Markets wobbled as Washington’s shutdown drama ended, but I don’t view last week’s pullback as the start of a bear market. The Dow just printed fresh highs, breadth rotated toward quality and defensive stocks, and the weakness centered on AI-linked capex stories repricing risks associated with the capex buildouts.
The Fed’s more hawkish tone is also a proximate driver of the risk-off sentiment, and I think that Fed stance is misguided. Categories pushing CPI inflation higher—health insurance and other regulated insurance lines, as well as energy prices—are not responsive to tighter demand caused from elevated interest rates; staying more restrictive on policy won’t move those needles. Fed funds futures mark December as roughly a coin flip for a cut. On net, I put the December cut odds about even money, but this is highly dependent on upcoming data. Nonetheless, I believe that the Fed will privot to a clearer easing bias into Q1 if incoming activity and prices continue to cool.
A notable tailwind is the first material roll-back of prior food tariffs—an implicit admission that tariff taxes raised prices for consumers. If this broadens beyond food, it dampens goods inflation and reduces political incentive for renewed tariff escalation; that is constructive for real incomes and margins.
Valuation debates are back in focus. At a New York CFA gathering last week, we revisited some long-held debates about forward returns. Consensus clustered around a 2–4% equity risk premium over bonds over the next decade, not far from its historical average. With TIPS real yields near ~2%, that implies a 4–6% long-run real return for equities—somewhat lower than the 20th-century average but still firmly pro-equity.
Growth stock’s last-decade dominance owed a lot to P/E re-rating from depressed to premium levels; but in the last five years, superior earnings have done some heavy lifting. Going forward investors should not bank on further multiple expansion doing the work.
If AI earnings compound, today’s ~23 forward P/E can be digested; if earnings under-deliver, P/E deflation becomes a second hit. That asymmetry argues for selective quality-value tilts, cash-flow discipline, and owning stocks that benefit from curve normalization rather than paying ever-higher prices for growth stocks.
