Last week’s Fed meeting was a non-event as the stock market’s instant positive reaction was reversed Friday. Fed Funds rates came down 25 basis points as virtually everyone expected, and Chairman Powell suggested that future cuts would be more spread out over time. But Powell is a lame duck and disparities of opinion among present FOMC members offer little guidance as to the future path for rates. Treasury has acknowledged the need for sufficient short-term Treasury bills to feed the appetites of stablecoin and money market funds, suggesting strongly that future issuance will continue to be heavily weighted toward the short-end of the curve. While that might raise hopes that less supply of longer-dated bonds would raise prices and lower rates, yields actually crept higher by week’s end. With deficits likely to stay elevated and debt levels continuing to rise, it will be hard to coerce rates lower barring a significant economic downturn.
The other big events last week were earnings reports from Oracle# and Broadcom#. Simply said, the reports were good, near expectations. But short-term results aren’t what mattered. It’s the long-term outlook. And in the case of Oracle, how future capital needs are going to be fulfilled remains a serious concern. When stocks decline on decent news big time, that is a clear message that needs to be heard. For several years, the surge in demand related to AI has created a boom Wall Street hasn’t seen in decades. While many of us think of AI as a ChatGPT query on your iPhone, big corporations understand the transformative nature of AI. While many companies are testing the waters, not yet ready to fully embrace all AI can do to enhance growth and productivity, the providers of the tech services that will support future growth have been racing to put the infrastructure in place to meet that expected demand. This is a process, not a one-time event. It isn’t critical that the ChatGPT response to your casual query is wrong occasionally (or perhaps more than occasionally), but for mission critical applications, almost any mistake won’t be tolerated. AI will only improve over time but for many, prime time isn’t quite here yet.
What made stocks like Nvidia# soar wasn’t the promise of future glory; it was the fact that sales and earnings over the past several years exploded beyond expectations. When Oracle’s stock skyrocketed this past summer, it was because management announced a roadmap, backed up by orders, that was transformative. Growth was to be several times earlier expectations. But fast forward to the past several weeks. One of its key customers wobbled. The company’s balance sheet, barely investment grade, was questioned. How could it finance all the promised growth? Bulls came up with one set of answers; bears another. Time will tell who is right. But the key point is that its earnings report, unlike so many before, didn’t raise the bar. Expectations had gotten so high that it seemed almost impossible, at least for now, to raise them further. Broadcom doesn’t share Oracle’s balance sheet concerns and its numbers last week were a bit more positive than Oracle’s. But the stock market didn’t seem to care. Nvidia and other Mag 7 names won’t be immune to the same factors. Unless future expectations continue to rise meaningfully, it is questionable whether the outperformance experienced over the past three years can be sustained. For instance, analysts raised future earnings estimates and price targets for Broadcom after it reported earnings. Yet, the market’s reaction suggested that investors had already baked in a quarterly report somewhat better than expected.
All AI or Mag 7 companies and stocks aren’t the same. Alphabet# has been a notable standout as its latest Gemini offering excited everyone. It had been the laggard earlier this year amid threats to its search franchise. Indeed, if we couple the way Alphabet has traded over the past year with others like Oracle, we reach the following conclusions:
• Growth continues to be explosive and we are probably still in the early innings of a transformative AI boom. But while the scope wasn’t fully appreciated one or two years ago, expectations may have caught up with reality making the path forward for the stocks more difficult.
• All AI participants aren’t going to be winners. Many of the obvious winners won’t even be winners. In the late 1990s it was hard to imagine that AOL wouldn’t be a dominant email provider or that Yahoo wouldn’t be a leader in search.
• Wall Street is fickle. It loves XYZ one day and disparages its future the next. A year from now, will Alphabet and Nvidia still be Wall Street darlings or will concerns rise?
• For the Mag 7 to continue to dominate, future growth must exceed elevated expectations. Oracle’s performance in recent weeks is a reflection not on the current growth path the company is on, but a return to earth for a stock whose expectations got way ahead of reality, at least for now. Other companies, new to public markets in 2025, that catered to AI investors with lots of hope and hype, came crashing back down to earth in recent months not because they failed to execute but because much of the early hype evaporated.
