The U.S. equity bull market continues. The unorthodox policies of the Trump administration are not hurting the U.S. economy in ways that investors expected. So far, this has supported both the stock and bond markets. A potential rate-cutting cycle by the Fed would continue to support further gains in both the equity and bond markets. However, those policies are negative for the USD, which is itself positive for stocks.
A recession could occur over the next two quarters. However, households are extremely delevered. Therefore, as long as borrowing rates continue to fall, consumption could be sustained by the transition from a cash-driven economy to a leverage-driven one.
- U.S. Data Keeps Surprising to the Upside
- AI-Driven Productivity Growth
- AI-Driven Stock Market
- Fed to the Rescue… of the Stock Market
- A U.S. Government Shutdown
- Chinese Internet Stocks Rally
- Asian Markets Offer More Opportunity
- Rising Geopolitical Risks
- Our Portfolio Positioning
U.S. Data Keeps Surprising to the Upside
The latest GDP tracking estimates point to an acceleration in U.S. growth in the third quarter. The Atlanta Fed’s GDPNow model projects GDP to increase by 3.8% in Q3. Real private domestic demand, a measure of GDP growth that strips out the impact of net exports, inventory swings, and government expenditures, is on course to rise by 2.4%.
The strength of high-income consumers deserves significant credit for the sustained strong consumer activity. In contrast, employment growth among the broader population has decelerated sharply. Outside of the healthcare sector, the 3-month average in private payrolls was -30K in August. The index of private sector aggregate hours worked is down 0.2% since May.
Still, U.S. GDP growth appears to have accelerated even as employment growth has faltered. If the recent divergence between GDP growth and employment growth does not get revised away, there are three possible scenarios behind what is happening.
- We are in the early stages of a major productivity revival: This would be the best outcome for stocks, as it would usher in a sustained disinflationary supply-side boom.
- Labor demand is set to catch up to the faster pace of GDP growth: This would have mixed implications for stocks. On the one hand, stronger labor demand would quash concerns about rising unemployment. On the other hand, in the absence of faster labor force growth, stronger labor demand could fuel inflation. This, in turn, could prevent the Fed from cutting rates as much as the market is currently discounting.
- Slower real income growth will ultimately drag down spending: Real disposable income increased by 2.0% year-over-year in July. However, the annualized 3-month rate dropped to -1.8%. Against the backdrop of weak employment growth and higher inflation induced by tariffs, real income growth could grind to a halt later this year. Considering that pandemic savings have been depleted and home prices are now falling, this could lead to a faltering of consumer spending, setting the stage for a recession. This scenario would be the worst one for stocks.
AI-Driven Productivity Growth
While everyone agrees that the U.S. labor market is softening, how soft remains a debate. All previous recessions and layoff cycles have been preceded by a sharp fall in corporate profit per employee. Today, this measure is soaring.
This marks a significant departure from past labor market recessions and could highlight profound shifts brought about by productivity and technological advances. It suggests that productivity statistics, which are calculated as a residual, may grossly understate the true extent of productivity gains.
So, it is possible that we are seeing a new productivity boom driven by Artificial Intelligence. This would be the most positive scenario for equity markets for the years ahead.
AI-Driven Stock Market
The current capital expenditure (capex) boom of AI hyperscalers echoes that of the telecommunications buildout during the 1990s dotcom era. However, the direct impact of equipment capital investment on GDP growth seems less pronounced than during the 1990s tech boom. While there is much focus on data centers, recent macro data suggest that software’s role in the current investment cycle may also be growing.
AI has become a major theme for stocks. The S&P 500 has reached unprecedented levels of concentration in AI-focused technology stocks, with the Magnificent Seven companies now representing over 34% of the index’s total market capitalization. This concentration mirrors and even exceeds the levels seen during the dot-com bubble, as the Technology, Media, and Telecom sector’s share of the S&P 500 has climbed to around 45%, matching its previous peak in 2000. NVIDIA alone commands over 7% of the S&P 500, making it the largest single stock by weight. The S&P 500 has experienced tremendous growth since 2022, driven by a select few names that promise an AI future they will create and monetize.
This high level of concentration creates potential risks. Current forward price-to-earnings ratios for the Magnificent 7 average around 28x, compared to 20x for the other 493 constituents in the S&P 500, suggesting that investor expectations for AI-driven returns have reached levels that may be difficult to continue. This concentration risk means that any disappointment in AI adoption, cooling of AI enthusiasm, or a lack of ability for these mega-cap stocks to monetize AI properly could have outsized adverse effects on overall market performance. While we acknowledge the potential of AI, we continue to recommend robust diversification, not only across various sectors but also globally, to mitigate the concentration risk associated with a limited number of AI companies.
