S&P 500 continues to bounce off the 7,000 threshold
Last week, we already noted that the S&P 500 seems to be pricing in a near-perfect future, something that rarely materialises in reality. This is especially true for stocks related to AI. While we do not deny that AI will bring many improvements, it is important to remember the vast amounts of money currently being invested in AI both in the West and in China. This is creating intense competition, which will make it very difficult for AI-related companies to meet the highly optimistic profit expectations. Moreover, it remains uncertain whether sufficient electricity can be generated in the future to power all AI-related businesses.
In our view, this alone is reason enough to be sceptical about the high valuations of various AI companies, a sentiment that likely applies to many other stocks as well.
This should be considered alongside the fact that markets have priced in a 50% chance of another cut by the Fed in December, and three additional cuts throughout 2026. Such cuts will only occur if economic growth slows to no more than 2% and inflation declines. The question is whether many companies can generate significantly higher profits in such a climate. Additionally, one must not forget that many of the import tariffs introduced by Trump still need to be passed on to consumers, and that the labour market remains tight even with 2% growth. In other words, we are not convinced that inflation will fall significantly in the near future.
Another important point is that although the government shutdown is now over, the Supreme Court’s ruling is still pending on whether Trump’s import tariffs were legally imposed. The expectation is that the ruling will fall somewhere between legal and illegal. Assuming this is the case, many companies remain uncertain about the level of import tariffs and whether existing trade agreements will remain valid. As a result, we believe this uncertainty will persist, causing companies to remain cautious about hiring new staff and making large investments.
Within the Fed, there is growing concern about whether the relatively strong economic growth seen so far will lead to more employment, or whether the stagnation in job creation observed over the past few months will result in declining consumer spending and slower growth. This question is particularly difficult to answer because part of the population is benefiting greatly from rising stock prices and high property values, while a larger portion is struggling to make ends meet. So far, the first group has helped maintain growth, but will this continue? That will depend heavily on how stock prices and property values evolve. One must also consider how these will respond to the climate we have described: a slowdown to around 2% growth, intense emerging competition in AI, and persistent inflation.
There are two ways to reason through this:
- The Fed, due to high levels of debt, is extremely wary of a recession. A recession could easily trigger a new credit crisis, which would be difficult to counter. Therefore, the Fed will do everything it can to prevent a recession and may overstimulate the economy with lower interest rates. If one assumes this scenario, there is a strong case for buying stocks and real estate during the upcoming period of slowing economic growth.
- Alternatively, one could argue that the economic climate will turn out to be much less favourable than current stock prices suggest. In other words, stocks are now hovering around a significant peak.
Our own view is slightly different. Due to the uncertainty surrounding the Supreme Court’s ruling, we do expect economic growth to decline significantly in the near term, which will increase calls for rate cuts by the Fed. However, we believe the Fed cannot respond too aggressively, as inflation will remain relatively high and, depending on the Supreme Court’s decision, the budget deficit could widen further. In other words, we foresee slowing growth, but a Fed that will not respond forcefully. Does this not risk a recession? We think not, because there are various reasons to believe that economic growth will pick up again next year on its own, and therefore may not fall far below 2%. At first glance, this outlook is not overly negative for stock prices. However, we fear that such growth will be too low to prevent a further increase in the budget deficit, while remaining too high to ease the labour market and reduce inflation. This means the Fed will have much less room to cut rates next year than currently expected, or may even need to raise them. This, in turn, could hurt stock prices, especially AI stocks, as these companies will increasingly need to borrow to fund their massive investments, rather than relying on internal resources.
All things considered, it remains to be seen whether the S&P 500 can break through the 7,000 threshold, or whether it is instead forming a major top.
