AI Capex Mania Extends Bull Run
Contrary to historical seasonal weakness in stocks, last month bucked the “September effect” trend as the S&P 500 posted fresh highs on the heels of easing monetary policy from the Federal Reserve, declining bond yields, and strong earnings from mega-cap technology firms and AI-related investments. Stocks have remained resilient despite a U.S. government shutdown that is now entering its tenth day after Congress failed to pass a continuing resolution before the fiscal year deadline. While government shutdowns are nothing new- the U.S. has experience over 20 shutdowns since 1976- they are disruptive with impacts including potential military pay delays, flight disruptions, and economic data collection delays to name a few.
The Federal Open Market Committee (FOMC) cut the federal funds rate by 0.25% on September 17th – the first in the cycle- amid increased downside risks to employment. Minutes released on Wednesday revealed a divided committee, with some officials favoring holding rates steady due to stalled inflation progress, while others projected two additional 0.25% cuts by year-end. Fed Chair Jerome Powell emphasized uncertainty, citing labor market cooling as a key factor. This dovish stance boosted equities and lowered yields, but highlighted cautious forward guidance. Since the Fed’s rate cut, U.S. equities are essentially flat, suggesting the market boost investors anticipated from lower rates was either already priced in, has since waned amid uncertainty over further cuts, or a combination of both.
While equity markets have been driven in large part by the mega-cap technology stocks tied to Artificial Intelligence, there is growing concern regarding the risk of the circular web of funding within the AI ecosystem. A number of key players across the supply chain have invested in each other in addition to their supplier/customer relationship, with each deal inciting more market exuberance. Hundreds of billions of dollars of deals have been announced over the last several weeks which has raised red flags with credit ratings agency Moody’s who has warned of “counterparty risk” with the fear that some of the companies may not have the cash to meet the commitments in the future. NBC news created an interesting graphic displaying how interconnected many of the companies have become.
The velocity and magnitude from the S&P 500’s April sell-off keeps many wondering if we’re overdue for a breather. There are quite a few evolving potential headwinds to markets for the balance of 2025. These include: the dynamics of the government shutdown and resulting economic data delays; the weakening labor market; the course of the current interest rate easing cycle; stretched valuations; geopolitical risk; and the impending results of third quarter earnings season. Consumer spending, which has been a bedrock for U.S. growth, is beginning to show signs of vulnerability. The latest University of Michigan Consumer Sentiment index fell roughly 5% from a month earlier. Most participants cited concerns about inflationary pressures and jobs weakness. It’s the third consecutive month in which sentiment has worsened.
While we are cautious of the current environment, we’re cognizant of structural shift that has carried the stock market. In fixed income, we continue to prefer high quality Agency MBS and Municipal bonds. Despite rising to a new all-time high, the Russell 2000 index of small-cap stocks remains steeply discounted versus its large-cap peers. Small-cap stocks have historically been key beneficiaries of Federal Reserve rate-cut cycles, offering a potential catalyst for sustained momentum in the space as long as a recession is circumvented.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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