Key Wealth Investment Brief

Key Takeaways:

Economic growth remains strong as the Artificial intelligence (AI) buildout continues to aid the growth. However, the market's reliance on AI is creating a riskier environment.

The advance estimate of Q3:2026 real GDP provided further evidence that the U.S. economy remains remarkably resilient. Growth accelerated during the quarter, supported by continued strength in consumer spending, robust business investment, and an extraordinary level of capital spending tied to artificial intelligence infrastructure. Importantly, Final Sales to Domestic Purchasers, often viewed as a cleaner measure of underlying economic demand, continued to point toward a strong and accelerating economy.

As the AI cycle matures, the funding model is beginning to shift from free cash flows toward debt and equity financing. That does not diminish AI's long-term potential, but it does introduce additional risk. We continue to view AI as a powerful investment theme, while favoring diversified exposure and companies that adopt AI to improve productivity rather than those most dependent on the buildout.

Earnings are coming in as expected, but we are seeing a rotation under the surface within earnings and performance.

Third quarter earnings season has largely confirmed expectations, with most companies exceeding analysts’ projections. Beneath the surface, however, a meaningful rotation is taking place. For the past few years, earnings growth and market returns have been heavily concentrated among the Magnificent 7 stocks. That trend is beginning to change, with earnings momentum improving across a broader group of companies and sectors while growth among many mega-cap companies is starting to moderate. The improvement in the equal-weight index, strength in value stocks, and better performance from smaller companies all suggest market leadership is expanding. We view this broadening as a healthy development that creates a stronger foundation for equity markets moving forward.

The Federal Open Market Committee (FOMC) held rates steady, but the Committee is less unified than it has been in a long time.

The FOMC left interest rates unchanged at its October 28 meeting while upgrading its assessment of economic conditions from "solid" to "strong." Markets continue to expect another rate increase at their December meeting as inflation remains elevated and economic growth continues. More noteworthy, however, is that two members dissented at the most recent meeting, highlighting the growing division among policymakers. The number of FOMC dissents this year has reached the highest level in decades, signaling increasing disagreement regarding the appropriate path for monetary policy. Investors have become accustomed to a united Fed, but that environment may be changing. A less unified Committee could lead to greater policy uncertainty and increased market volatility, even if the overall direction of monetary policy remains restrictive.

Bottom Line – how to invest now.

We expect volatility to remain elevated, and we continue to advocate for robust diversification. Bonds may continue to struggle to add ample diversification amidst an environment of larger federal deficits and higher interest rates. Bonds may show higher correlations with stocks in such an environment, leading to less portfolio diversification. To gain the desired diversification in a portfolio, we continue to emphasize the use of New Tools where appropriate. We also note that international markets may also provide additional diversifying qualities and believe opportunities exist beyond traditional asset classes.

Equity Takeaways:

Stocks were up in early Monday trading. The S&P 500 rose approximately 0.4%, while the tech-heavy Nasdaq rose 0.6%. Small caps also rose 0.6%, and non-U.S. stocks were mostly higher.

The S&P 500 declined approximately 0.6% last week, ending October down 1.0% for the month. The market experienced a significant shift in October, as large-cap value outperformed large-cap growth by 11 percentage points, the largest monthly outperformance in at least 30 years. Additionally, small-cap equities performed well during the month, and the S&P 500 equal-weight index continued to recover relative to the cap-weighted S&P 500, providing further evidence that market participation is broadening. This shift has been accompanied by a rotation in factor leadership, with minimum volatility, quality, and high-dividend strategies outperforming after spending much of the year lagging growth and momentum stocks. 

Fixed-Income Takeaways:

The yield curve experienced a “bull steepener” last week as short-term yields fell by more than long-term yields. Specifically, at the short end, 2-year yields moved 9 basis points (bps) lower, closing the week at 4.59%; longer out on the yield curve, 10-year yields moved 6 bps lower to close the week at 4.93%, and 30-year yields moved 1 bps lower to close the week at 5.31%.

Credit markets reflected investors' growing focus on quality and security selection during October. Credit spreads widened modestly as concerns surrounding AI-related borrowing and capital spending increased, particularly among issuers relying heavily on external financing. While announcements from companies such as Meta and Oracle suggesting a more measured borrowing approach were initially welcomed by investors, subsequent earnings reports renewed concerns about portions of the AI ecosystem. In contrast, demand for high-quality issuers remained strong, highlighted by Microsoft's significantly oversubscribed $25 billion bond offering. 

The riskiest portions of the bond market have experienced significant spread widening, highlighted by the CCC – B spread differential reaching its highest level in nearly 20 years. However, we do not believe this is signaling significant market stress due to the majority of the CCC spread widening being caused by just a handful of companies. 

