Executive Summary
Markets extended their rally in October, rising for a sixth straight month and hitting new highs despite weakening breadth. Parallels to the late 1990s, marked by narrow leadership, expensive valuations, and transformative tech, continue to fuel debate of a bubble. While today’s AI leaders are fundamentally stronger than their dot-com era peers, questions remain around the profitability of AI infrastructure investments. The Federal Reserve delivered a second consecutive rate cut despite not having the latest economic data, but downplayed the probability of another rate cut in December. Earnings growth remained solid, despite being concentrated in a handful of mega-cap tech stocks. The government shutdown delayed key data releases, though private indicators showed a split economy: AI-driven capex is lifting growth, while labor, housing, and manufacturing remain soft.
1. Key Themes Driving the Market
Markets continue to draw comparisons to the late 1990s, with artificial intelligence replacing the internet as the transformative technology. This parallel, while not perfect, has ignited a debate over whether the market is in the early stages of a bubble. Investors are weighing whether AI-fueled capital spending can deliver sustainable growth or if expectations are running ahead of reality. The key difference: unlike the dot-com era, today’s AI leaders are highly profitable, generate strong cash flow, and fund investment from operations. History shows that bubbles can last longer than investors think, and spotting bubbles is easier than timing them. The Investment Office views AI as a fundamental, long-term, durable theme that is still in its early stages, presenting significant investment opportunities across the entire value chain and beyond just mega-cap tech stocks. It emphasizes a need for fundamental analysis across both the public and private market strategies, with an understanding of the ongoing infrastructure buildout to identify future winners in this rapidly evolving landscape.
2. Stock Market Recap
U.S. stocks posted a sixth consecutive month of gains in October, led by Growth and Large Cap stocks. Markets rallied early but faced volatility mid-month due to regional bank concerns and renewed U.S.–China trade tensions, causing the stock market to trade lower. Stocks rebounded after the Fed signaled another rate cut and credit fears eased, but the rally faded into month-end amid rising tech capex guidance and cautious Fed commentary. Sector performance was uneven: Technology and Health Care outperformed the broader S&P 500, while the other nine sectors lagged. International markets modestly underperformed U.S. stocks, with Emerging Markets outperforming Developed.
3. Bond Market Recap
Bonds posted early gains in October as Treasury yields declined on expectations of a second consecutive Fed rate cut and a flight to safety tied to regional bank credit concerns and U.S.-China trade tensions. However, interest rates reversed higher in late October following hawkish commentary from Fed Chair Powell. The Treasury yield curve ended the month mostly unchanged, as credit fears faded and trade tensions eased. Corporate credit spreads widened briefly early in the month, and while spreads recovered later in the month, the riskiest segment—CCC-rated high-yield bonds—did not fully bounce back. The group’s underperformance signals lingering concern about credit risk and broader economic resilience. Munis continue to offer some of the highest returns, on an after-tax basis from an income perspective, compared to other fixed income alternatives. Municipal bond defaults are rare, and sector default rates are meaningfully lower than their corporate peers.
Technical conditions have historically had an outsized impact on municipal bond returns. Muni technicals have turned significantly positive in recent weeks as demand, in the form of asset class inflows into municipal bond mutual funds, has accelerated since September, while supply has fallen by over 58% since October 16, 2025.
4. Fed Policy and Interest Rate Expectations
The Fed cut interest rates at a second consecutive meeting in October, citing concerns about labor market softening, and announced the end of quantitative tightening (keeping the balance sheet stable and potentially leading to lower interest rates) as of 12/1/25. The central bank framed the cuts as a risk management move, saying that risk has shifted to the labor market despite inflation remaining above target. Market participants had priced in another rate cut at the Fed’s December meeting, but the probability fell in late October after Fed Chair Powell downplayed the likelihood of a cut. There continues to be a divergence between the Fed’s forecast and market expectations. The Fed sees a slower pace of cuts through 2026, while markets expect a slightly quicker rate-cutting cycle. The prospect of rate cuts has boosted investor sentiment and stock prices, and the disconnect suggests Fed policy will remain an area of investor focus.
