Resilience And Risks

Buoyed by a resilient corporate sector, equity markets have largely shrugged off an unsettled backdrop and the day’s often-distracting headlines. Stocks continued to climb over the summer, reflecting investor confidence in companies’ ability to navigate an ever-shifting economic and political landscape. Meanwhile, bond yields drifted lower as markets anticipated an eventual easing of Federal Reserve policy and a slow-but-positive pace of economic growth.

Despite significant tariff-related costs and a more cautious consumer, second-quarter earnings results were quite strong, reassuring markets that corporate America could take steps to mitigate the headwinds. The S&P 500 achieved 11% year-over-year profit growth, well above analysts’ 4% target. The so-called “Magnificent Seven” again led the way, but the strength proved broad-based: the median S&P 500 company boosted earnings by 8%. Moreover, eight in ten firms delivered positive surprises with many raising guidance for the remainder of the year.

Central intelligence

As an investment theme, artificial intelligence has been a key stock market driver since late 2022 when OpenAI introduced the world to ChatGPT. More recently, the AI buildout has also become a key macroeconomic driver, supporting growth as consumer spending softens. Data-center-related investment—those massive buildings full of GPUs (graphics processing units) and servers used by AI firms to train and run models—may have accounted for roughly half of total U.S. GDP growth during the first half of the year.

The big five “hyperscalers” constructing AI infrastructure—Alphabet, Amazon, Microsoft, Meta, and Oracle—are projected to allocate about $350 billion to capital spending in 2025, a 60% increase from the prior year. Over the past twelve months, their combined spending on capex has equaled about 1% of GDP. Yet, while optimism around AI’s potential seems high, some observers have begun to question both the pace of this heavy investment and the ultimate returns these firms will achieve.

Maintaining momentum

Whether corporate earnings momentum continues will heavily influence the near-term path of stock prices. Trade policy remains in flux, and the full impact of tariffs has likely not yet been felt. On the other hand, new corporate tax provisions in the OBBBA—such as 100% bonus depreciation on most equipment and immediate expensing of R&D outlays and factory costs—could lift corporate cash flows by several percentage points.

While larger businesses have not generally sounded alarms about the economy, many still report that economic uncertainty is weighing on customer behavior and delaying investment decisions. In response, many executives have turned to cost management and efficiency improvements to protect profit margins.

Fed at a crossroads

Consequently, the labor market has softened this year as businesses become more conservative in their hiring and expansion plans. Concerned about this trend, the Federal Reserve reduced its policy rate by ¼ percentage point in mid-September, the first cut in nearly a year. Policymakers have signaled the potential for two additional cuts in the months ahead.

The central bank’s mandates are to maintain stable prices while also promoting full employment. The Fed faces an unenviable balancing act today: inflation remains stubbornly near 3%, above its 2% target, even as employment shows signs of strain. The conventional cure for inflation—higher rates—directly conflicts with the remedy for labor market weakness—lower rates. By choosing to cut, policymakers are prioritizing support for jobs while hoping inflation continues to moderate.

Pushing the bankers

The Federal Reserve has been under intense political pressure from the Trump administration to aggressively ease monetary policy to spur growth. Earlier this year, the president publicly mused about removing Chair Powell and later sought to dismiss Governor Lisa Cook, alleging misconduct. The Supreme Court is expected to review the Cook case in January.

Political pressure on the Fed is nothing new, though the public and confrontational nature of today’s actions is unprecedented. Lyndon Johnson leaned on William McChesney Martin to keep rates low to help fund his Great Society programs and the Vietnam War. Richard Nixon aggressively pushed Arthur Burns to ease policy ahead of the 1972 election to ensure a strong economy.

While Martin resisted Johnson’s demands, Burns eventually succumbed to Nixon’s pressure. Burns’ Fed lowered interest rates and greatly expanded the money supply. Cheap credit fueled a rapid economic expansion, and Nixon won re-election in a landslide. However, the Nixon-Burns era vividly illustrates the danger of sacrificing the Fed’s independence in the name of short-term political expediency.

Cost of caving

Yielding to political influence can carry steep economic costs and lasting institutional damage. Burns’ stimulus unleashed a wave of inflation which quadrupled from 3% to 12% in just two years. The policies also set the stage for a wage-price spiral, a deep recession, and nearly a decade of very high interest rates.

More damaging still was the erosion of public trust. The Fed’s credibility as an inflation fighter collapsed. Markets lost confidence that the central bank would resist political interference or adopt tough measures to control prices. Paul Volcker’s Fed in the early 1980s had to take painful, politically unpopular, recession-inducing measures to restore that lost credibility—credibility the Fed still benefits from today.

The Fed’s institutional design helps insulate it from day-to-day political control. Governors serve staggered 14-year terms, making it harder for any single president to “stack” the board. The policymaking Federal Open Market Committee (FOMC) also includes five regional Reserve Bank presidents, providing additional balance and independence. And the Fed funds its operations through portfolio income, not congressional appropriations, further limiting political leverage.

Structural shifts

Even so, concerns about central bank independence—and inflation more broadly—are resurfacing as some structural disinflationary forces of the past quarter-century weaken. Globalization, which for years delivered cheap imports and kept goods prices low, has been waning. Pandemic-era disruptions led many firms to prioritize resilience over efficiency and consider “reshoring” portions of their supply chains back to the United States. Current trade policies have accelerated this shift.

At the same time, demographic pressures and potential labor shortages may embed inflationary forces over time. Like most developed nations, the U.S. faces an aging population and declining fertility rates. Fewer workers are supporting a growing retiree base, and immigration—a key source of labor force growth—has slowed. Tighter labor markets could put upward pressure on wages and potentially sustain a somewhat higher inflation baseline.

Encouragingly, generative AI may emerge as a powerful offsetting force. Though adoption remains in the early stages, AI has the potential to boost productivity, lower costs, and reshape entire industries—from software and pharmaceuticals to media and manufacturing. History suggests, however, that transformative technologies often take one to three decades to deliver broad productivity gains. Like two breakthroughs before it—electricity and personal computing—AI’s true economic impact will unfold gradually, not overnight.

Crosscurrents

Financial markets today are navigating a complex mix of resilience and risk. Corporate America has delivered strong earnings despite higher costs and policy uncertainty. The Federal Reserve is walking a tightrope between competing mandates while political pressure tests its autonomy. Meanwhile, deep structural changes—from retreating globalization to the rise of AI—may be quietly redrawing the long-term inflation landscape.

The path ahead will not be linear. Inflation may remain somewhat higher and more volatile than in the past several decades, yet innovation and productivity gains could serve as natural offsets. Investors should expect crosscurrents rather than clear trends, and remain focused on quality, diversification, and discipline as the cycle evolves.

– Christopher J. Singleton, CFA, Managing Director

October 15, 2025