The concentration extends far beyond just market capitalization into the fundamental drivers of economic performance. The Magnificent 7 companies are responsible for generating 37% earnings growth compared to just 6% for the rest of the S&P 500, while simultaneously accounting for over 30% of total capital expenditure across the index. These firms are investing heavily in AI infrastructure, with hyperscalers now representing nearly 6% of all U.S. private domestic investment – double their share from 2023. Their capital expenditure as a percentage of operating cash flow has reached 60%, demonstrating an unprecedented commitment to AI-related infrastructure spending.
Together, Big Tech and the Trump administration are driving a capex surge that favors hardware over labor, fueling growth without a broad employment rebound.
Trump’s preferential tariffs, deregulation, and tax policy are accelerating the AI boom, while tech leaders treat the race as existential. Financing is still abundant, and demand remains strong, keeping capex elevated. However, the U.S. economy is investing in machines, not workers, reinforcing the case for further Fed easing.
Fed to the Rescue… of the Stock Market
In its September meeting, the Fed lowered interest rates by 0.25%, starting a new rate-cutting cycle. The key argument for the rate cut is that the job market weakness is now a bigger risk than inflation.
President Trump continues to call for the Fed to cut interest rates more aggressively, while simultaneously attempting to reshape the board of Fed governors. Even though the Supreme Court stopped him from firing Governor Lisa Cook in the short term, we think that Trump will eventually succeed in reshaping the Fed board with his appointments. This is likely to lead to further rate cuts over the next 18 months.
Today’s environment bears several parallels with the late 1990s. Will the stock market turn parabolic this time, as it did in 1998–1999? What are the key differences between now and then?
In 1994, the Fed raised rates aggressively, followed by small cuts in 1995, and then held them steady through 1998. In October of that year, the Fed eased three times, fearing the LTCM crisis would drag the economy into recession. What did the stock market do back then? The S&P 500 dropped 20% in 1998October LTCM due to the LTCM crisis, rallied back within two months, and then the bull market turned parabolic with the rate cuts, led by the “Four Horsemen” of Intel, Dell, Cisco, and Microsoft.
Fast forward to today: the Fed raised rates aggressively in 2022/23, followed by three cuts in 2024 and has held them steady till today. Back in April, S&P 500 fell nearly 20% on recession fears triggered by Liberation Day, rallied back in two months, and has since been making new highs on expectations of renewed Fed easing.
The bottom line is that monetary policy is turning dovish, bond yields are well behaved, USD is falling, and as are oil prices. These are all positive for stocks over the next 12 months.
A U.S. Government Shutdown
The October 1st U.S. government shutdown risks denting near-term GDP and sentiment, but it should present a buying opportunity if it triggers equity weakness. The U.S. federal government partially shut down on October 1 after the Republican-controlled Senate failed to garner the support of eight Democratic senators for a continuing resolution that would have maintained government funding levels until November 21. Three Democratic senators voted with Republicans on a second failed vote on Wednesday.
Democratic leaders are attempting to revive their spirits and show their popular base that they are willing to fight the Trump administration. That means the shutdown has become a battle of wills. It has a 50/50 chance of lasting a month or more. The last shutdown, from December 2018 to January 2019, also featured congressional Democrats opposing President Trump. It was also the longest, lasting 35 days. The key topic back then was Trump’s southern border wall. Today, the key topic is the Covid-era expansion of Obamacare health insurance subsidies, for which Democrats are also willing to fight hard.
A shutdown could serve as a negative catalyst for a toppy stock market if it combines with other events to weaken sentiment. But investors should not obsess over the shutdown and should view any significant equity drop as a buying opportunity if it is based on nothing more substantial. Taking the most generous reading of the economic impact, quarterly nominal GDP has averaged a 3.3% trough in the wake of shutdowns since 1977. Demand is expected to rebound once the shutdown is over and funding resumes.
Chinese Internet Stocks Rally
Despite their recent rally, Chinese internet stocks continue to trade at attractive discounts relative to their own history. Concurrently, sales growth and profit margins have broken above their long-term averages.
On the policy and macroeconomic fronts, although Beijing’s stimulus remains piecemeal and is yet to spark a meaningful broad-based business cycle recovery, the authorities have also demonstrated their willingness and capacity to avert a downturn in the economy, thus suggesting that downside risks to household consumption are likely to remain contained.
