Executive Summary
Over the next few months, the market is navigating a delicate balance of a strong economy, soft labor market conditions, AI disruption vs. destruction, and a Fed pause. The narrative centers on a near-perfect outcome: a soft landing, strong earnings growth, AI capex that both boosts productivity and generates revenue, and a tailwind from last year’s three rate cuts and the steepening yield curve. These high expectations, combined with elevated equity valuations and tight credit spreads, create an environment where modest disappointment could trigger a meaningful sell-off. Key risks include data that challenge the soft-landing narrative (slower job growth, weaker consumer spending, declining savings), renewed scrutiny around AI’s economics and return on investment (ROI), and heightened policy uncertainty (Fed independence, White House policy statements, geopolitics). The outlook for the next few months is constructive, but downside risk is elevated if confidence in the narrative erodes.
Over the next twelve months, investor sentiment remains cautiously optimistic, with markets near all-time highs on expectations for a soft landing and another year of double-digit earnings growth. However, the market is widely viewed as pricing in these themes, and there’s recognition that expensive valuations and narrow market leadership introduce downside risks. While Fed rate cuts remain part of the narrative, the Fed’s pause and data-dependence place a greater emphasis on the economy’s ability to grow even if rates remain higher for longer. The risks are less about an imminent recession and more about execution. Credit concerns are more structural than cyclical, centered around refinancing risk and leverage in private markets. The AI debate has evolved from whether capex continues to whether the aggressive spending will pressure margins. The overall backdrop remains constructive, but future returns look more subdued and increasingly path-dependent on fundamental earnings. Further gains will require more than optimism, with follow-through on corporate earnings and economic growth in the absence of multiple expansion.
Equities
Last week, the S&P 500 returned -0.1% for the week. Under the surface, however, a rotation out of technology and into more economically sensitive sectors roiled markets. Software stocks substantially declined as Anthropic released a new tool, which heightened concerns over the core software business models; bitcoin declined to $63,000, almost 50% off its October 2025 peak. Most stocks in the index rose with the S&P 500 Equal-weighted index rising 2.1%. Mid cap (+2.6%) and small cap (+2.2%) stocks outperformed large caps. Consumer staples (+6.0%) and industrials (+4.7%) were the best-performing sectors in the S&P 500; communication services (-4.4%) and technology (-1.4%) were the laggards. EAFE (non-US developed) markets returned +0.5% with gains across geographies, while emerging markets (EM) markets returned -1.4% led by recovery in India (+3.1%), while Korea (-5.0%) and China (-3.9%) lagged.
From a valuation perspective, the S&P 500, NASDAQ, EAFE and EM trade at or above +1 standard deviation based on historical forward P/E ratios with the S&P 500 at +1.8, NASDAQ at +1.0, EAFE at +1.5 and EM at +1.2. For the next 12 months, EPS growth for S&P 500 is expected to be 12.9% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 24.2% (vs. 10.7% annualized over the last 20 years). Equities across markets caps in the U.S., and in non-U.S. developed and emerging markets, trade at or above their 20-year averages based on forward P/E ratios.
Fixed Income
Investment-grade fixed-income sectors had positive returns as rates fell slightly across the curve. Municipals returned +0.4%, US AGG returned +0.3%, and US IG returned +0.3%. HY bonds returned +0.1% while bank loans returned -0.2%. EM debt returned +0.2% as the U.S. dollar rose 0.7%.
Rates
Rates fell slightly across the curve. The recession-watch 3M-10Y spread compressed 4bps to +53. The 2Y-10Y spread was unchanged at +70. Rates fell in other developed markets. The BTP-Bund spread is at 0.63%. 5-year breakeven inflation expectations fell 4bps to 2.52% (vs. low of 1.88% on Sept 10, 2024); 10-year breakeven inflation expectations fell 1bp to 2.33% (vs. recent low of 2.03% on Sept 10, 2024); the 10Y real yield fell 2bps to 1.88%. For 2026, the market expects between 2 and 3 cuts vs. the Fed’s guidance of 1 cut. At year-end 2025, the market expects the Fed Funds rate to be 3.07% vs. the Fed’s guidance of 3.25%-3.5%.
Currencies/Commodities
The dollar index rose 0.7%. The commodities complex fell 1.7% as energy prices fell 4.1% for the week. Brent prices fell 3.7% to $68/bbl as U.S. negotiations with Iran seemed to be back on track. U.S. natural gas prices fell 21.4%, continuing recovery from the snowstorm-induced spike, while European gas prices fell 8.4%. Gold rose 1.4% to $4,894/oz, while Silver fell 8.6% to $78/oz, and copper fell 0.7% to $588/lb.
Market monitors
Volatility rose for equities and bonds (VIX = 18, MOVE = 64); the 10-year average for each is VIX=19, MOVE = 80. Market sentiment (at midweek) remained bullish, falling slightly from +14 to +11.
