Navigating Crosscurrents: Optimism, Risk, and the Consumer
As we navigate the final months of the year, the market finds itself trading near record highs, fueled by two significant pieces of upbeat news that have bolstered investor confidence. First, Washington finally reached a compromise to end the record-long government shutdown. The Congress has passed a continuing resolution, which the House signed last night, that will fund the government through January and provide back pay to federal workers. This removes a major source of economic uncertainty and a significant drag on consumer sentiment.
This political relief has been compounded by an exceptionally strong third-quarter earnings season. With over 90% of S&P 500 companies reporting, the blended earnings growth rate accelerated to an impressive 13.1%, marking the fourth consecutive quarter of double-digit growth. This combined optimism has propelled the “soft-landing” narrative, but it also masks several underlying tensions. We are closely monitoring three key crosscurrents that we believe will define the investment environment ahead: the Federal Reserve’s stubborn fight against inflation, the monumental spending—and associated risks—in artificial intelligence, and the visible signs of strain on the U.S. consumer.
A Cautious Fed vs. Market Hopes
The disconnect between market hopes and central bank rhetoric is most apparent in the debate over interest rates. While market probabilities suggest a ~65% chance of another rate cut in December, a growing chorus of Federal Reserve officials is pushing back, adopting a far more cautious stance. Boston Fed President Susan Collins has stated that the bar for further cuts is “relatively high,” arguing it is appropriate to hold rates “for some time” to ensure inflation sustainably returns to the 2% target.
This hawkish sentiment is not isolated. Atlanta Fed President Raphael Bostic recently identified inflation as the “more urgent risk” over the job market, seeing little evidence that price pressures will dissipate before mid-2026. Chicago’s Austan Goolsbee has similarly noted that inflation is “trending the wrong way.” While doves like Governor Stephen Miran argue that inflation measures are backward-looking, the dominant view at the Fed appears to be one of heightened caution, fearing that premature easing could stall or even reverse hard-won progress.
The AI Boom: A Trillion-Dollar Bet
A second, and perhaps defining, theme of this market is the capital expenditure boom in artificial intelligence. U.S. hyperscalers are on pace to invest nearly $3 trillion by 2029. However, as noted by observers like Michael Burry, this spending spree carries immense risk. Unlike traditional infrastructure like railroads, this investment is concentrated in AI chips with a very short useful life, estimated at just three to five years. This is creating a “tidal wave of depreciation” that could reach $240 billion annually by 2027.
The central risk here is a massive gap between costs and monetization. To offset these staggering depreciation expenses and turn a profit, AI revenues will need to exceed $1 trillion by conservative estimates. The current run-rate, estimated at below $50 billion, is not even in the same ballpark. This creates a dangerous incentive for accounting “shenanigans,” such as arbitrarily extending the “estimated useful life” of these chips to overstate income. The dynamic builds the case for a potential bubble, setting the stage for massive future write-downs if the promised revenue fails to materialize.
The Corporate-Consumer Disconnect
Third, the resilience of corporate America stands in stark contrast to the emerging fragility of the U.S. consumer. The Q3 earnings season was, as noted, outstanding, with an impressive 82% of companies beating EPS estimates. Yet, this corporate strength is not reflected on Main Street, where a look “under the hood” reveals an increasingly strained consumer. We are seeing a significant rise in delinquencies, a classic indicator of distress. The share of subprime borrowers at least 60 days past due on their auto loans rose to 6.65% in October. This stress is not confined to auto loans; the share of student-loan debt becoming delinquent has climbed to 14.4%, the most on record.
Navigating a Precarious Market
These issues paint a complex picture: a market valued for perfection, a Federal Reserve reluctant to provide relief, an AI boom on a questionable foundation, and a consumer whose financial health is deteriorating. The disconnect between high valuations and mounting fundamental risks is our primary concern. Given this environment, we must acknowledge that while stocks are near record highs, a pullback should be expected, even if the timeframe is unpredictable. Our core strategy remains one of prudence: stay diversified across asset classes and geographies and focus on quality—owning companies with robust balance sheets, strong free cash flow, and durable business models that can weather an economic downturn. In other words, this is a time to avoid the most speculative of investments, even those that have been the biggest winners in recent years.
Birthdays:
Former U.S. Attorney General Merrick Garland turns 73 today, Actress/TV host Whoopi Goldberg turns 70, Texas Governor Greg Abbott turns 68 and Actor Steve Zahn turns 58.
Christopher Gildea 610-260-2235