AI Stocks Rebound, but Concentration Risks Remain

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

In a week marked by continued concerns about rising interest rates, the bond market found some relief after two large Treasury auctions of 10- and 30-year securities were well received by investors. The week’s most significant development came Thursday, when questions emerged about OpenAI’s revenue. Reports suggested revenue was running at a $50 billion annual pace, well below the $70 billion investors had expected.

The news triggered a sharp, one-day shift in recent market dynamics and offered an important test of whether investors’ portfolios are truly diversified. The tech-heavy Nasdaq fell 1.25 percent, while the S&P 500 declined 0.47 percent as the technology sector dropped 1.78 percent. A Goldman Sachs basket of U.S.-listed companies driving the development of artificial intelligence (AI) fell 2.74 percent, while the Philadelphia Stock Exchange Semiconductor Index declined 3.39 percent. Yet the weakness was not universal. The equal-weighted S&P 500 rose 0.60 percent, the S&P MidCap 400 and S&P SmallCap 600 gained 0.35 percent and 0.22 percent, respectively, and the Dow Jones REIT Index rose 0.64 percent. Investors whose portfolios suffered far more than the broader market on Thursday may not be as diversified as they believe.

Much of Thursday’s move reversed Friday after OpenAI said it was indeed on pace to reach $70 billion by December, sending stocks broadly higher and helping the S&P 500 finish the week with a 1.15 percent gain. Taken together, the two days delivered a clear message: Diversification opportunities remain available, but the market’s direction, and some investors’ wealth, remains heavily influenced by developments in the AI trade.

The week’s economic data continued to confirm that the U.S. economy is advancing but with the unwanted risk that sticky inflation becomes more deeply embedded and adds to consumers’ growing angst. Minutes released Wednesday from the Federal Reserve’s September 29 meeting showed broad agreement on the need for higher rates. All 19 participants, not just voting members, supported the 25-basis-point hike, while almost all judged inflation risks to be tilted to the upside, and some believed those risks had increased. Most participants also thought another hike would be appropriate by year-end.

Speaking in Istanbul on Thursday, October 8, Fed Governor Christopher Waller, who had previously suggested additional tightening might not be necessary, appeared to move firmly into the rate-hike camp. With the economy strengthening in the second half, Waller said that if the data continues to evolve as expected, he anticipates additional hikes to support a timelier return of inflation to the Fed’s 2 percent goal. At the same time, he emphasized that the Federal Open Market Committee (FOMC) retains flexibility over when those hikes occur, provided they are delivered within an acceptable period.

His rationale centered on the risk that supply-side pressures, including tariffs, supply-chain disruptions, higher energy prices, and escalating trade conflicts, could keep inflation elevated even as economic growth remains resilient. As Waller put it, “I am concerned that the recent acceleration in inflation, after what soon will be five and a half years of it above the FOMC’s target, will lead consumers, investors, and price-setting businesses to revise up their expectations for future inflation.”

The economic data released this week reinforced both sides of Waller’s argument: Economic growth remains strong, but inflation risks are building. The Institute for Supply Management (ISM) Services Purchasing Managers’ Index (PMI) checked in at a still healthy 54.9, with new orders remaining elevated at 59.8 and order backlogs rising to their highest level since July 2022. When this week’s services survey is combined with the prior week’s manufacturing survey and weighted to reflect each sector’s respective share of the economy, the overall reading remained elevated at 54.9, just below last month’s 55.3 and February’s 55.7 and, outside those two months, tied for the highest reading since September 2022. Simply put, current growth remains not only strong but broad.

The less welcome news came from prices. The ISM Services Prices Paid Index rose to 74.0 from 72.6, its highest reading since July 2022, while 17 of 18 services industries reported paying higher prices. This is particularly concerning because services inflation tends to be stickier and suggests broader cost pressures are increasingly spilling into the services side of the economy.

Indeed, when the manufacturing and services prices-paid measures are combined and weighted by their share of the economy, the index checks in at a historically elevated 74.4 and points to continued inflationary pressures. Outside the March 2021 to June 2022 period, this is the highest reading since May–July 2008 and November 2007. In the 351 observations since the measure began, only 23 have been higher, and each occurred during a period of elevated inflation. ISM Services Business Survey Committee Chair Steve Miller provided important context, noting, “Tariffs and fuel cost impacts were the most cited issues impacting respondents’ supply chains. In fact, fuel costs were mentioned twice as often as any other single issue impacting performance.”

After nearly five and a half years of above-target inflation, the combination of resilient growth and broadening price pressures is raising the risk Waller highlighted: Consumers may begin to embed higher inflation into their expectations for the future. The New York Fed’s one-year inflation expectation rose to 3.9 percent, its highest level since May 2023, while the three-year measure increased to 3.25 percent. Outside of readings of 3.26 percent in July and 3.34 percent in June, the three-year measure is now at its highest level since June 2022. The risk is no longer simply that inflation remains elevated today, but that it becomes increasingly embedded in expectations for tomorrow, a concern reinforced by Friday’s University of Michigan survey.