In early Monday trading, yields were lower: 2-year Treasury yields were trading at 4.59%, 5-year Treasury yields at 4.70%, 10-year Treasury yields at 4.89%, and 30-year Treasury yields at 5.26%.

The Fed Hits Pause, But Is It Done?

Key Takeaways:

• The Fed holds policy steady, maintaining its benchmark rate at 3.75%–4.00%
• Not everyone agreed, as two policymakers, Beth Hammack and Lisa Cook, favored a 0.25% increase
• Economic resilience complicates the outlook
• Financial conditions remain a consideration
• The next move remains uncertain
• For investors, discipline remains essential

The Federal Reserve left interest rates unchanged at its October meeting, choosing to assess the impact of September’s rate increase before taking additional action. But the decision was hardly a unanimous endorsement of standing still. Two policymakers favored another rate increase, highlighting the tension between an economy that continues to demonstrate resilience and inflation pressures that have yet to subside. For investors, the message is becoming increasingly clear: the Fed may be on hold, but the direction of its next move remains an open question.

No Change in Rates, but Not Without Disagreement.

The FOMC voted 10-2 to maintain the federal funds target range at 3.75%–4.00%. Beth Hammack and Lisa Cook dissented, preferring an additional 0.25% increase. The disagreement is significant. While the majority favored allowing more time to evaluate economic conditions, the dissenters signaled the inflation risks may still warrant additional restraint. The decision also reinforces an important distinction: holding rates steady does not necessarily mean the Fed believes its work is finished.

The Pause is Clear. The Path is Less Certain.

The economic backdrop offers little evidence of an economy losing momentum. Consumer spending remains resilient, capital expenditures are robust, and productivity gains continue to support economic activity. During his press conference, Chair Warsh acknowledged the strength of the economy, stating, “Real activity is clearly pointing in the right direction; that’s good news, but inflation is too high.” His remarks reinforce the challenge of balancing economic resilience against persistent inflation pressures.

Labor market conditions also appear relatively stable, with job gains broadly keeping pace with labor-force growth and the unemployment rate showing little change. Together, these developments provide the Fed with flexibility. Policymakers can afford to wait for additional evidence without facing immediate pressure to support a weakening economy. But that same resilience could complicate the inflation outlook, particularly if stronger demand limits further progress toward the Fed’s 2% objective.

Higher for Longer – or Higher Still?

Perhaps one of the more revealing comments from Warsh’s press conference concerned financial conditions. Warsh said, “While overall financial conditions are tighter, I’m unwilling and unable to call them tight.” That distinction matters. While policy rates remain elevated, the broader financial environment including credit availability, asset valuations, and market liquidity, helps determine how restrictive monetary policy is.

If financial conditions are not meaningfully constraining economic activity, the Fed may have less reason to ease policy. Stronger growth could also leave policymakers questioning whether the current level of interest rates is sufficiently restrictive to bring inflation sustainably back to target. For investors, this introduces an important consideration. The debate may not simply be about when the Fed begins cutting rates, but whether additional tightening can be ruled out altogether. Treasury yields will continue to reflect shifting expectations for inflation, economic growth, and the future path of monetary policy. Until the data provides greater clarity, volatility around those expectations may persist.

Patience Is a Strategy, not a Prediction.

The October decision reflects a Federal Reserve that appears comfortable waiting but not necessarily satisfied with where inflation stands. For investors, the distinction is important. A pause in policy action should not be interpreted as a commitment to lower rates, particularly when economic growth remains firm and some policymakers continue to favor additional tightening.

In addition, another form of longer-term “patience” was introduced by Warsh during the press conference, in which he stated, “Now, with this objective in mind, we have decided on a change in our FOMC schedule, starting next fall. We believe eight meetings per year is the right number for the FOMC. But in 2027, one meeting will focus exclusively on broad monetary policy strategy, with neither a vote on the federal funds rate nor a policy statement anticipated.” Thus, introducing more of a deliberate long-term strategic protocol to attempt to get monetary policy right. Once next fall arrives, we’ll have a better understanding of whether this new protocol will trigger additional volatility or warrant praise.

The coming months will test whether the economy can sustain its momentum while inflation continues to moderate. That combination would give the Fed greater flexibility. Persistent inflation, however, could keep interest rates elevated for longer – or reopen the discussion about additional increases.

The Fed may have paused, but the policy debate is far from settled.

Key Takeaways:

Momentum continued as earnings season got underway last week, but investors are seemingly focused on other things.

Third quarter earnings season is off to a decent start, with corporate profits continuing to demonstrate remarkable resilience despite elevated interest rates and persistent inflation. Approximately 25% of S&P 500 companies have reported results thus far, with 83% beating earnings expectations. While the magnitude of earnings surprises has been modest relative to historical averages, analysts have continued revising earnings growth estimates higher, with third quarter earnings now expected to rise 29.5% year-over-year. 