Weekly Commentary
AI Disruption, Fed Pause, and Rotating Equity Leadership: What’s Driving Markets Now
Stuart Katz
Executive Summary
Over the next few months, the market is navigating a delicate balance of a strong economy, soft labor market conditions, AI disruption vs. destruction, and a Fed pause. The narrative centers on a near-perfect outcome: a soft landing, strong earnings growth, AI capex that both boosts productivity and generates revenue, and a tailwind from last year’s three rate cuts and the steepening yield curve. These high expectations, combined with elevated equity valuations and tight credit spreads, create an environment where modest disappointment could trigger a meaningful sell-off. Key risks include data that challenge the soft-landing narrative (slower job growth, weaker consumer spending, declining savings), renewed scrutiny around AI’s economics and return on investment (ROI), and heightened policy uncertainty (Fed independence, White House policy statements, geopolitics). The outlook for the next few months is constructive, but downside risk is elevated if confidence in the narrative erodes.
Over the next twelve months, investor sentiment remains cautiously optimistic, with markets near all-time highs on expectations for a soft landing and another year of double-digit earnings growth. However, the market is widely viewed as pricing in these themes, and there’s recognition that expensive valuations and narrow market leadership introduce downside risks. While Fed rate cuts remain part of the narrative, the Fed’s pause and data-dependence place a greater emphasis on the economy’s ability to grow even if rates remain higher for longer. The risks are less about an imminent recession and more about execution. Credit concerns are more structural than cyclical, centered around refinancing risk and leverage in private markets. The AI debate has evolved from whether capex continues to whether the aggressive spending will pressure margins. The overall backdrop remains constructive, but future returns look more subdued and increasingly path-dependent on fundamental earnings. Further gains will require more than optimism, with follow-through on corporate earnings and economic growth in the absence of multiple expansion.
Equities
Last week, the S&P 500 returned -0.1% for the week. Under the surface, however, a rotation out of technology and into more economically sensitive sectors roiled markets. Software stocks substantially declined as Anthropic released a new tool, which heightened concerns over the core software business models; bitcoin declined to $63,000, almost 50% off its October 2025 peak. Most stocks in the index rose with the S&P 500 Equal-weighted index rising 2.1%. Mid cap (+2.6%) and small cap (+2.2%) stocks outperformed large caps. Consumer staples (+6.0%) and industrials (+4.7%) were the best-performing sectors in the S&P 500; communication services (-4.4%) and technology (-1.4%) were the laggards. EAFE (non-US developed) markets returned +0.5% with gains across geographies, while emerging markets (EM) markets returned -1.4% led by recovery in India (+3.1%), while Korea (-5.0%) and China (-3.9%) lagged.
From a valuation perspective, the S&P 500, NASDAQ, EAFE and EM trade at or above +1 standard deviation based on historical forward P/E ratios with the S&P 500 at +1.8, NASDAQ at +1.0, EAFE at +1.5 and EM at +1.2. For the next 12 months, EPS growth for S&P 500 is expected to be 12.9% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 24.2% (vs. 10.7% annualized over the last 20 years). Equities across markets caps in the U.S., and in non-U.S. developed and emerging markets, trade at or above their 20-year averages based on forward P/E ratios.
Fixed Income
Investment-grade fixed-income sectors had positive returns as rates fell slightly across the curve. Municipals returned +0.4%, US AGG returned +0.3%, and US IG returned +0.3%. HY bonds returned +0.1% while bank loans returned -0.2%. EM debt returned +0.2% as the U.S. dollar rose 0.7%.
Rates
Rates fell slightly across the curve. The recession-watch 3M-10Y spread compressed 4bps to +53. The 2Y-10Y spread was unchanged at +70. Rates fell in other developed markets. The BTP-Bund spread is at 0.63%. 5-year breakeven inflation expectations fell 4bps to 2.52% (vs. low of 1.88% on Sept 10, 2024); 10-year breakeven inflation expectations fell 1bp to 2.33% (vs. recent low of 2.03% on Sept 10, 2024); the 10Y real yield fell 2bps to 1.88%. For 2026, the market expects between 2 and 3 cuts vs. the Fed’s guidance of 1 cut. At year-end 2025, the market expects the Fed Funds rate to be 3.07% vs. the Fed’s guidance of 3.25%-3.5%.
Currencies/Commodities
The dollar index rose 0.7%. The commodities complex fell 1.7% as energy prices fell 4.1% for the week. Brent prices fell 3.7% to $68/bbl as U.S. negotiations with Iran seemed to be back on track. U.S. natural gas prices fell 21.4%, continuing recovery from the snowstorm-induced spike, while European gas prices fell 8.4%. Gold rose 1.4% to $4,894/oz, while Silver fell 8.6% to $78/oz, and copper fell 0.7% to $588/lb.
Market monitors
Volatility rose for equities and bonds (VIX = 18, MOVE = 64); the 10-year average for each is VIX=19, MOVE = 80. Market sentiment (at midweek) remained bullish, falling slightly from +14 to +11.
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