Bad is good
Post FOMC meeting last week, equity markets in the US and abroad have bounced to new highs despite fears of an AI bubble, more signs of weakness in the labor market, and a Supreme Court battle over tariffs. But "Bad” economic news currently is beneficial to stocks because it raises the likelihood of continued dovish monetary policy (more interest rate cuts). Also, global liquidity looks to be reaccelerating. Central banks avoid using the politically charged ‘QE’ (Quantitative Easing) but some form is being used. Our Fed could take a leaf from China’s playbook, since their Central Bank the PBoC, now uses a long list of monetary acronyms, such as MTL, RRRs, RRPs and now ORRPs, probably to hide what policy makers are really doing. My point is that virtually all governments across the globe are continuing to make sure liquidity is being provided to their economies, even though this simply postpones the ultimate taking of the necessary medicine of financial competency. This past week, this is the list of US stock market indicators / indexes that traded at new all-time highs:
At the same time though the bellwether S&P 500 Index exhibited quite a different pattern. A pattern that could signify that it is getting a bit tired after such a strong move up off the April low, a slight contraction (as was expected) in October and the beginning of its push into the much-loved year-end rally. This doesn’t necessarily mean to throw in the towel for the year-end final push, but rather a deeper dive into what is and what isn’t showing strength should be done. Here is what the S&P looked like at the close of last week:
Please take note of the last red bar showing the sell-off on Friday. To be clear, this obviously is not a positive way to have ended the week, but unless it is followed up by continued negativity, it should be simply viewed as normal noise.
Supply or demand deflation is key
Global liquidity is driving debt to its highest levels, but it is also driving AI and robotics which are squeezing inefficiency out of every corner. Companies can now drive more profits with fewer employees, which is usually referred to as “good deflation.” This is a sort of follow the bouncing ball sort of thing. Companies make stuff, and by using AI, robotics, and other advanced technologies, they make stuff cheaper, with fewer employees needed. The result is higher profits with same amount of business done, and higher profits with both less and more business done as a result of the added efficiencies. This is the benefit of deflation. Prices can fall and profits can rise at the same time. This is not a normal thing, but it is a benefit of technological advancement. But when most think of deflation, they think of the 1930s, which was caused by lack of demand and resulted in The Great Depression. But plenty of deflationary periods exist throughout history that were instead supply-driven thus economically bullish. They occurred at major turning points such as:
From 1815-1860, prices dropped an average of 1-2% a year due to rapid industrialization and westward expansion. Real GDP rose. In today's world, it is “digital expansion” due to AI.
From 1873-1879 prices fell 3% annually due to increased production in agriculture and technological progress in railroads and steel. Real wages rose and the economy expanded. Again, technology, in the form of more expedient transport and delivery and better construction.
In the late 19th century, bouts of deflation arose due to positive supply shocks from the advances in technology as well.
In all cases, deflation was supply-driven, which led to economic growth, not depression. Since the 19th century, technology has brought prices down and created economic booms. When a major tipping point were reached, supply-side deflation and an economic boom resulted. Today, exponential growth in AI and robotics are pushing the planet into another tipping point.
Elon Musk, for one, understands this. That said, neither AI nor robotics are yet making a big enough impact on the economy to reach a supply-driven deflationary state due to record amounts of liquidity being created by central banks. But AI and robotics are catching up fast to where Elon’s estimation is that the US economy will hit a supply-driven deflationary period shortly. This is one reason why it is difficult to assign a value to him and his companies. He makes cars, owns Twitter, and has a satellite network. Where is he going with all this? Tough to say, but wherever he is going, it will be far more advanced than many of us can fathom, but we should all benefit from.
Recession?
As to a looming recession, which many Boo-birds keep squawking about, there have now been 1.2 million job cuts announced in 2025, the second highest in 16 years, with layoffs currently set to match levels seen in the 2008-2009 Great Financial Crisis. 60% of Americans say we are in a recession. Of these polled, they tend to be of the same political bent that is not happy with the way the economy is progressing, so they tend to be consistently negative. Here is a clear illustration of this political leaning of these polls:
Yet Polymarket, which is a measure of what the betting money is voting with their wallets, are currently saying there is just a 33% chance that the US economy enters a recession by 2027, down ~11% percentage points since October 2025 and at their lowest level yet. The Atlanta Fed is estimating GDP Q3 growth to be between 3.5% - 3.8% driven mostly by AI. Approximately 63% of all GDP growth is coming from AI-related spending. This means that without the AI capital expenditure boom, the US economy would be in a significantly worse position. In consequence, the S&P 500 is seeing one of its best runs in history. The market just posted its 6th 35%+ rally in 6 months over the last 30+ years.
Spending on data centers in the US has tripled since the release of ChatGPT in November 2022 while spending on everything else is down ~20% since the 2023 high. Refer to the chart above. This has created a bifurcated economy. On the one hand, consumers are struggling from a rapidly declining labor market and high inflation which necessitated a rate cut last week. On the other hand, the largest US companies doing more with fewer employees are thriving as AI explodes, and rate cuts will add fuel to the fire. This is called progress!!! With interest rate cuts and global liquidity, we could expect more record highs ahead for the S&P 500 and global developed markets. The biggest companies don't need rate cuts, but consumers do. This is super important. The Fed has cut rates six times since 2022. In every case, they have stated their intentions and reasons for doing so and done so without the economy looking like it is going into a contraction prior to the cuts.