While Fed officials remain optimistic about economic growth, the preliminary October University of Michigan survey highlighted the mounting frustration consumers feel over the cost of living. Five- to 10-year inflation expectations rose to 3.5 percent from 3.4 percent, well above their 2024 range of 2.8 percent to 3.2 percent. Overall sentiment fell to 46.3 from 48.1. Outside of May’s 44.8 reading, this is the lowest level in the survey’s history going back to 1978. Consumers’ assessment of current conditions dropped to a record low 44.7 from 50.9, while expectations edged up to a still historically depressed 47.3 from 46.3. Perhaps most telling, buying conditions for large household durables fell to the lowest level ever recorded in the survey, reflecting the combined burden of high prices and borrowing costs.

The Michigan survey is sometimes discounted because political affiliation can heavily influence sentiment, with Republicans and Democrats often changing their views depending on which party occupies the White House. Yet the current deterioration extends beyond the usual partisan divide. Republican sentiment has fallen nearly 15 percent since the beginning of the year, compared with 9 percent among Democrats, while sentiment among independents has dropped more than 20 percent. The levels may retain a political tint, but the trend is difficult to dismiss: Consumers across the political spectrum believe the economic outlook has weakened since the start of the year, before the Iran conflict.

The more consequential divide may be by wealth. Sentiment among lower-wealth consumers, non-stockowners, and those with the smallest stock portfolios has collapsed roughly 25 percent since January. By contrast, sentiment among those in the middle and largest terciles of stock ownership has declined by less than 10 percent. For households with limited assets, higher prices are steadily eroding financial security. For those who own financial assets, strong market values are helping cushion the impact of those higher prices. That wealth cushion, however, has become increasingly dependent on a narrow group of AI-related stocks continuing to advance.

Thursday’s market action also provided an encouraging reminder that diversification opportunities remain available. While AI-related stocks declined sharply, equal-weighted stocks, small- and mid-cap companies, and REITs all advanced. Investors do not need to abandon the AI theme. Rather, they should complement it with investments whose outcomes are driven by different economic and market forces, including (as we have discussed) the expected shift in value toward users of the technology.

Diversification is always important, but it is even more critical today given the concentration in AI-related investments both in the U.S. and around the globe. The Fed raising rates does not preordain any particular outcome, but historically it has increased the risks. Nor do we believe AI spending is independent of the economic cycle. Bringing this technology to life requires increasingly large amounts of capital. Last week, Oracle, Broadcom, and SpaceX were reportedly looking to borrow additional dollars, while OpenAI and Anthropic continue to explore going public to unlock much-needed capital.

That brings us full circle to Thursday’s OpenAI news. The risk is becoming increasingly circular: AI investment requires continued access to capital, while the resulting market gains help support the wealth and spending that sustain the broader economy. Much of the stock market’s advance over the past several years has been concentrated in narrow segments tied to AI. Any meaningful disruption would therefore threaten not only the market but also the wealth cushion supporting consumers and, ultimately, overall spending.

For investors, the message is not to abandon AI but to avoid tying their portfolio, and their financial future, to a handful of AI-related stocks whose fortunes could shift quickly. Thursday offered a useful reminder that alternatives still exist and that a genuinely diversified portfolio can participate in the AI opportunity while being better positioned if enthusiasm for the theme begins to fade.

Wall Street wrap

ISM services activity remains strong as price pressures intensify

The ISM Services PMI registered 54.9 in September, down slightly from 55.4 but still signaling healthy expansion in the largest segment of the U.S. economy. New orders remained strong at 59.8, down modestly from 60.9, while order backlogs rose to 56.6 from 55.6, the highest level since July 2022. Encouragingly, the employment component moved back into expansion territory at 50.1 after spending two months in contraction, suggesting labor demand within the services sector remains resilient.

The more concerning development came from inflation. The Prices Paid Index rose to 74.0 from 72.6, its highest reading since July 2022, when it reached 74.5. The increase points to continued stickiness in services-sector inflation and suggests broader inflation pressures may remain elevated in the months ahead, particularly when combined with growing order backlogs. Price increases were also widespread, with 17 of the survey’s 18 industries reporting higher prices.

[H3] Consumer sentiment remains near historic lows

Consumer sentiment deteriorated further in October, according to the University of Michigan’s preliminary survey. The headline index fell to 46.3 from 48.1, marking the second-lowest reading on record. Current conditions dropped sharply to 44.7 from 50.9, the lowest reading ever recorded, while expectations edged up slightly to 47.3 from 46.3.

Inflation concerns continued to weigh on households. One-year inflation expectations rose to 4.7 percent from 4.6 percent, while five- to 10-year inflation expectations increased to 3.5 percent from 3.4 percent. At the same time, consumers appeared somewhat less concerned about job losses, as the share expecting unemployment to rise over the next 12 months fell to 56 from 60, the lowest level since February 2025.

