The latest Global Fund Manager Survey published by the Bank of America is out. The survey canvasses the opinions from 238 institutional fund managers, collectively managing around $364 billion, on a wide spectrum of issues around the economy and financial markets. The tenor is pretty upbeat. Well, very upbeat, actually. The sentiment indicator – a broad measure of expectations about economic growth and equity market performance – is the highest it has been since July 2021.

What to Expect When the Market Expects Bulls

That sounds nice, perhaps. Fund managers (for reasons we do not entirely share) are happy with the economic direction of things. They have high risk appetite. Cash levels among these fund managers, at 3.3 percent, is the lowest on record since BoA started keeping tabs on these things in 1999. Defenses are lowered, in other words. Meanwhile another metric in the BoA report, called with a full dose of clarity the “Bull & Bear Indicator,” currently reads 7.9. This indicator has a couple key threshold levels. One is 2.0, which investors interpret as a buy signal because it suggests that the fund managers are overly bearish. The other is 8.0, which is interpreted as a sell signal because it points to too much optimism among the fund manager set – an outpouring of animal spirits reflecting what former Fed chair Alan Greenspan called “irrational exuberance” back in 1996.

Of course, just because a number like the Bull & Bear indicator warns of too much optimism does not mean that a course correction is just around the corner. Anyone who took Greenspan’s comments seriously and sold out of the US equity market in 1996 missed out on some of the best years stocks in this country have ever experienced. What it does say, though – and this should not be a surprise to anyone who has been following the path of the market over the past few months – is that markets are closer to being priced for perfection than being tethered to historically reasonable valuation ranges. That means that any number of things could happen in the global economy next year to take the wind out of the market’s sails. Here is where we come back to the comment we made above: we see plenty of reasons to question whether the 2026 economic growth story is quite as robust as the fund managers seem to think.

The Mixed Bag Economy

To be clear, the base case we have been building for next year does not contemplate a recession at least for the foreseeable future. It has been a while since we have seen GDP growth numbers – thanks to the government shutdown, we won’t get the Q3 reading until next Tuesday. But the consensus estimate among economists is around three percent, and that comes on the heels of the 3.8 percent growth recorded in Q2. A big part of the growth story involves the hundreds of billions of dollars pouring into AI infrastructure, and that trend shows no signs of slowing down, even as some observers question how much of that capex is going to produce a real return on investment. On the consumer spending side, the slowdown we have been watching all year has not turned into a freeze.

We expect growth will slow next year. What might make outcomes differ from a modest slow-growth base case, though, are negative developments in the labor market and consumer prices. Today we finally got a look at the November jobs numbers from the Bureau of Labor Statistics, and they presented a mixed bag. Nonfarm payrolls rose by 64,000, which was more than the 40,000 consensus estimate (the NFP number for October, which also came out today, showed job losses amounting to 105,000 but that was almost entirely due to the one-off factor of federal employees accepting deferred resignation). But the overall unemployment number rose to 4.6 percent, the highest since September 2021 in the aftermath of the Covid pandemic. Unemployment has risen steadily all year, while companies that track layoffs such as Challenger, Gray and Christmas have reported multi-year high levels of layoffs in recent months. In his remarks last week following the Federal Open Market Committee’s monetary policy meeting, Fed chair Jay Powell noted that risks to both unemployment and consumer prices are skewed to the upside, meaning more potential to get worse than to get better. We concur. The best way we think we can describe the economy now is as a mixed bag, open to interpretation.

So we see the potential (though in no way inevitable) for a bumpy ride – and that is to say nothing of the concerns about the bond market which we shared with you a couple weeks ago. You will see a deeper set of our thoughts about the economy in a few weeks when we publish our annual outlook. In the meantime, let’s enjoy the fund managers’ upbeat vibes while they are still around.

It has been something of a rite of passage in recent years. As the year gets underway in January, the financial chattering class lands on the age-old question. Is this Europe’s year? Is it time for portfolio managers to shift weights out of the US and into assets on the other side of the Atlantic? Typically, this festival of talking heads will take place immediately after a day in which the MSCI Europe Index or a similar benchmark ends up ahead of the S&P 500. In recent years, though, it has always ended the same way. Whether the out-of-US rotation was for one day or one month, US stocks always found their way back. Over the past ten years, the performance gap between US and non-US stocks has been immense. During this time the S&P 500 delivered a cumulative total return of around 308 percent, while the MSCI EAFE Index (an index of developed economies in Europe, Australia and the Far East) returned a cumulative 131 percent over the same period.