It is tremendously positive for economic growth and earnings expansion to get an interest rate cut. This is even more true when the cut does not precipitate inflation growth. This is still quite puzzling to many economists as there is a tremendous amount of cash on the sidelines, falling interest rate here and abroad (excluding Japan) and ebullient cash available.
The AI Revolution is transforming just about all parts of financial markets. AI is not in a bubble about to burst—it's a structural transformation powering 2/3 of US GDP growth (data centers alone), with $6.7T global capex 2025-2030, hyperscale contracts (Google/Microsoft 20yr PPAs), and multi-decade power demand (US data centers 4→12% electricity). Layoffs reflect efficiency gains (like 2000.com shift), not weakness—S&P's top 10 (76% weight) are AI profiting from it. Over the last 200 years, whenever we have seen transformative technologies add to real economic growth, stocks have done well. AI is such a technology so has spurred those such as Musk to call for supply-side deflation which has historically been bullish for markets. There is study after study being done trying to shove the current tech expansion peg into the same hole that was in during the Tech Bubble of 2000, but there just isn’t the same set of metrics in place.
Cash on sidelines and how much for over 70
Many many times over the last couple of years I keep on showing graphs of the amount of cash on the sidelines due to political helicoptering of monies throughout the world but most specifically in the United States. I keep on stressing this as the need for prices to go up on both goods and services as well as prices of hard assets and equities needs to be precipitated by an ample supply of money to consummate the purchases. If there is still this huge cash trove available, it should, in theory, provide a cushion to any kind of price decline. If prices do come down- on anything, there will always be money available to buy and therefore create a new and higher floor for prices. I don’t mean this to say that there cannot be corrections in price levels, but rather that these corrections should be far less painful when in excess of $7.5 Trillion is present in desperate need of a home.
Intergenerational wealth transfer
Although some politicians and media types obsess over the top 0.1%/1%/10% of the income and wealth spectrum, perhaps a better way to look at it is from an age distribution perspective. Households aged 70 and up are the fastest growing segment of wealth accumulation. Since the Great Financial Crisis in 2008-2009, the 70+ share has increased from one-fifth to nearly one-third. Households at least 55 years old own almost three-quarters of the net worth.
The big question is what happens to this money?
Some of it is clearly being spent on themselves for travel, leisure, and entertainment. Some of it being used to fund health care expenses such as assisted living facilities.
Some of it goes to support children and grandchildren who might need help with education expenses or buying their first home. The annual gift exclusion is currently $19,000 per recipient for individuals and $38,000 per recipient for married couples. It could also help tide some folks over who may have lost their job or had their hours reduced.
Eventually, there will be the inheritance, which will support family members and charities. This is not a trivial amount. Household net worth for those 70 and over was $53 trillion in Q2 and even higher today! That’s money that can support spending and the economy and pay down debt.
Any windfalls from inheritances will likely move from more conservative investments, such as fixed income, into equities due to the younger demographic.
Given the magnitude of this wealth transfer, I have to chuckle about the strategists who are endlessly waiting for some of the $7.5 trillion sitting in money market funds to come off the sidelines and into the equity markets. They’ll be waiting a long time. It will take a bear market and accommodative monetary policy to get these savers to take more risk. And it’s a pittance compared to what is already moving and will move between generations.
Patrick Ayers, of Ned Davis Research has provided research support for this.
Net worth of the 70+ age group is fastest growing
NDR 2026 Market Predictions based on cycle work
The NDR cycle composites combine three historical price patterns: the one-year cycle, the four-year presidential cycle, and the 10-year Juglar cycle. The data behind the four-year cycle (mid-term years) and 10-year cycle (years ending in six) already exist. Since daily data for the S&P 500 starts in 1928, the one-year cycle for 2026 had 97 of the 98 years as of 2024, so it is safe to say it will not change much, but I will share the final cycle composite when they publish it on the first trading day of January.
As long as (1) inflation doesn’t re-flare, (2) credit markets stay orderly, and (3) AI/earnings narratives hold, the path of least resistance for equity markets is higher. The main derailers live in those three areas. Markets climb a wall of worry since mainstream media can always make a case for why the fear seems real, yet FEAR also stands for false evidence appearing real.
Bottom line
Cycle composites are history’s view of how the future could unfold. Absent outside forces like a financial crisis or pandemic, the U.S. stock market tends to roughly follow historical patterns. The S&P 500 Cycle Composite for the coming year suggests caution in the middle of the year. More immediately, it pointsto the current uptrend continuing deep into Q1, which is also the message of the folks at FundStrat.
Note the cycle chart from the Ned Davis crew above before referring to this chart. The cycle work shows that the the trend we are in should continue into the first quarter of next year, and then some digestion, and then a push into year-end. I believe that the foes of the continued run higher are:
- Tax day April 15th. Many are going to need to pay their fair share after many years of gains.
- Tariff Tussle round two. Does the Supreme Court have a distaste for Trump tariffs?
- A new Fed Chief in town. Who it is isn’t as important as the fact that new chief is an unknown to the markets, and as we all know, the market hates what it can’t quantify.
- Midterm elections. Back to markets hating what they can’t handicap. Here is the biggest one of President Trump’s second term. I don’t feel particularly sanguine about the most recent elections in New York City and Miami. Not a testament for ebullient GOP support.
Only time will tell, but rest assured, we will continue to bring you up to speed with what we feel is important most every step of the way.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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