Wicked rotation, solid fundamentals
Read time: 8 minutes
The S&P 500 finished the month down 0.9%, while the 10-year Treasury yield declined to 4.91%, in a market that can only be described as a wicked rotation. The modest decline in the headline index masks a much broader market beneath the surface, with nine of the 11 S&P 500 sectors finishing higher for the month. Weakness was concentrated in the ever-important information technology and communication services sectors, while energy, consumer staples and utilities all posted double-digit gains. Internationally, developed markets declined 0.7%1, while emerging markets fell 8%,2 weighed down in part by a sharp decline in tech-heavy South Korea.3
This month was a stark reminder of the importance of diversification and balance, and an example of the ever-present tug of war between the wall of worry and the FVTs. The underlying picture across fundamentals, valuations and technicals remains more balanced than the headline index return might suggest. This month, we’ll spend some time on that tension before addressing one of the most common questions and fears surrounding AI. To close, we’ll look at the midterm elections and what they may—or may not—mean for markets.
FVTs: fundamentals still win the tug of war
For all the noise, the FVTs remain fairly straightforward.
Fundamentals continue to be the strongest part of the story. Economic growth remains healthy after a very strong Q3 GDP report, with consumer spending increasing at a 3.8% annualized rate and business investment surging 12.7%. Corporate earnings continue to advance at a very strong pace, while AI-related investments remain a significant driver of business spending.
Valuations are also more reasonable than they were at the start of the year, providing a bit more cushion if investors demand lower multiples. The market itself is broadening as well, as demonstrated by nine of eleven sectors advancing in the same month that the S&P 500 declined. We’ve long argued that a market dependent on only a handful of companies for growth is more fragile than one supported by a broader range of businesses. From that perspective, October’s shift in market leadership was uncomfortable for some investors but ultimately constructive.
That doesn’t mean the FVTs are flashing an “all clear.” Technicals remain neutral rather than outright positive, and we continue to monitor long-term interest rates, credit spreads, inflation, oil prices and the ongoing conflict with Iran. Still, strong fundamentals, reasonable valuations and broader participation continue to outweigh the concerns driving the wall of worry.
Artificial intelligence: boom or bubble?
One of the questions we continue to receive most frequently is whether AI has entered a bubble. Our answer remains the same: AI is unquestionably experiencing a boom, but that’s not the same thing as a bubble.
We certainly don’t believe cycles have been repealed. At some point, AI capital spending will slow, expectations will reset and winners and losers will emerge. But for now, continued demand, strong orders, high utilization and ongoing capital commitments suggest that this cycle has more room to run. The largest hyperscalers are still signaling substantial infrastructure investment, and the funding for these buildouts no longer depends solely on a few companies recycling internally generated cash flow. Meta has recently tapped the capital markets, Anthropic is moving toward the public equity markets and SpaceX is exploring significant outside financing for AI infrastructure.
There is another reason we’re reluctant to use the word “bubble”: bubbles normally require a healthy dose of exuberance and we’re still seeing plenty of skepticism. Investors constantly question the returns on AI capital spending, the circular nature of some transactions, the useful life of GPUs and whether today’s extraordinary demand can persist. Those are all reasonable questions and frankly, we’re glad investors are asking them.
We also find it difficult to reconcile the bubble argument with the valuation trends we’re seeing in several of the AI ecosystem’s most central companies. Some semiconductor and technology shares have had meaningful declines in their valuations even as their earnings continue to grow. That’s not typically the picture associated with an unquestioning speculative frenzy.
So yes, this is a boom, and booms eventually mature. We’ll continue to watch order trends, utilization, capital spending intentions and financing conditions. When the time comes, we’ll watch for returns on these companies’ enormous investments. But at present, the evidence still points to a powerful investment cycle rather than a speculative bubble nearing an obvious breaking point.
The wall of worry hasn’t gone away
While the FVTs keep us constructive, we acknowledge that the range of possible outcomes has widened somewhat since our Mid-Year Outlook. Our base case remains intact, but we’re a little less confident that the path will be as orderly as we envisioned several months ago.
There are many factors contributing to this. Pressure on long-term interest rates can eventually make bonds a more competitive alternative to stocks. Fed policy is less predictable under new leadership. The Iran conflict and resulting uncertainty around energy prices remain an important inflation and economic risk. AI capital spending is providing tremendous support today, but its sheer size makes any meaningful slowdown worth monitoring closely. The midterm elections are also introducing another potential source of short-term volatility.
We don’t think these concerns necessarily make the base case less attractive. Instead, they increase the probability of outcomes that fall outside our central expectations, both on the upside and the downside. A resolution to the Iran conflict, lower energy prices, moderating inflation, declining long-term yields and continued earnings momentum could produce a meaningfully better outcome. Conversely, persistent energy inflation, higher rates and wider credit spreads or an unexpected slowdown in capital spending would make us more cautious.
In other words, our central outlook remains constructive, but the range of potential outcomes has widened on both ends of the spectrum. This is exactly the type of environment where a more thoughtful approach to risk management and diversification continues to make sense.
Midterms: don’t predict the predictors
As we write this, Election Day is upon us and voters have yet to cast their final ballots, so the thoughts that follow reflect our perspective ahead of the results.
Past midterm elections have brought elevated volatility, and this year’s backdrop has given investors no shortage of political narratives to trade around. Historical patterns for midterm elections from 1950 through 2022 suggest that the 12 months following midterm elections have not produced negative returns for the S&P 500, and gains during those periods have tended to be substantial. This year we think it’s more complex than that. Prediction markets currently view Democratic control of both chambers of Congress as the most likely outcome, but that would still leave Washington divided given the Republican White House.
There are potentially constructive aspects to that setup. Divided government can constrain sweeping legislative changes and may create greater visibility for businesses. But gridlock isn’t automatically bullish. It can also bring budget battles, shutdown threats and debt-limit uncertainty.
More importantly, we continue to caution against building portfolios around political predictions. “Democrats win, buy alternative energy” or “Republicans win, buy fossil fuels” makes for a tidy narrative, but markets and businesses rarely behave so neatly. The election results matter only to the extent that they ultimately change the fundamental picture.
So, our advice remains consistent: don’t predict the predictors. Watch what happens to capital spending, energy prices, inflation, interest rates, credit spreads, economic growth and earnings. Those variables will tell us far more about the direction of markets than the campaign headlines.
Conclusion
October’s wicked rotation was another reminder that diversification isn’t simply about reducing risk; in a broadening market, it can also be an important source of return. We continue to believe the FVTs support a constructive outlook, but we also recognize that investors are navigating a wider range of plausible outcomes than they were at mid-year.
That is precisely why our 2026 theme—Risk Awareness and Diversification 2.0—remains so relevant. Stay balanced, avoid unnecessary concentrations and resist the temptation to make large portfolio decisions based on the loudest headline of the day. The wall of worry is very real, but for now the fundamentals continue to win the tug of war.
Sources:
- MSCI EAFE Index
- MSCI EM Index
- FactSet
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