This year has been different. European bourses started 2025 on a strong note, and they are finishing strong. The chart below shows the relative performance of a handful of national European indexes, as well as the more broad-based EAFE index, versus the S&P 500 for the past 12 months. The returns are shown in US dollar terms, the relevant number for a US-based investor.

The Midyear Correction That Wasn’t

The sustained outperformance of European equities caught a number of market observers by surprise, particularly after US markets settled down in the weeks following the ill-considered “Liberation Day” tariff plan unveiled in early April. Once investors figured out that the White House was going to back away from completely scuttling the global economy, US stocks rallied sharply. In particular, the AI-themed growth darlings of the past three years, which endured a rough patch in the first couple months of the year, bounced back with their customary brio. AI infrastructure dollars kept pouring into the economy, raising growth expectations and (for the time being, anyway) putting paid to the earlier fears of an economy brought low by rising tariffs and fading consumer spending. Surely, investors thought, the moribund economies of Western Europe would once again pale in the background while US tech dynamism surged back onto center stage. That brief moment in the sun for European equities would end the way it always ends, with second-half doldrums leading once again to a second-place finish. But no, not this time. Throughout the second half of the year the relative performance numbers waxed and waned, but Europe and non-US equities generally held their ground and then some. Barring some entirely unexpected development between now and December 31, European equities will see out the year with a healthy record of outperformance.

Currencies and Other Matters

Investing in foreign assets, of course, exposes an investor to more than the underlying cash flows of the assets; it also exposes her to the currencies in which the assets are domiciled. Currently, the euro is up around 13 percent versus the dollar for the year to date. Let’s think about that in terms of our US-based equity investor with a position in European equities. That 13 percent currency differential translates to an immediate gain: even if the European equity position ends the year completely flat in local currency terms, our investor’s year-end statement records a 13 percent positive return.

But there has been more to the story than just the fact that 2025 was a relatively bad year for the US dollar. Currently, the total return for the MSCI Eurozone Index, which tracks the performance of stocks in the single currency region, is up around 39 percent versus 19 percent for the S&P 500 – a differential of around 20 percent. We can attribute 13-ish percent of that to the currency factor, leaving around seven percent of pure equity vs. equity outperformance. The question a reasonable investor wants to know is – why? And is that differential sustainable?

If by “sustainable” you mean “likely to outperform again in 2026” – well, who knows? The short term is unknowable. But if “sustainable” means a structural, medium to long term case for more diversification out of US dollar-denominated assets, then we would say yes. The world is a very different place today from what it was just several years ago. What that means specifically for Europe – or for China, or Japan, or for frontier markets in Africa, for that matter – remains to be seen. But having more geographic dispersion in one’s portfolio than may have been necessary in the recent past is, we think, an appropriate goal when looking beyond whatever happens in the next twelve months.

Happy December! It’s the last month of 2025, which has been a strange year in oh so many ways. It is also the month when, by custom and tradition, our leading financial institutions tell us, in very specific terms, how the S&P 500 and the Nasdaq and the Dow will all fare in 2026. Please. You will have just as much insight into what the US stock market will look like twelve months hence if you ask the question of your friendly neighborhood psychic. Or your dog, for that matter.

Rather than trying to pin a number on something that is entirely unknowable, let us instead think about what some of the wild cards might be that buffet assets hither and yon next year. One that we have been paying attention to recently is the Japanese bond market. It was not too long ago – little more than a year in fact – when the most notable feature of this market was negative yields. Under the hyper-stimulatory policies of the Bank of Japan, investors in Japanese government bonds (JGBs) not only received no interest income, but those interest payments actually went in the other direction

Takaichi-nomics

Those days are gone. The 10-year Japanese government bond yield has nearly doubled since the beginning of the year, with much of the growth spurt coming in the past two months as the new government led by prime minister Sanae Takaichi came into office with big plans for some major fiscal stimulus to shake Japan’s economy out of its recent lethargy. At the same time the Japanese yen, which had risen sharply against the US dollar earlier in the year, has plunged by around seven percent against the greenback.