Despite the healthy earnings environment, investors appear increasingly focused on other developments, including this week’s Federal Open Market Committee (FOMC) meeting and next week’s midterm elections. While earnings momentum remains a strong tailwind for equities, market leadership has begun to broaden beyond technology, suggesting investors may be positioning for a more complicated environment as the year draws to a close. 

Markets expect the upcoming midterm elections to result in a divided government, which is customarily good for markets. However, a potential showdown over the debt ceiling in 2027 could limit those good times.

With midterm elections next week, markets increasingly expect a divided government to re-emerge. Historically, financial markets have generally responded favorably to political gridlock, as it tends to reduce the likelihood of significant policy changes and allows investors to focus on economic fundamentals and corporate earnings. Additionally, once election uncertainty passes, markets have typically produced positive returns over the following year, although periods of volatility have occurred along the way.

However, investors may eventually need to contend with a potential major consequence of a divided government. Unless addressed during the narrow post-election window, Congress could face another debt ceiling fight in 2027. These standoffs have had increased significance in recent years, as they occur against the backdrop of rising federal debt levels, persistent budget deficits, and multiple sovereign credit rating downgrades. While markets appear largely unconcerned for now, any future debt ceiling battle could become a meaningful source of volatility and place upward pressure on interest rates.

Artificial intelligence (AI) remains the focal point of the economy as we enter a new riskier phase.

AI continues to dominate the investment conversation, but recent developments suggest the investment cycle may be entering a more challenging stage. Following hotter-than-expected inflation data earlier this month, several AI-related companies experienced significant volatility as investors re-assessed the risks of funding increasingly capital-intensive infrastructure projects. Credit spreads widened for several AI infrastructure providers, while a few planned AI-related public offerings were delayed.

This does not necessarily signal the end of the AI trade. Adoption continues to expand, and the long-term productivity benefits remain substantial. However, investors appear increasingly focused on whether revenue growth can keep pace with capital expenditures and whether future returns will justify the enormous investments currently being made. Higher financing costs and increased scrutiny from investors creates a more demanding environment. We continue to believe AI remains a transformational theme, but recent developments reinforce the importance of diversification. 

Bottom Line – how to invest now.

We expect volatility to remain elevated, and we continue to advocate for robust diversification. Bonds may continue to struggle to add ample diversification amidst an environment of larger federal deficits and higher interest rates. Bonds may show higher correlations with stocks in such an environment, leading to less portfolio diversification. To gain the desired diversification in a portfolio, we continue to emphasize the use of New Tools where appropriate. We also note that international markets may also provide additional diversifying qualities and believe opportunities exist beyond traditional asset classes.

Equity Takeaways:

Stocks were up in early Monday trading. The S&P 500 rose approximately 0.2%, while the tech-heavy Nasdaq rose 0.3%. Small caps rose 0.2%, and non-U.S. stocks were mostly higher.

The S&P 500 declined approximately 0.5% last week as investors balanced solid earnings results against concerns surrounding the AI investment cycle. Leadership continued shifting away from areas that led earlier in the year, most notably semiconductors, and toward more defensive sectors such as Health Care, Consumer Staples, and Utilities. This rotation helped market breadth jump above 50% for the first time since May.

We believe a modest pullback is possible in the next few weeks as the market resets in anticipation of the upcoming seasonally strongest part of the year.

Fixed-Income Takeaways:

The yield curve experienced a “bull rally” before partially reversing last week. Specifically, at the short end, 2-year yields moved 3 basis points (bps) lower, closing the week at 4.68%; longer out on the yield curve, 10-year yields moved 8 bps lower to close the week at 4.99%, and 30-year yields moved 10 bps lower to close the week at 5.32%.

Market participants overwhelmingly expect the FOMC to leave interest rates unchanged at this week’s meeting, while assigning an approximately 70% chance of a rate increase at the Committee’s final meeting of the year in December. 

AI borrowing concerns sent spreads wider last week, highlighted by high yield spreads reaching their highest level since May 2025. Software companies and chipmakers experienced the bulk of the widening within the Technology sector. Despite a few AI-related companies showing some signs of stress, the Technology sector overall appears to have a manageable level of debt.

In early Monday trading, yields were mixed: 2-year Treasury yields were trading at 4.70%, 5-year Treasury yields at 4.81%, 10-year Treasury yields at 4.98%, and 30-year Treasury yields at 5.30%.

Key Takeaways:

Elevated levels of inflation continue to put pressure on interest rates.

Last week’s inflation report continues to highlight the persistent price pressures impacting the economy. Headline inflation, as measured by the Consumer Price Index (CPI), accelerated to 3.7% year-over-year in September, while core CPI rose 2.6%, both coming in above expectations and signaling that the path back to the Federal Reserve’s 2.0% target may be slower than anticipated. Recent inflation trends have been supported by several factors, including rising energy prices, ongoing geopolitical uncertainty, and continued investment in the artificial intelligence (AI) buildout.

