Inflation and Interest Rates

This week brought another reminder of how sensitive the market is to inflation and interest rates. The one thing holding back the economy has been higher interest rates and restrictive federal policy. Inflation is under control and near historical averages. Consumer prices rose 3.0% in September, slightly above August’s 2.9% pace but still below forecasts. That slim 0.1% miss against consensus was enough to spark a rally on Friday, underscoring how much stocks rise when expectations shift toward a rate cut. At the same time, the Social Security Administration said next year’s cost-of-living adjustment will be 2.8%, one of the smaller increases in recent years. This matches long-term inflation rates. Inflation isn’t gone, but price pressures are not as disruptive as they were a year ago, and markets are rewarding even modest signs of relief. While inflation is low, prices remain high. This remains the biggest challenge for consumers whose budgets are stretched.

Tariffs and Corporate Outlooks

One place where costs remain elevated is tariffs. However, companies are managing the impact better than expected. According to the Wall Street Journal, Procter & Gamble recently updated its outlook for fiscal 2026 and has essentially cut its estimate in half. They are now projecting $400 million from tariffs compared to an earlier forecast of roughly $800 million. Profit guidance remained unchanged, suggesting P&G is confident it can absorb higher input prices without derailing earnings.

Market Volatility and Earnings

Market volatility has remained high. This is seen with the VIX briefly reaching levels not seen since spring. The daily volatility range for the most popular group of stocks is anywhere between 1% and 4%. A reason for the higher volatility is earnings season. It is not uncommon for stocks to move 10%–20% when they report. This week Netflix shares fell 10% despite beating estimates once unusual tax charges were excluded. Tesla dropped 7% after missing earnings before clawing back to finish 2% higher the same day. IBM was down 7% after earnings and ended up finishing 9% higher for the week. I am expecting these same types of moves for Meta, Google, NVIDIA, and Amazon when they report. These sharp swings capture how little patience investors have for near-term results and how much is riding on longer-term growth narratives. IBM missed but is becoming one of the leaders in quantum computing. Tesla’s cars are not as popular, but shareholders are being sold that an army of robots is being developed. Even though Netflix’s growth was 17%, it does not have an AI story and its earnings have become predictable and stable with its subscription model. It is suffering the same fate as Berkshire Hathaway, being left behind as investors chase higher returns in the AI boom.

Growth Narratives and Market Bubbles

Businesses with little or no profit but a compelling story about future growth continue to capture investor attention. There was a column in the Wall Street Journal on why bubbles can keep inflating in plain sight. The article argued that bubbles can continue inflating even when investors widely acknowledge them, as seen during the dot-com boom when warnings were ignored and stocks kept rising until the crash. Much of the frenzy then was driven by envy, momentum, and the greater fool theory, with professional fund managers often forced to participate for fear of underperforming. Today’s debate over an AI bubble carries similar traits, with high valuations, limited ways to bet against leaders like OpenAI, and the same career risks pushing money managers to stay invested until and unless it bursts.

Risk Appetite and Innovation

My take on it is slightly different. I believe investors are willing to underwrite riskier companies on the chance they dominate future industries. Another factor is the pace of technological change. The experience of the last decade reinforces this bias. Some of the biggest winners of the era, from Tesla to Amazon, spent years operating without steady earnings before eventually rewarding early believers. This dynamic explains why volatility is sharp but buyers still step back in quickly. Investors worry that missing out on the next wave of innovation—whether in AI, quantum, clean energy, or biotech—could mean underperformance for years. The companies that do not grow have never made good investments, and allocating capital to those companies is how you lose or end up with low returns. Another lesson learned is that some of the lowest-volatility stocks carry the highest risks, while the most volatile companies often have lower long-term risks. This has everything to do with growth rates. A company with zero growth and a 7% dividend can still drop 10% quickly, while a company with no dividend can announce a partnership and jump 20% on future prospects.