The Bank of Japan has already raised rates three times since March 2024, at which time the benchmark policy rate was still negative. The BoJ meets again next Thursday (one day after the Fed holds its December meeting), and analysts are now expecting that this meeting will produce another rate hike. BoJ Governor Kazuo Ueda suggested as much in public comments earlier this week, and swaps markets are now pricing in around a 70 percent probability of another hike.

The policy action stems from concerns that the new Takaichi government will be tapping the debt market for sizable supplemental issuances next year in order to fund a massive budgetary program to promote economic growth. Investors have grown wary of longer-dated bonds recently, with a collective holding of breath and then a measure of relief when a 20-year JGB auction this week managed to scrape out enough demand to cover the issue. Observers worry that the government’s plans will prove too ambitious for the market to swallow, particularly if the size of the government’s budget necessitates going back to those shaky longer maturities. The same concerns have been behind the recent pronounced weakness in the yen against other major currencies.

Carry That Weight

The other major implication for bond markets outside Japan is the way higher yields upend the carry trade, a long-standing and arguably stabilizing factor in global credit markets. In a world of ultra-cheap Japanese yields, investors borrowed in yen and invested in higher-yielding opportunities elsewhere. Japanese financial institutions are among the world’s largest creditors, and in recent years Japan surpassed China as the largest international holder of US Treasuries. But the prospect of higher rates in their home country may drive the Japanese financial institutions to repatriate a meaningful part of their overseas holdings, which in turn could drive rates higher elsewhere. Including, yes, the US Treasury market. And equity markets, as we all know, are downstream from and highly affected by changes in fixed income yields.

This could be one catalyst for a very messy year in global credit. There are plenty of other reasons to not be looking forward to bond markets next year. Here at home, latter-day bond vigilantes have been trying to steer the White House away from turning the Fed into a supplicant to the president’s monomaniacal desire for ultra-low interest rates. Dissension among Federal Open Market Committee members has been a factor of the past several FOMC meetings, a trend which could turn even sharper in the months to come.

But even in the event that the administration were to get its way and start pushing the Fed funds rate ever lower, the forces affecting longer-term rates – i.e., the ones that have more impact on real-world economic activity – are much less easy for politicians to control. Such as, for example, a sizable exit by Japanese banks from their US Treasury holdings in response to the higher yields back home. This may not come to pass, of course. But it will require close attention in the weeks and months ahead.

And then there were two. Oh how ye have fallen, mighty Magnificent Seven of yore. Today, just two of these august mega-cap companies, so crucial to the long-running saga of AI dominance over the US stock market, are outpacing the S&P 500 in price gains for the year. The fortunate two are Nvidia and, now in the group’s pole position, Alphabet. And herein lies a lesson about how the AI story, through all its strange twists and turns over the past three years, keeps coming out ahead.

The Deep Seek Effect, Reborn

Earlier this year, the AI world was shaken by the sudden appearance of Deep Seek, an offering from China that appeared to do just about everything its US competitors could, only at a much cheaper price. What if, the pundits asked, all those hundreds of billions of dollars being poured into AI infrastructure projects here at home turned out to be wildly overdone? For a couple weeks, the Mag Seven and others in their orbit took a big hit. Then, as tends to be the case, investors did a rethink and decided that there was plenty of room for both the Deep Seeks of the world and the cascade of dollars building out data centers and large language models and all the rest of it on our shores.

This week, the financial chattering class has been all abuzz about what is being called “another Deep Seek moment.” Deep Seek is apparently the AI equivalent of Watergate – the iconic event whose name one attaches to every subsequent development of major note in the space, be that leaps forward in AI technology or political scandals. In any case, this week’s Deep Seek moment is called Gemini 3, the newest addition to the world’s stable of AI large language modules (LLMs), this one courtesy of Alphabet, the parent company of Google. Gemini 3, according to experts familiar with the milestones by which LLMs are evaluated, has demonstrated superior capabilities to OpenAI’s ChatGPT, up to now the US poster child for the wonders of generative AI.

