“Summer really flew by this year…” are words that nearly every American thought or heard over the Labor Day holiday weekend. We agree. In the investment business, the summertime dog days have historically been categorized as sluggish, driven by lighter news flow and resultant lackluster trading volumes. The past few months, however, hardly seemed lethargic considering ongoing geopolitical turmoil, the historic SpaceX# IPO, and the blowup of the highly levered Situational Awareness hedge fund. In fact, this summer’s average U.S. stock dollar trading volume was 37% above 2025 and 86% ahead the trailing five-year average. What is striking is that despite the surge in trading activity, volatility levels have actually remained benign, hovering just below historical averages. Nonetheless, with back-to-school season in full effect, we acknowledge September’s historical tendency for lackluster returns, especially as the market looks cautiously ahead to the November midterm elections.
Summer School for Traders and Investors
As the robust summer trading volumes imply, 2026 did not include much of a vacation for many market participants. Retail trading rose to record levels and ETF inflows accelerated. Growth-oriented equity investors entered a new regime with June’s SpaceX# public debut, while mega-IPOs from Anthropic and OpenAI wait in the wings. Moreover, the collapse of the AI-focused Situational Awareness hedge fund in late July highlighted the dangers of momentum strategies, crowded trades, and most importantly, the use of leverage. It is estimated that the $20 billion hedge fund had employed debt to increase exposure to something closer to $100 billion, predominantly in high-risk, high-momentum AI-related equities. This is a good reminder that leverage cuts both ways, serving to magnify returns regardless of the direction.
One key theme over the past several months has been the relative outperformance of value stocks over growth stocks as the Technology sector and the general AI trade lagged the broader market. Formerly high-momentum stocks, such as those in the Magnificent 7, have seemingly lost their luster among traders, despite continuing to demonstrate strong fundamentals and growth prospects. That said, one singular area of the market simply cannot outperform forever, and we believe the AI trade is currently facing two major near-term headwinds. First, we believe the surge in next-generation technology company IPOs has the strong potential to “suck the air out of the room,” particularly among large-cap growth investors, as Anthropic and OpenAI combined represent several trillion dollars in future equity market value. Managers will be forced to reevaluate their current holdings relative to these new opportunities, which will likely result in some level of rotation. Second, while the late-’90s dot-com bubble was valuation-driven, today’s market participants have been increasingly focused on AI-related peak earnings, with some calling out an unsustainable earnings bubble caused by the rapid buildout. This skepticism has resulted in S&P 500 underlying earnings growth outpacing returns year-to-date, making the current 19.7x forward price-to-earnings ratio approximately 10%–15% cheaper than the near-23x level at the beginning of the year.
Strong Attendance Levels in the U.S. Job Market
As students returned to the classroom last week, the U.S. labor market also showed up in force, posting 162,000 new jobs in August. This was significantly better than the 55,000 consensus expectation, beating even the loftiest estimates, and resulted in the unemployment rate holding at a healthy 4.1%. For reference, an unemployment rate between 4% and 4.5% is generally considered “full employment.” Revisions to previous months were also positive, alleviating some fears about recent deterioration in hiring data.
For equities, however, good economic news doesn’t necessarily translate to better near-term returns. While a healthy labor market supports better consumer spending and corporate earnings, it gives the Federal Reserve less reason to lower interest rates. This is particularly true in an environment where inflation has been running above its 2% target for years. Consequently, equity share prices declined last Friday as the strong report increased the market-implied probability of a September Fed hike from about 49% to 58%. U.S. Treasury yields also moved up across maturities. One favorable data point in the August jobs report worth mentioning: average hourly earnings increased at just a 2.8% annualized rate over the past three months. This measure of labor force inflation has slowly and steadily receded from its 5.9% high water mark in March 2022, which supports a less hawkish Fed over time.
Warsh as Disciplinarian? Bessent as the Facilities Manager?
With both the Federal Reserve and the U.S. Treasury back at center stage, investors are being reminded that fiscal and monetary policy are somewhat intertwined. The national debt recently surpassed $40 trillion, while federal interest expense reached $931 billion through the first ten months of fiscal 2026—11% higher than the same period last year and nearly double the annual total paid in 2022. As more government revenue is consumed by interest payments, less is available for other priorities, and the Treasury must issue still more debt to finance the shortfall.
Against that backdrop, new Federal Reserve Chair Kevin Warsh appears ready to play the disciplinarian. His recent comments emphasized that inflation remains above target and that the Fed must be confident it is moving sustainably lower before declaring victory. Treasury Secretary Scott Bessent, meanwhile, is playing something closer to the role of facilities manager, attempting to keep the bond market’s plumbing running smoothly. Beginning this week, Treasury is at least doubling the size of its long-term bond buyback operations from $2 billion to $4 billion. As a response to rising yields, these purchases can improve liquidity in older Treasury securities, but this should not be confused with paying down the national debt. At the end of the day, Warsh can defend price stability and Bessent can improve market functioning, but neither can resolve the underlying mismatch between federal spending and revenue. Unfortunately, that responsibility rests with Congress, which almost always prefers to kick the can down the road.
The Long-Term Report Card Is Still Incomplete
This Friday marks the 25th anniversary of the September 11 attacks–an occasion first and foremost for respect and remembrance. It also reminds us that history contains true inflection points, after which the world does not simply return to the way it was. The rise in artificial intelligence is, of course, an entirely different kind of development, but it too appears likely to bring lasting changes to how we live and work. As investors, we strive to understand how AI’s potential can translate into durable profits and which companies will capture them. Beyond the Technology sector, we believe AI-driven efficiencies will support greater profitability across all economic sectors.
For now, the market’s report card is mixed. Concerns about peak AI earnings have increased even as underlying earnings continue to grow, and this skepticism has helped make the S&P 500 less expensive this year despite higher share prices. Importantly, the strength is also broadening: the 493 companies outside the Magnificent 7 are expected to produce roughly 16% earnings growth in 2026. That suggests the market’s fundamental support is not limited to a handful of technology giants, even if AI remains its most prominent storyline.
In an investing world increasingly shaped by same-day options, leverage, speculative trading, and lightning-fast algorithms, we believe long-term investors have an edge that can be described as “time-horizon arbitrage.” This is simply the ability to buy and patiently hold high-quality investments through the market’s ups and downs. The real advantage is the capacity to look beyond the next headline or quarterly earnings report and allow good businesses to compound over time. Our investing approach focuses on participating in the extraordinary generational opportunities in front of us, while maintaining proper diversification and conservative risk management. We prefer to let the fundamentals—rather than momentum or FOMO—do the grading.
Birthdays:
Actor/comedian Adam Sandler is 60, Canadian singer Michael Bublé turns 51, and Super Bowl-winning quarterback Joe Theismann celebrates his 77th birthday.
Shawn Gallagher, CFA® 610-260-2211