Consumers also increasingly expect higher borrowing costs. Expectations for rising interest rates climbed to 74 from 65, the highest level since December 2022. Reflecting the pressure from both high prices and elevated rates, buying conditions for large household durables fell to 52, the lowest level ever recorded, while buying conditions for homes dropped to 24 from 35, the lowest reading outside August 2024.

University of Michigan Survey Director Joanne Hsu noted, “Sentiment of lower-income consumers and those with smaller stock portfolios dropped steeply this month.” She also observed that, despite political differences, "consumers of all political identifications agree that the outlook for the economy has softened since the beginning of the year prior to the Iran conflict."

At the same time, Hsu highlighted an important disconnect between sentiment and spending. While consumer sentiment has remained historically weak for much of the year, spending has remained relatively healthy, supported by a stable labor market and a buoyant stock market. However, consumers’ perceptions of buying conditions for durable goods fell to a record low because of concerns over higher prices and interest rates.

Labor market remains historically strong

Initial jobless claims fell to 197,000 from a slightly revised 199,000 and remain near historically low levels. The four-week moving average declined to 198,000, only modestly above the 197,500 reading recorded on Sept. 23, 2022, which was the lowest level since September 1969.

Taken together, the data continues to point to a labor market that remains remarkably resilient despite elevated interest rates and concerns about slowing economic growth.

Consumer credit growth slows as borrowing costs remain elevated

Consumer credit increased by $8.3 billion in August following a revised $17.7 billion increase in July. Revolving credit, which primarily includes credit cards, declined by $4.8 billion during the month. Meanwhile, nonrevolving credit, including loans for vehicles and tuition, increased by $13.1 billion.

Borrowing costs remain elevated across major categories. The average assessed interest rate on credit card balances stood at 22.36 percent, while the average rate on a new 60-month auto loan was 7.54 percent. Consumers continue to face higher financing costs even as some measures have moved down from recent peaks, with the Consumer Credit Outstanding Interest rate for 60-month vehicle loans below its August 2024 high of 8.4 percent.

Overall, the report suggests consumers remain willing to borrow for larger purchases, but higher financing costs continue to influence how households access and use credit.

The week ahead

Monday: Markets will be operating on a holiday-thinned schedule as Columbus Day and Indigenous Peoples’ Day are observed in the United States. Equity markets will remain open, while the U.S. bond market will be closed. No major economic reports are scheduled for release, which will likely leave investors focused on digesting recent market developments and looking ahead to a busy slate of inflation and consumer data later in the week.

Tuesday: The National Federation of Independent Business Small Business Optimism Index is scheduled for release at 6:00 a.m. ET, followed by the National Association of REALTORS (NAR) Existing Home Sales report at 10:00 a.m. ET. We will be watching the small-business survey for signs of continued hiring, investment plans, and inflation pressures. Existing home sales will provide another look at how elevated mortgage rates are affecting housing demand.

Wednesday: The Bureau of Labor Statistics will release the Consumer Price Index (CPI) for September at 8:30 a.m. ET, followed by the Federal Reserve’s Beige Book at 2:00 p.m. ET. CPI remains one of the market’s most closely watched inflation measures, and investors will be looking for signs of whether price pressures continue to ease or remain stubbornly elevated. The Beige Book will provide anecdotal insight into economic activity, labor markets, and pricing trends across the Fed’s districts.

Thursday: Several important reports will be released at 8:30 a.m. ET, including the Producer Price Index (PPI), Retail Sales, and Initial Jobless Claims. We will be paying particularly close attention to retail sales for insight into the health of consumer spending, which remains the primary driver of U.S. economic growth. At the same time, PPI and jobless claims will provide additional information about inflation pressures and labor market conditions. Regional manufacturing surveys from New York and Philadelphia will offer a timely read on business activity.

Friday: Import and Export Prices will be released at 8:30 a.m. ET, followed by Industrial Production at 9:15 a.m. ET. Investors will be watching industrial production for signs of continued strength or weakness across manufacturing, mining, and utilities. Together, these reports should provide additional insight into the pace of economic activity as the fourth quarter gets underway.

Frequently Asked Questions

Why does AI concentration matter for investors?

When a large share of market gains comes from a narrow group of AI-related companies, portfolios can become more exposed to shifts in sentiment around that theme. This week’s market action showed how quickly weakness in AI-related stocks can affect broader indexes, even when other areas of the market are holding up better.

Why is inflation still a concern?

Inflation remains important because price pressures are still elevated in services and expectations have moved higher. If consumers and businesses begin to assume inflation will stay above the Fed’s target, the Fed may need to keep rates higher for longer, which can affect borrowing costs, consumer spending and market valuations.

What role does diversification play in the current market?

Diversification can help investors avoid relying too heavily on one market theme or group of stocks. In this environment, a diversified portfolio can still participate in the AI opportunity while also including investments whose results are driven by different economic and market forces.

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