The Fed and Rates
The FOMC meets, and the market prices more than a 90% chance of a rate hike - the first in years. My call is 25 basis points. Rates are climbing in the US and worldwide because the Fed worries about inflation and cannot push it down to 2%. Oil above $100, a tight labor market, and a sticky CPI give the Fed clear reasons to raise. This rate rise mostly reflects a strong global economy.
Global bond yields back this up. The UK 10-year sits at its highest since 2007, matching current US levels. Japan's 10-year is the highest since 1996, and Japan just raised its defense budget to a higher share of GDP than before, adding its own fiscal pressure.
If retail sales come in soft, it would help the case for restraint and might cost one vote, but I doubt it. The Fed wants to get closer to 2% and has had no ability to do so, so a weak retail number likely will not stop the 25 basis point move.
Oil as the Main Risk
$100 oil is the biggest risk to the market - it could bring a normal correction or something worse. Oil above $100 for months at a time is the real danger; the recent back-and-forth in price is fine. The Saudi pipeline has been the recent problem. It looks set to come back online this fourth quarter, within the next few weeks, which should push oil prices down. This is a short-term problem, not a long-term one. If the pipeline reopens and oil falls under $100, a fourth quarter rally in equities follows.
Why AI Leads the Rally
The rally is led by the AI trade. There is a tall wall of worry: circular financing, fears that AI is growing too fast and is uncontrollable, and bubble talk. Those bubble worries are fading because price-to-earnings ratios are low. Once the dust settles on these concerns, these companies report strong fourth quarter numbers and drive equities higher. My S&P target is 8,100. Yadeni, one of the most bullish voices, is at 8,400, and one bank came out with 7,400, arguing the market is due for a correction.
Where the Value Is
My AI exposure is broad: Alphabet (GOOGL), Meta (META), GE Vernova (GEV), and Caterpillar (CAT), which has turned into an industrial AI and data center play. The rule is to go where the PE and growth rates are most attractive.
Because stocks have not moved, their PE ratios have contracted, which creates value in the chip makers: Nvidia (NVDA), ASML (ASML), and Taiwan Semiconductor (TSM). The second layer is the hyperscalers. I am not sure about Meta (META), but I am a big fan of Google (GOOGL) for its tech stack, and Amazon (AMZN).
Looking further out, 2027 brings strong earnings in names like Caterpillar (CAT). Investors should also look at biotech and healthcare, where AI turns accretive in 2027. The industrial sector plays in too, and there is a large bull market in financial stocks that are also adopting AI, since they need to fund all of this.
The AI Slowdown Debate
Talk of an AI slowdown has become part of the national conversation and picked up over the past week, including a phone call where Trump brought Jensen Huang on stage. China pushes back while running its own program, with a cyber security department that monitors and regulates the technology itself.
My concern is not the present - it is overbuilds in the future. These companies are not used to or good at slowing down, and that is what they are now being asked to do to cut risk. Nobody wants AI risk to the degree described over the weekend. These are the most innovative companies in the world, facing tremendous demand for use cases and profits. Capitalism 101 says they will find ways to self-regulate quickly and move things along. This is the last worry on the pile of negativity around AI stocks. In hindsight, this looks like the moment to buy, since some of these stocks have already come down. The warnings may be aimed at sending a message to the government to regulate the companies.