Historically, interest rates have remained elevated until economic activity begins to slow meaningfully. While the economy continues to show resilience, the combination of persistent inflation and large government borrowing has contributed to upward pressure on longer-term interest rates. Thus far, equity markets have generally been able to withstand higher rates, thanks to strong earnings growth; but the latest inflation data served as a reminder that rising rates can quickly create headwinds for both stocks and bonds.

The AI trade may be entering a new, riskier phase.

Almost exactly one year ago, we flagged concerns that the AI investment cycle was moving into a more speculative phase as AI-related spending for the AI “hyperscalers” was increasingly being funded from debt, rather than from cash flow generation. Recent market developments suggest new, yet related, concerns may be surfacing. Shortly after the CPI report was released, several AI-related stocks experienced significant volatility, and credit spreads widened notably for several AI infrastructure companies. One high profile example was weakness across the “neocloud” providers, many of which carry substantial debt loads and are at risk of not having sufficient cash flow to meet their obligations if AI demand slows.

Recent reports also raised questions regarding the pace of AI revenue growth, and a few AI-related IPOs were postponed. At the same time, capital expenditures across the industry have continued to rise while free cash flow has turned negative. This creates a more challenging environment as higher rates make capital more expensive, and investors become more discerning about providing capital. Nevertheless, AI adoption continues to accelerate, with advancements in reasoning and agentic systems suggesting the long-term productivity opportunity remains intact.

The current market concentration is creating opportunities for portfolio diversification.

Market concentration continues to be a defining characteristic of today’s market as a small number of AI-related stocks represent an outsized portion of major equity indexes. As a result, recent weakness in the AI trade had an outsized impact on broader market performance despite strength in several other areas of the market.

At the same time, higher interest rates have improved the return outlook for fixed income investments. With Treasury yields near multi-decade highs, investors no longer need to take the same level of equity risk to achieve target portfolio returns. We believe this environment reinforces the importance of diversification and presents opportunities to broaden portfolio exposures beyond the areas that have driven market returns in recent years.

Bottom Line – how to invest now.

We expect volatility to remain elevated, and we continue to advocate for robust diversification. Bonds may continue to struggle to add ample diversification amidst an environment of larger federal deficits and higher interest rates. Bonds may show higher correlations with stocks in such an environment, leading to less portfolio diversification. To gain the desired diversification in a portfolio, we continue to emphasize the use of New Tools where appropriate. We also note that international markets may also provide additional diversifying qualities and believe opportunities exist beyond traditional asset classes.

Equity Takeaways:

Stocks were up in early Monday trading. The S&P 500 rose approximately 0.6%, while the tech-heavy Nasdaq rose 1.2%. Small caps rose 0.3, and non-U.S. stocks were mostly lower.

Stocks moved lower last week as investors reacted to hotter-than-expected inflation data and renewed concerns surrounding AI-related capital spending. The S&P 500 declined approximately 1.9%, while the Nasdaq experienced an even steeper decline of 5.5%. In contrast, value stocks finished the week up 1.2%.

Despite the continued rise in interest rates, the S&P 500 has held up reasonably well, primarily due to strong earnings growth offsetting declining valuation multiples. Last week, major banks released decent earnings and provided a positive outlook. Looking ahead, results from several large technology companies may provide important insight into whether earnings growth can continue supporting the market through year-end. Investors appear to be taking a wait-and-see approach until there is greater clarity around both AI spending and future interest rate policy.

Fixed Income Takeaways:

The yield curve experienced a “bull flattening” last week as yields fell across the curve. Specifically, at the short end, 2-year yields moved 8 basis points (bps) lower, closing the week at 4.71%; longer out on the yield curve, 10-year yields moved 17 bps lower to close the week at 5.07%, and 30-year yields moved 18 bps lower to close the week at 5.42%.

Federal Reserve officials delivered their final comments ahead of the blackout period for the upcoming Federal Open Market Committee (FOMC) meeting on October 27 – 28. While policymakers generally maintained that one additional rate hike remains the base case for this year, they also emphasized a cautious approach regarding further tightening in 2027. Market participants are pricing in a 17% chance of a rate hike at the upcoming meeting and a more than 80% chance at the December meeting.

Credit markets showed some signs of stress last week, particularly in the high-yield space. Credit spreads widened meaningfully, driven partially by concerns about inflation as well as weakness in AI infrastructure companies, most notably CoreWeave. Investment grade issuance slowed as several issuers remained on the sidelines following the inflation release.

In early Monday trading, yields were higher: 2-year Treasury yields were trading at 4.75%, 5-year Treasury yields at 4.91%, 10-year Treasury yields at 5.10%, and 30-year Treasury yields at 5.44%.