Key Wealth Investment Brief

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%.

Key Takeaways:

Last week’s employment report underwhelms, but a changing labor market may be the cause. 

The unemployment rate rose slightly to 4.2%, and the U.S. economy gained 29,000 jobs in September, well below the consensus forecast of 90,000, according to Bloomberg. Additionally, the July and August non-farm payrolls were revised lower by a combined 60,000 jobs. While these numbers may appear “soft” on the surface, most economists believe this data is above the labor market’s breakeven rate, which has fallen recently due to changes in immigration policy and other factors. 

One area of the report that is cause for concern relates to wage growth. Average hourly earnings for workers have grown at a slower pace than inflation in every month since March. This slower wage growth is a positive for corporate profitability, but it reduces workers’ purchasing power, which reinforces the K-shaped economy.

Interest rates are rising around the world. 

The rise in government bond yields this year is not just a U.S. phenomenon; almost every developed market has experienced an increase in rates. Most major economies are seeing long-term yields near their highest levels since 2007, just prior to the Great Financial Crisis. While credit markets are showing some signs of strain among a small number of the riskiest borrowers, we have not seen signs of widening concern. Additionally, the economy has changed quite significantly since 2007, becoming much less interest rate sensitive. 

Rising rates have been a significant drag for fixed income returns, highlighted by the Bloomberg U.S. Aggregate Bond Index generating one of its lowest 5-year returns (for the period ending 8/31/26) since 1980 according to Ritholtz Wealth Management. However, with yields now firmly above 5.00%, future returns will likely be better as approximately 90% of bonds’ 5-year annualized returns can be explained by the yield-to-maturity at the time of purchase.

Third quarter earnings look poised to continue their strong growth. 

When the third quarter began, analysts were expecting earnings for the S&P 500 to rise 26.7% year-over-year. As of the end of the quarter, analysts have revised that number higher to 29.5%. Historically, analysts revise their forecasts lower prior to quarter end; however, that trend has been bucked this quarter, primarily driven by positive revisions to the Energy and Technology sectors. An additional positive sign for equities is the increase in the number of companies providing positive pre-announcement guidance. All said, analysts are expecting another strong earnings season, and corporations are expecting good things, too.

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 largely unchanged in early Monday trading. The S&P 500 rose approximately 0.1%, while the tech-heavy Nasdaq was unchanged. Small caps were also unchanged, and non-U.S. stocks were mixed.

The S&P 500 rose approximately 0.5% last week. Through the first three quarters of 2026, the Index is up 12.7%, and the small-cap index is up 14.1%. Emerging Market equities have been the top performer, up 22.7%. The Nasdaq broke out to its first all-time high since June, thanks in part to the mega-cap technology companies regaining their leadership position. Outside of the mega-cap tech companies, the broader market has been experiencing a difficult environment, highlighted by market breadth continuing its steady decline since its peak in mid-August.

Fixed-Income Takeaways:

The yield curve experienced a “bear steepener” last week as long-term yields rose and short-term yields fell. Specifically, at the short end, 2-year yields moved 2 basis points (bps) lower, closing the week at 4.83%; longer out on the yield curve, 10-year yields moved 11 bps higher to close the week at 5.27%, and 30-year yields moved 13 bps higher to close the week at 5.62%.

The drop in short-term yields was likely due to the softer-than-expected employment report reducing the odds of an interest rate hike at the October Federal Open Market Committee (FOMC) meeting. After the report’s release, the odds of a rate hike fell from more than 60% to approximately 20%. Yields at the long end of the curve were likely driven higher by continued strong consumer spending, as well as robust corporate issuance crowding out Treasuries. Foreign holdings of Treasuries have experienced a notable dip in the past year after seeing a sharp rise in 2023 and 2024.

In early Monday trading, yields were mixed: 2-year Treasury yields were trading at 4.82%, 5-year Treasury yields at 5.06%, 10-year Treasury yields at 5.30%, and 30-year Treasury yields at 5.66%.

Key Takeaways:

Rising interest rates are causing volatility in the bond market to jump. 