The Artificial Intelligence Boom

The current AI story differs from the dot-com bubble in one important way: trillions of dollars are being invested to build this ecosystem. A correction will come when growth slows or if reports show that adoption is lagging. For now, demand remains strong and governments around the world are racing to develop the technology. The pace of change feels faster this time. As machines learn from each other and as quantum computing advances, breakthroughs once thought impossible are moving into reach. Drug discovery is one clear example. AI models can now analyze millions of compounds in weeks, a process that once took years. By simulating molecular interactions, algorithms can identify which drugs are most likely to succeed in trials. This shortens the research cycle, reduces costs, and opens the door to treatments that traditional methods might never have uncovered. While there is plenty of clickbait warning that AI will take over the world, the more realistic outcome is that it will save lives. The bigger risk for markets is whether the rapid pace of change displaces too many workers, leaving people unable to find jobs as machines take over more roles.

Economic Resilience and Earnings Strength

Overall the market rallied this week because the early stages of third-quarter earnings season are encouraging. Roughly 20% of companies in the S&P 500 by market capitalization have reported, and so far 85% have topped expectations. This would mark the strongest beat rate in four years. There is not much negative news reported, but companies are doing very well and there is no sign of an economic slowdown. While still early, the breadth of positive surprises suggests resilience across sectors. Combined with steady consumer demand, momentum in AI-related capital spending, and the likelihood of further Fed easing, the foundation for continued gains remains intact. The job market remains weak because companies are becoming more efficient with technology, and I expect this trend to continue.

Government Shutdown Updates

In other news, the ongoing U.S. government shutdown continues to capture attention in Washington. However, the financial markets are maintaining a measured, resilient stance. Investors have grown accustomed to these recurring fiscal standoffs, which historically result in little long-term damage to portfolios. This prevailing attitude suggests the near-term market impact remains contained, with traders anticipating an eventual resolution, as seen in previous episodes. The central point of conflict preventing a deal is the Affordable Care Act health insurance subsidies. Democrats are refusing to vote to reopen the government until Republicans negotiate an extension of these enhanced credits, which are set to expire soon. Republicans are demanding a clean funding bill first. While this core disagreement creates a degree of short-term uncertainty and has delayed key economic indicators, markets are focusing on underlying corporate strength and positive economic momentum. For now, markets are largely holding steady and looking past the political noise.

International Trade Developments

On the international front, President Trump has signaled a willingness to ease tariff pressures, calling the current regime “not sustainable.” He has confirmed plans to meet with President Xi in South Korea in the coming weeks. That raises the prospect of a deal, though past episodes show how fragile these arrangements can be. Both countries are pursuing leadership in artificial intelligence and advanced technology, and that competition sets the boundary for how far cooperation can go. Markets may rally on any progress, but the underlying rivalry is not going away.

Looking Ahead

In the weeks ahead, the focus will remain on inflation’s trajectory, the durability of corporate earnings, and the policy backdrop in Washington. Tariffs and commodity costs are proving less damaging than feared, while early earnings reports reinforce that companies still have pricing power and demand. The risks of a government shutdown and unsettled trade policy linger, but they are unlikely to alter the underlying trend of resilient growth and steady markets. For investors, volatility will continue, and while the foundation for longer-term gains remains intact, sharper corrections can occur at any time.

Have a great weekend!

Sources

• Consumer prices rose 3.0% in September (vs 2.9% in August).

• Social Security Administration: Cost-of-living adjustment set at 2.8%.

• Procter & Gamble: Updated tariff outlook to $400 million (down from $800 million).

• Netflix: Shares fell 10% despite beating estimates.

• Tesla: Dropped 7% after earnings, finished 2% higher.

• IBM: Fell 7% after earnings, finished 9% higher.

• S&P 500 Earnings: 85% of reporting companies have topped expectations.

Disclaimer

The information provided in this communication is for informational purposes only and does not constitute financial, investment, or legal advice. All content is based on data and sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Market conditions and economic factors are subject to rapid change. Past performance is not indicative of future results. The views expressed herein are those of the author and do not necessarily reflect the official policy or position of any other agency, organization, employer, or company. Investors should conduct their own research and consult with a qualified financial advisor before making any investment decisions. The author may hold positions in securities mentioned in this post.