The lesson is clear. Hype today counts for less. High expectations not only have to be matched, they have to be raised, if the Mag 7 type names are going to continue to outperform in 2026. It’s a high bar that may or may not be achieved.
Let me now flip back to the Fed and Washington politics. For all the headlines in 2025 around the new tax bill, tariffs, immigration crackdowns, a record long government shutdown and all kinds of Executive Orders, the economy as measured by final demand, keeps chugging along at a pace greater than 2% annualized. Growth, of course, isn’t even. AI spending is surging while housing starts are no higher than they were 50 years ago. Nonetheless, you would think that Americans would be in a decent mood given decent growth and an unemployment rate near 4.5%. But consumer surveys suggest discontent, particularly among those in lower income strata. Perhaps the answer is embedded within the CPI data. We only have numbers through September thanks to the government shutdown. We will get more up to date numbers Thursday. But based on what we have, while the overall 12-month CPI growth was 3.0%, the costs of key necessities was higher. That includes rents, utility costs, insurance, and medical services, all categories one would classify as necessities. Thus, while Americans may have more money than they had a year ago, they may not have more discretionary money without dipping into savings or relying more on credit. Moreover, while inflation has stayed closed to 3%, wage growth continues to fall. No longer are workers seeing increases in real wages.
But with that said, Americans are still spending. And they are likely to receive bigger tax refunds than normal early in 2026. Thus, while consumer sentiment readings are unfavorable, Americans should continue to spend presuming unemployment doesn’t spike. They are paying for necessities and borrowing, where necessary, to enjoy themselves. Early sales data for Christmas season suggests no change in behavior. With big tax refunds coming, spending at least through early 2026 should be solid.
With that said, the White House faces perception problems when it comes to the economy. Labeling talk of affordability a “hoax” doesn’t sit well with Americans who can’t afford a downpayment on a home or a car. Republicans still want to get rid of Obamacare but have no replacement. Without some new remedies, health care premiums for those using the Affordable Care Act may rise sharply. That will not help mid-term election prospects. But perhaps more important than White House responses will be how the Federal Reserve is transformed in 2026. Trump wants a leader whose first priority is loyalty to the White House. Trump, in his usual bravado style has called for a Fed Funds rate of 1% or lower. Unless there is a crisis, that won’t happen and even he knows that. But asking for 1% may help to jawbone the Fed Funds rate down toward 2%. Even that is unlikely. When the Fed Funds rate is below the rate of inflation, making borrowing virtually free, bad things happen and every member of the FOMC knows that. Nonetheless, markets want direction. That won’t happen until a new head is approved and he can begin to coalesce a significant majority to a new roadmap for rates.
Make no mistake. What the Fed does in 2026 will have more impact on the economy than what the While House does. As for Congress, there is no reason to expect anything, just as little happened in Trump’s first term after his tax bill passed in 2017. Will the new Fed focus more on inflation or growth? Will the Fed Funds rate at the end of 2026 be near or below 3% or not? And how will 10-year Treasury yields react to any changes in the Fed’s roadmap? Those will be the keys to 2026. Last year I suggested that if you could tell me where the 10-year Treasury yield might be a year hence, I could give you a pretty accurate prediction of stock market performance. The same statement holds true this year. Yields have spent most of 2025 within a 4.0-4.5% range. If they stay there, equity markets should rise yet again next year.
As for the mid-term elections, Trump can brow beat the media and politicians but he can’t brow beat voters. They will vote with their wallets. For investors, does it matter if the House flips? Probably not. Except for the tax bill enacted last summer, Congress has done little of economic importance for years. Don’t expect that to change. The message for 2026 will center around the Fed’s messaging once a new leader is at the helm. If that leader is going to be influenced by the Executive branch, he is more likely to listen to Scott Bessent than anyone else. The bottom line is that growth, inflation and the state of the labor market all matter. It will be the Fed’s job to navigate a path that can balance all three. Powell’s Fed was one of caution, reactive rather than proactive. Future leadership more than likely will attempt to be more proactive. Markets will be watching.
Today actor Don Johnson turns 76.
James M. Meyer, CFA 610-260-2220