Yields across the curve climbed higher last week. Continued high gas prices and signs of sticky inflation pushed short-term yields higher, while massive hyper-scaler debt issuance has attracted investors, diverting demand from Treasuries and putting upward pressure on intermediate-term yields.

Growing concerns about the U.S. fiscal situation have continued to drive long-term rates higher. These increases in yields caused volatility in the bond market to jump, with the ICE BofA MOVE Index experiencing its largest weekly increase since April 2025. Bond performance has struggled thus far in 2026, highlighted by the Bloomberg U.S. Aggregate Bond Index falling more than 2.0% year-to-date and longer-dated bonds faring even worse. 

Despite the turmoil in the bond market, the U.S. economy continues to show strength. 

Recent economic data releases have pushed the Atlanta Fed’s GDPNow forecast for Q3:2026 GDP to 5.0%. While 5.0% growth may be overly optimistic, the economy is still growing at a very healthy clip. In addition, the labor market has shown no signs of stress as the initial weekly unemployment claims have held steady near historic lows.

The S&P 500 is expected to continue its strong earnings growth into the third quarter, with forecasted year-over-year growth of 29.1%. In short, while the volatility in the bond market is making headlines, the underlying economy continues to press ahead.

The artificial intelligence (AI) build-out has become the economy.

In a recent article, The Wall Street Journal noted that the AI build-out has become the biggest economic bet in U.S. history, echoing a theme we have been signaling for the past 12 months. The average annual infrastructure spending as a percentage of GDP for the AI build-out is expected to be approximately 3.6% through 2032, far surpassing the spending on the railroad, highway, and internet build-outs.

The rise in AI valuations has been the primary driver in the rise of U.S. household wealth, which recently surpassed $60 trillion, and has enabled consumers to continue spending despite rising prices. Due to this dependence on AI, if the AI trade reverses, we will likely see a significant pullback in consumer spending and a slowdown in economic growth. We continue to favor AI adopters over AI enablers. 

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.

Even before the Iran War, we held the view that inflation could be persistent (due to rising nationalism along with other forces). The Iran crisis adds a material new source of risk, and although we don’t see history repeating itself in lock step with the 1970s, investors may want to maintain allocations to real assets after the conflict ends.

Equity Takeaways:

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

The S&P 500 rose approximately 1.4% last week. Year-to-date, the Index is up 14.1% while the small-cap index is up 16.0%. Despite testing new highs last week, the S&P 500 Index has remained in a tight price range for the past two months, suggesting market participants are waiting for clarity before deciding on a future direction.

The Magnificent 7 stocks have surged back into the headlines as the group broke through to a new all-time high, supported by positive reactions to Meta’s new AI agent, Muse. Semiconductors are also showing signs of a resurgence, breaking out from the downtrend that started in June.

Fixed-Income Takeaways:

The yield curve experienced a “bear steepener” last week as long-term yields rose by more than short-term yields. Specifically, at the short end, 2-year yields moved 11 basis points (bps) higher, closing the week at 4.85%; longer out on the yield curve, 10-year yields moved 16 bps higher to close the week at 5.16%, and 30-year yields moved 16 bps higher to close the week at 5.49%, its highest level since 2004. 

The rise in yields was likely caused by multiple factors including hawkish comments from multiple Federal Reserve officials, a strong PMI data release, and falling demand for U.S. debt. The probability of an October interest rate hike rose to approximately 70%, and market participants are pricing in nearly four rate hikes by September 2027.

In early Monday trading, yields were higher: 2-year Treasury yields were trading at 4.92%, 5-year Treasury yields at 5.07%, 10-year Treasury yields at 5.23%, and 30-year Treasury yields at 5.55%.

Both Investment Grade (IG) and High Yield (HY) spreads widened modestly last week. While IG and HY spreads have remained contained, the CCC & Lower rated debt has experienced a steady rise over recent months, bringing its spread to its highest level since April 2025.

Key Takeaways:

The Federal Open Market Committee (FOMC) raised interest rates and made a firm commitment to deliver price stability.

For the first time in three years, the FOMC raised interest rates by 25 basis points (bps) or 0.25%, bringing the target range for the fed funds rate to 3.75% – 4.00%. The vote was unanimous, signaling the Fed's commitment to delivering price stability and underscoring its acknowledgement that “inflation is too high and has been too high for too long.”

