By: Brent Schutte, Northwestern Mutual
Economic data that continued to show a strong U.S. economy, housing aside, took a back seat this week as investors once again focused on potential risks to future growth: rising energy prices, sticky inflation, and most importantly, questions about the sustainability of the artificial intelligence (AI) boom. Those growth anxieties helped bonds rally, as investors continued to reimagine Treasurys not as a risk but rather as a port in a potential storm. That rally came despite oil’s continued climb on the back of heightened geopolitical risks, with Brent crude rising 6.2 percent to $116.72 per barrel, its highest level since late April and just shy of the $118.35 high set on March 31.
Against this backdrop, the S&P 500 Index of large-cap stocks slipped 0.47 percent, its second straight weekly decline. For the second week in a row, AI-related stocks led the way lower, as the Philadelphia Semiconductor Index (SOX) fell 3.21 percent and a Goldman Sachs basket of U.S.-listed companies pursuing AI development across all categories declined by 4.12 percent. Since peaking on June 22, the SOX is now down 26 percent, and the broader AI basket 23 percent, with much of that slide occurring since October 6, which (not so coincidentally) was the day after Treasury yields peaked. We believe that timing is a sign that both markets have begun asking the same question about the durability of AI-driven growth.
Make no mistake; the week’s data continued to highlight a U.S. economy that is pushing forward. S&P Global’s flash Purchasing Managers’ Index (PMI) for October showed the composite reading checking in at a strong 57.6, the second-strongest reading since 2022, behind only last month’s 58.4. Manufacturing posted its highest reading since May 2022, with its employment component reaching the strongest level since March 2012. Across the broader economy, new orders posted their fastest growth in four and a half years, while composite employment rose to its second-highest level in four years.
According to S&P Global, the survey’s output readings are consistent with GDP growing at a 5 percent annualized rate at the start of the fourth quarter, after signaling a 4 percent expansion in the third quarter. As the firm noted, “If the reopening of the economy after COVID is excluded, recent months have seen the best growth spell for U.S. businesses since early 2015.”
Yet that strength continues to come with an unwanted side effect: sticky inflation. Selling prices rose at the fastest pace in more than four years, while supplier delivery times lengthened the most since 2022 as both material and labor shortages created challenges. In other words, demand remains strong enough—and supply tight enough—for companies to continue passing higher costs on to their customers.
Rising oil prices are only adding to that pressure. As S&P Global noted, cost pressures remain a key concern, “notably as the renewed surge in oil prices reverberates through to impact a wide variety of goods and services.” The firm added that the pace of selling-price increases indicates “consumer price inflation is likely to rise further above the Fed’s target in the coming months.” Coming on the heels of last week’s hotter than expected consumer and producer price readings, the latest data is a reminder that the inflation pressures we have continually warned about have yet to fade.
One key exception continues to be housing, the most interest-rate-sensitive corner of the economy, which remains mired in a downturn as elevated mortgage rates and high home prices keep it unaffordable. Existing home sales, released in the prior week, checked in at 3.99 million, near the lows of the Global Financial Crisis and well off the January 2022 level of 6.43 million. This week, the National Association of Home Builders (NAHB) survey fell to 29 from 32, its lowest level in 14 years (since June 2012). A reading below 50 indicates that more builders see conditions as poor than good.
Housing is a reminder of what higher rates can do to a capital-intensive part of the economy, and investors are increasingly asking whether the AI buildout could be next. Meta’s earnings mid-week highlighted the questions investors are beginning to ask about the sheer number of dollars being spent to bring AI to life. While the company beat earnings expectations, it also raised its 2026 capital expenditure plans to $135 to 145 billion while noting that its future spending commitments, which include leases, compute deals, and energy agreements, rose to $825 billion from its prior level of $700 billion.
Most importantly, the company reported negative free cash flow for the first quarter since 2012. That means more of that spending must be financed with debt, which we continue to believe makes the AI buildout increasingly sensitive to the direction of interest rates and the willingness of investors to take on credit risk.
Credit markets are already taking notice. The cost to insure Meta’s debt against default through credit-default swaps rose to 126.5 basis points from 108 the prior week, well above its one-year low of 51.5 on December 4, 2025. While this still represents low credit risk, it highlights the repricing that continues to occur for companies borrowing to fund the AI buildout. Equity investors took notice as well, sending Meta’s shares down 9.4 percent on the week. That pushed the Magnificent 7 down 1.67 percent and, given their heavy weighting in the index, helped drive the S&P 500’s negative performance.
Questions about the sustainability of AI spending will likely continue to dominate headlines in the week ahead as heavyweights Amazon, Intel, Microsoft, and Alphabet report earnings. With Apple joining the fray on November 2, these companies represent over 23 percent of the index, and what they say will have a large impact on the performance of the S&P 500.
The good news is that we continue to believe there are opportunities outside the largest companies in the S&P 500 and outside the overall AI theme. Much as in the prior week, equity markets were healthier beneath the surface than the headline index suggested. While the tech-heavy and concentrated S&P 500 fell, 66 percent of the companies in the index actually posted positive returns, pushing the equal-weighted S&P 500 up 1.13 percent. Meanwhile, the S&P 600 Index of U.S. small-cap companies rose 1.71 percent, and the Dow Jones Select U.S. Real Estate Investment Trust Index pushed forward by 1.18 percent.
A slowdown in AI growth would certainly increase economic risks, which could weigh not only on growth but also on the broader equity market in the near term. While these other segments of the U.S. market would almost certainly feel the impact of a slowdown, we believe the relative discounts they offer today mean that intermediate- to longer-term investors will be rewarded for their patience.
The other good news is that bonds not only offer high levels of income but are also confirming our belief that they can provide a hedge against potential equity downside caused by an economic slowdown. Since peaking at 5.30 percent on October 5, the day before the pullback in AI stocks accelerated, the 10-year Treasury yield has fallen to this week’s closing level of 4.99 percent, helping push the Bloomberg U.S. Aggregate Bond Index up 193 percent over this period. The decline has been driven by lower real yields, which we continue to believe reflects investors contemplating that if AI spending slows, the U.S. economy will slow along with it. Put simply, despite the strong growth and sticky inflation in today’s data, the bond market is focused on the risks to tomorrow’s growth.
That tension between today’s data and tomorrow’s risks will be on full display this week as the Federal Reserve meets on October 27–28 and will likely drive the near-term narrative and contribute to heightened volatility. With an economy that continues to grow strongly, inflation that remains sticky, and investors increasingly questioning the durability of the AI buildout, we continue to believe diversification is more important today than it has been in recent decades.
We advocate building portfolios around multiple themes that are not overly reliant on the AI trade, including segments of the U.S. equity market that trade at relative discounts and bonds that offer both attractive income and a potential hedge against a weaker economy. Much as we have witnessed time and again, we believe investors with intermediate- to longer-term horizons will benefit from staying invested and remaining true to their financial plans.
