Strong Economic Data Meets Rising AI Concerns

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.

Wall Street wrap

Economic growth remains strong

S&P Global’s flash PMI readings for October continued to point to strong economic activity at the start of the fourth quarter. The composite PMI came in at 57.6, down from 58.4, while the Manufacturing PMI rose to 56 from 55.9. The Services PMI remained firmly in expansion territory at 57.9, although that was down from 58.8.

According to S&P Global, the output readings from the survey 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. The survey also pointed to especially healthy corporate earnings and profits, while hiring surged as companies sought to increase capacity to meet stronger customer demand.

S&P Global noted that if the reopening of the economy after COVID is excluded, recent months have produced the best growth stretch for U.S. businesses since early 2015.

Employment rose in October at the fastest rate since June 2022, barring only the jump in payrolls reported in September. Payrolls increased in both the service and manufacturing sectors. Manufacturing employment rose at the fastest rate since March 2012, while the increase in service-sector jobs was below September’s gain but was still the third largest in more than four years.

Inflation pressures remain elevated

The underlying strength in activity continues to come with signs of persistent inflation. Selling prices rose at the sharpest rate since August 2022 as companies sought to pass a further steep rise in costs on to customers.

The overall rise in prices across goods and services was the largest since August 2022. The increase was also broad based. Services inflation edged up to its steepest rate since August 2022, while manufacturers’ selling prices rose at a pace not seen since July 2022, with the rate of inflation accelerating markedly.

Higher prices reflected another sharp increase in companies’ costs. Average input costs measured across both goods and services rose at the fastest pace since November 2022, excluding only the rise seen in September. The surge in cost pressures was most prominent in manufacturing, although service-sector costs also rose sharply again.

As Chris Williamson, chief business economist at S&P Global Market Intelligence, 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.”

Supply-chain pressures also intensified. Supplier delivery times lengthened the most since 2022, with S&P Global citing material and labor shortages as well as overloaded suppliers and shipping delays. Growing order backlogs are making it easier for companies to pass higher costs on to customers. The pace of selling-price increases indicates that consumer price inflation is likely to rise further above the Fed’s target in the coming months.

Despite those inflation and supply-chain pressures, the underlying growth picture remains strong. Williamson noted that, excluding the pandemic reopening, U.S. businesses are experiencing their strongest period of growth since 2015.

Jobless claims point to continued labor market strength

Initial jobless claims came in at 194, the lowest reading since 189 in July and among the lowest levels since 1969. The four-week moving average came in at 197.75.

The claims data adds to evidence in the PMI report that the labor market remains resilient, with companies continuing to add workers as they seek to keep pace with stronger demand.

Housing market remains under pressure

Housing activity remains depressed as elevated mortgage rates, high home prices, and low embedded mortgage rates continue to keep housing unaffordable.

This week, the National Association of Home Builders (NAHB) survey fell to 29 from 32, marking its lowest level in 14 years (since June 2012). A reading below 50 indicates that more builders view conditions as poor than good.

Current sales fell to 33, a 14-year low, while expected sales over the next six months declined to their weakest level since November 2022.

Interest rates on outstanding mortgage debt stands at 4.33, compared with an all-time low of 3.31 set in March 2022 and an MBA 30-year contract rate of 7.41 percent.

Housing starts and building permits decline

Housing starts fell to 1.221 from 1.288, reflecting declines in both single-family and multifamily construction. Single-family starts fell to 859 from 900, while multifamily starts dropped to 262 from 388. Aside from a reading of 1.182 in May, the latest figure is the lowest since May and April 2020, during the heart of COVID.

Building permits also declined, falling to 1.4 from 1.403. Single-family permits fell to 845 from 880, while multifamily permits moved slightly higher to 555 from 523.

The week ahead

Monday: The U.S. economic calendar is relatively light, with no major market-moving economic reports scheduled for release. With a busy stretch of economic data and the Federal Reserve’s October policy meeting later in the week, investors may turn their attention toward corporate earnings and expectations for monetary policy.

Tuesday: The Conference Board’s Consumer Confidence Index for October is scheduled for release at 10:00 a.m. ET. We will be watching the report for a timely read on how households are feeling about their finances, the job market and rising prices, including higher energy costs. Durable Goods Orders for September are also scheduled for release at 8:30 a.m. ET, with New Home Sales following at 10:00 a.m. ET. Durable goods orders should offer signs of how business investment and manufacturing demand are holding up, while the housing data should provide an additional look at demand in a market that continues to contend with affordability and borrowing-cost pressures. Together, the reports should offer further insight into the health of the economy ahead of Wednesday’s Federal Reserve decision.

Wednesday: The Fed concludes its two-day policy meeting, with its interest rate decision scheduled for 2:00 p.m. ET. Barring a surprise, rates are expected to remain unchanged, with market pricing indicating only a 10 percent chance of a hike at this meeting. Attention will instead focus on the accompanying policy statement and policymakers’ comments for clues about the December meeting, for which markets are pricing in a 91 percent chance of a hike. We will be watching how officials balance persistent inflation, labor market conditions and risks to growth as they discuss the path of monetary policy.

Corporate earnings will also be in focus, with Microsoft and Alphabet among the major companies reporting during the week. Their results could provide additional insight into corporate spending and investment trends, including developments surrounding AI.

Thursday: The reports for the advance estimate of third-quarter Gross Domestic Product, September Personal Income and Outlays including the Personal Consumption Expenditures Price Index, and Initial Jobless Claims are scheduled for release at 8:30 a.m. ET. We will be paying particular attention to Gross Domestic Product for the latest assessment of the pace of economic growth. The Personal Consumption Expenditures Price Index, the Federal Reserve’s preferred inflation gauge, should offer an important update on price pressures, while jobless claims will provide another timely reading on labor market conditions. Together, the reports should give investors a broad look at growth, inflation, and employment following Wednesday’s Federal Reserve decision.

Friday: The third-quarter Employment Cost Index is scheduled for release at 8:30 a.m. ET. We will be watching the report for signs of how wage and benefit costs are evolving, which should provide additional perspective on labor-cost pressures as the Federal Reserve continues to assess the inflation outlook. With several major economic reports and the Federal Reserve meeting earlier in the week, Friday’s data should help round out the latest picture of labor market conditions and inflationary pressures heading into November.

Frequently Asked Questions

Why are bond yields falling when the economy is growing strongly?

Bond investors look ahead, not just at today’s data. Even with strong business activity and sticky inflation, investors are increasingly concerned that a slowdown in AI spending could weigh on future economic growth. That has driven the 10-year Treasury yield down from 5.30 percent on October 5 to 4.99 percent and pushed the Bloomberg U.S. Aggregate Bond Index up 1.93 percent over that period, reinforcing the role bonds can play as a potential hedge against a weaker economy.

Why are investors questioning AI spending?

The amount of money required to build AI infrastructure keeps growing. Meta, for example, raised its 2026 capital spending plans to $135 to 145 billion and reported negative free cash flow for the first quarter since 2012, meaning more spending must be financed with debt. That makes the AI buildout more sensitive to interest rates and credit conditions. With Amazon, Intel, Microsoft, Alphabet, and Apple reporting soon, investors will be watching closely, which is why we believe diversification beyond the AI theme remains important.

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