The Committee also released the updated Summary of Economic Projections (SEP) that showed, relative to the June SEP, Committee members believe the economy will grow faster, unemployment will be lower, and inflation will be higher. Additionally, any premonitions of a “one and done rate hike” were decisively dismissed as members projected at least one additional 25 bps hike this year and Fed Chair Warsh declared “a dose of accommodation” needs to be removed; translation: more rate hikes are coming.

The Federal Reserve (the Fed) believes they are tightening into a strong economy that can tolerate higher rates.

Recent economic and corporate data releases signal a resilient consumer, robust capital spending, and a stable labor market that combined underpin an economy set up to handle rising interest rates. The August Retail Sales report released last week showed consumers are still spending freely, rising 1.2% month-over-month. Third quarter gross domestic product (GDP) forecasts estimate the economy to expand by nearly 3.0% in the quarter.

Historically, the first rate hike has not ended equity bull markets, especially when the economic backdrop is this strong. Since 1970, in all but two instances, the S&P 500 had a positive one-year return in the period immediately following the first rate hike. The most important question going forward is how far the Fed ultimately tightens and whether earnings can remain strong enough to absorb the higher rates.

Artificial intelligence (AI) backlash is growing and could materially slow the buildout.

Recent surveys have found growing opposition to the AI buildout, highlighted by 71% of respondents opposing a local data center, up nearly 20 percentage points from earlier this year, according to data compiled by the Pew Research Center. This growing backlash has led to a sharp increase in the number of data center projects facing new hurdles. In the first quarter of this year, 26 data center projects have been blocked, more than the number blocked in the entirety of 2025.

With the market relying heavily on AI, a dramatic slowdown in the buildout could lead to a return in volatility. Despite this uncertainty, we continue to emphasize the importance of staying invested and diversified, as well as our preference for AI adopters over AI enablers.

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.

Even before the Iran War, we held the view that inflation could be persistent (due to rising nationalism along with other forces). The Iran crisis adds a material new source of risk, and although we don’t see history repeating itself in lock step with the 1970s, investors may want to maintain allocations to real assets after the conflict ends.

In sum, real investors need real assets, and U.S. investors need exposure beyond U.S. financial assets and concentrated indexes.

Equity Takeaways:

Stocks moved higher in early Monday trading. The S&P 500 rose approximately 0.6%, while the tech-heavy Nasdaq rose 1.0%. Small caps were up 0.5%, and non-U.S. stocks were higher.

The S&P 500 recovered from its post-FOMC lows last week, to end the week essentially flat. Year-to-date, the Index is up 12.7%, while the small-cap index is up 16.6%. Since the end of May, the S&P 500 has generally moved sideways, up approximately 1.0% during that time.

The rising backlash against AI has led to a slowdown in growth across the companies exposed to the AI buildout. The performance over the past few months for the future-year beneficiaries (Industrials and Utilities) suggests investors have already been pricing in this kind of event. The recent AI pullback has dragged down the momentum factor; but it remains the top performing factor year-to-date, up more than +20.0%.

Fixed Income Takeaways:

Last week, the front-end of the yield curve led the sell-off, as the curve experienced a bear flattening. Specifically, at the short end, 2-year yields moved 11 basis points (bps) higher, closing the week at 4.74%; longer out on the yield curve, 10-year yields moved 3 bps higher to close the week at 5.00%, and 30-year yields moved 2 bps lower to close the week at 5.33%.

The rise in short-term yields was likely caused by market participants pricing in additional rate hikes, following the FOMC decision on Wednesday. Market participants are now fully pricing in one additional 25 bps hike this year, and a second hike is fully priced in for early next year.

In early Monday trading, yields were lower: 2-year Treasury yields were trading at 4.73%, 5-year Treasury yields at 4.82%, 10-year Treasury yields at 4.96%, and 30-year Treasury yields at 5.30%.

Both Investment Grade (IG) and High Yield spreads tightened by 4 bps last week. Within IG, every sector experienced tightening spreads, with Technology seeing the largest tightening, moving lower by more than 5 bps.