TPUs Ratchet Up the Tensors

Gemini 3 is powered by internally developed (at Alphabet) chips called Tensor Processing Units (TPUs), which are different from the Graphic Processing Units (GPUs) dominated in the AI space by Nvidia. Hence, in the chart above, the stark contrast between the recent share price trends of Alphabet (way up) and Nvidia (way down). TPUs appear to be a cheaper alternative to Nvidia’s GPUs (here again the “cheaper alternative” refrain from Deep Seek), and Alphabet has been approaching other LLM developers, such as Anthropic, in what could be a direct threat to a portion of Nvidia’s revenues (Alphabet itself is also a customer of Nvidia, illustrating the tangled web of customers, partners, investors, friends and enemies in this industry).

Time For Another Rethink?

The story, of course, is never that simple and is likely to evolve and shape-shift yet again. Alphabet’s TPUs were developed largely with that company’s products in mind, and there are probably serious limits to how fungible they will turn out to be in adapting to the products of other AI service providers. Nvidia’s chips have an edge here in that its software platform is designed for a broader spectrum of applications. Recent comments from spokespersons at Nvidia suggest a lack of undue concern over there, whether due to confidence in their chips being one or two generations ahead of the pack or simply a show of bravado. One way or another, though, there are likely to be many more chapters to the AI story, and plenty of “Deep Seek moments” in store for the months ahead.

Meanwhile, it is time to take a short break from all things global markets and enjoy the company of our friends and loved ones as we gather for Thanksgiving. May yours be full of good cheer and good health.

We don’t talk much about bitcoin (or other cryptocurrencies) in this space, mostly because this asset class does not have a place in our asset allocation models. Our advice to clients in this regard is simply: treat cryptos like you would treat any purely speculative wager, be it sports betting or the roulette table in Vegas or whatever else. In other words, a discretionary activity to undertake outside the guardrails of your long-term financial portfolio with specific objectives for growth and capital protection.

Punters Rise, and Fall

Sometimes, though, a discussion about bitcoin is helpful, and this tends to be the case when it serves as a useful proxy for a market environment that has been awash in speculative fever. As has been the case for much of 2025, ever since traders and other short-term punters dusted off their momentary fears of economic Armageddon in the wake of the April tariff follies. Bitcoin had one heck of a ride, surging by 64 percent from its low on April 8 to a high of $126,315 (per coin) on October 6. But then things went south.

Since that October 6 high, the price of bitcoin has fallen by around 32 percent. Interestingly, bitcoin’s drop started about three weeks before the S&P 500 recorded its last all-time high, on October 28. Needless to say, that 32 percent reversal is far bigger than what the benchmark equity index has experienced – as of today’s market open the S&P 500 was down 5.1 percent from the October 28 high (stocks are trading more or less flat about an hour into today’s session). As we noted in our commentary last week, a number of factors are at play here for equities, including AI bubble concerns, the ongoing data fog problem, evidence of a slowdown in consumer spending and the fragile backdrop of geopolitical instability. Investors have been particularly unwilling to reward strong earnings reports (e.g., yesterday’s Nvidia numbers) while unleashing their full fury on companies that fall short of their expected numbers.

Cash Flows Persevere

In a market environment dominated by speculation and sometimes mindless momentum, it makes sense that the less fulsome assets are the first to fall. For all that Silicon Valley evangelists (and, more recently, late-to-the-party types from Wall Street) have been hyping the importance of cryptocurrencies as a mainstream asset class, they still collectively have yet to demonstrate a convincing use case in the real economy (apart from facilitating shady transactions on the dark web and, well, speculation for its own sake). These assets have no value apart from what people trading them perceive that value to be (this is not true for stablecoins, which is a separate discussion entirely and possibly a subject for a future article). The absence of a convincing real world use case is what keeps cryptocurrencies out of the realm of the asset classes we consider for portfolio construction.

Companies with solid cash flows, manageable debt to equity ratios, and believable models for sales and profits growth, on the other hand, will persevere through the periodic downturns that are an inescapable part of long-term investing. We believe that the most important thing we can tell our clients is to stay disciplined and hold onto their quality assets during the downturns. Trying to guess when to get out is hard; trying to guess when to get back in is even harder and much more likely than not to result in missing out on those important early recovery days after a low point is hit. This discipline is likely to be called on as we head into what could very well be an extremely tricky year ahead.

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.