5. Investor Sentiment and Market Positioning
Investor sentiment remained constructive throughout the month, supported by Fed easing, AI enthusiasm, and easing trade tensions. Equities continued their upward trend, though gains were increasingly concentrated in mega-cap tech stocks, an indication of weak market breadth. While stocks continued to hit record highs, participation narrowed. Net inflows to equity ETFs were strong, and investor sentiment was cautiously optimistic. Seasonally favorable conditions suggest the rally can continue into year-end, though cracks in market breadth could signal increased fragility.
6. Corporate Earnings and Valuations
Valuations remain stretched, with the S&P 500 trading at levels only surpassed during the dot-com era. Elevated multiples reflect high expectations for AI-driven earnings growth, accommodative Fed policy, and expectations for continued economic growth. Earnings continue to support the S&P 500’s valuations, with Q3 earnings exceeding forecasts and over 80% of companies beating estimates. However, earnings strength remains concentrated in a few mega-cap tech firms. The margin for error is limited as markets price in an ideal mix of disinflation, Fed support, and AI-capex-driven growth. A disappointment in tech earnings or economic growth could test investor confidence.
7. “Special K” Economic Trends and Outlook
The federal shutdown delayed key economic data releases in October, clouding the near-term outlook. High-frequency, private economic data pointed to softening labor conditions, with major employers like Amazon and UPS reporting layoffs. Credit card spending data from banks remained solid, and the housing market showed signs of life, helped by lower mortgage rates. Overall, the economy appears bifurcated: AI-related investment is propping up headline economic growth, while traditional sectors like housing and manufacturing continue to struggle. Today, “K Economy” high earners continue to enjoy a strong economy where income growth and asset valuations (“wealth effect”) support robust spending. Recent data from Moody’s reveals that the top 10% of earners are responsible for nearly 50% of all U.S. consumer spending, which marks a dramatic increase from this group’s roughly 30% contribution in the 1990s. In contrast, low-income households continue to struggle. Delinquency rates on subprime auto loans have reached record highs, signaling growing financial strain among lower-income Americans as vehicle prices and borrowing costs remain elevated. According to Fitch Ratings, more than 6% of subprime auto loans are now at least 60 days past due, the highest rate ever recorded, as tighter household budgets, slowing wage growth, and unemployment edge higher.
Bullish Considerations
- The Fed cut rates at back-to-back meetings in September and October, which lowered borrowing costs.
- Disinflation progress continues, as housing and shelter price pressures continue to ease.
- AI-related capital expenditures are translating into earnings growth and productivity gains.
- Corporate earnings remain resilient, with many firms beating expectations despite macro headwinds.
- Falling energy prices provide a boost to consumers’ incomes and reduce inflation pressure.
- The recently passed tax bill includes provisions to spur business investment.
Bearish Considerations
- Valuations remain high across stocks, housing, and corporate bonds, fueling talk of an “everything bubble”.
- Stock market indices trade well above historical averages, increasing the risk of downside surprises.
- AI spending is strong, but there’s uncertainty around the profitability of AI capex investments.
- The federal government shutdown is delaying key data and could weaken consumer and business sentiment.
- Rising unemployment and slower job growth could threaten future consumer spending.
- U.S.–China trade tensions haven’t been fully resolved, and private credit business development (“BDC”) and certain regional bank stress signal potential credit risk.
What’s Next
The Investment Office continues to see macro expansion remaining positive, although slowing, held up by AI capex, Fed rate cuts, earnings growth, and modest oil prices, but vulnerable to downside surprises. Earnings growth is strong but concentrated in a few mega-cap tech stocks. Valuations are among the highest since the dot-com era, and corporate credit spreads are extremely tight. The labor market, housing, and manufacturing suggest a more fragile backdrop. It’s still a constructive backdrop for risk, but not one to blindly chase. Risk management is essential, putting the focus on purposeful asset allocation and manager selection domestically and abroad, and integrating private market strategies that provide access to more defensive allocations such as asset-backed lending.