March 2024 and March 2025 were revised down by 911,000 – that’s roughly 75,000 fewer payroll gains over that period than previously reported. Also this week, we saw that inflation is not showing much sign of trending down. Year-on-year core inflation (measured by the Consumer Price Index) is up 3.1 percent. Grocery prices, which don’t show up in the core inflation number but which very much do show up in household budgets, rose by 0.6 percent in the month of August alone. The effect of tariffs as a sales tax on consumers is showing up in an ever-widening array of goods and services.

The stickiness of inflation complicates the Fed’s interest rate calculus, but the central bank has been clear in recent messaging that current concerns are tilted towards the jobs side of its dual mandate. So while the market is probably right that rate cuts are coming, they will be coming with plenty of attendant concerns about future developments. Several FOMC members have expressed confidence that inflation will level off and subside after one or two months of tariff-related increases, so job number one is making sure that employment conditions don’t venture far enough south to push the economy into recession territory. Maybe they’re right – and we can see a world in which markets continue to buy into this worldview for some time to come. But reality has a way of biting back, sooner or later. In our view, this is a time neither for overly defensive pessimism nor excessive optimism.