We expect additional stimulus measures in the coming months. Notwithstanding their effectiveness in meaningfully reviving aggregate economic growth, these pro-growth measures should at the very least provide incremental support to consumption and investor sentiment. The worst of Chinese internet stocks’ valuation compression may thus be in the rear-view mirror.
Additionally, the expansions of Chinese internet companies into global markets have already shown promise, and Beijing has identified the tech sector, as well as the export of services, as strategic priorities. China is also ahead of the game in the AI race. Its companies are adopting AI at a rate on par with that of the U.S. and filing a leading number of global AI patents.
Regulatory risks have also significantly eased. While the US-China rivalry remains a significant source of uncertainty over the next 12 months, political and economic constraints suggest a window of relative stability. On the one hand, Beijing has little appetite for destabilizing markets at a time when it is actively working towards boosting business confidence. On the other hand, the U.S. midterm elections are limiting the Trump administration’s incentive to trigger major economic or financial disruptions. In addition, the risk of delisting from U.S. markets is less destabilizing for Chinese offshore stocks, now that most leading internet platform companies are also listed on the Hong Kong Stock Exchange.
Asian Markets Offer More Opportunity
So far this year, broader Asian stock markets have rallied 24% in USD terms, outperforming global equities by 6%. Despite this recent outperformance, the 10-year track record leaves much to be desired, with Asian stocks lagging behind their international counterparts by 5% annually. In our view, we believe 2025’s outperformance marks the beginning of a multi-year trend, rather than an anomaly that will revert to past patterns.
Below, we summarize a few catalysts that we believe will likely drive Asian equities to continued outperformance over the next 12-18 months:
Valuations have drifted significantly below those of global markets, with Asian stocks trading at 15 times forward earnings, compared to 20 times for developed markets and 23 times for the U.S. This represents one standard deviation below historical averages. Even a marginal shift back to the historical average of a 14% discount to global valuations (vs. 25% today) implies significant upside on a relative basis. The one exception is India, which continues to trade at a premium. Its recent correction from 2022 valuation highs has not yet run its course and thus we await cheaper entry points for an India overweight.
Tariff uncertainty is largely behind us, with the marginal change now fully reflected in market prices. The path going forward will now be driven by trade rerouting optimization, greater ex-U.S. trade growth, and a focus on domestic markets. The year-on-year comparisons will fade, and tariff headwinds will be steadily replaced by a status quo, providing a potential tailwind to local markets. A post-tariff world will be less growth-driven in the U.S., potentially giving diversification as the U.S. economy slows.
Currency dynamics favor Asia. The U.S. dollar remains overvalued on most major metrics, and U.S. capital inflows, fiscal and trade deficits point to further FX adjustment. So far this year, European currencies are up ~10% against the dollar, while Asia remains mispriced, particularly in areas where the U.S. trade deficit is most pronounced. As China grows more comfortable with a stronger yuan, there will be scope for the yen, Korean won, and Singapore dollar to strengthen as well. As a result, USD-denominated returns of their stock markets are likely to outperform U.S. stock market returns.
Korea holds the crown for the region’s cheapest market. However, it is chipping away at the “Korea discount” by following in Japan’s footsteps and implementing governance reforms that encourage greater focus on shareholders and are starting to deliver greater buybacks, dividends, and tighter capital discipline. The potential for re-rating from domestic retail investors and international investors returning is high.
China is the second cheapest on a relative basis. Property difficulties are known to all and have likely troughed. China continues to export overcapacity and deflation to the rest of the world, but this approach has a limited shelf life and will necessitate domestic change. The name of the game will be domestic consumption, and initial signs in the form of tech sector outperformance, domestic champion investment after years of cost savings, and reawakened stock market animal spirits all point in the right direction.
Japan remains the largest and most developed market in the region. The yen is one of the cheapest currencies in the world, and the return of inflation plus continued shareholder-friendly policies are resulting in capital inflows that should support equity markets, particularly in USD terms, for some time.
While it is too early to call the second half of this decade in favor of Asian markets, investors concerned about high U.S. valuations should look to diversify into North Asian markets like Japan, China and Korea. The combination of low stock and currency valuations, fading tariff headwinds and ongoing regulatory reform and domestic focus should drive continued outperformance over the medium-term.
Rising Geopolitical Risks
If there is one thing that can unsettle markets in the near term, it is rising geopolitical tensions. Especially, if the U.S. and Europe will step up pressure on Russia.
President Trump said that NATO countries should shoot down Russian drones and fighter jets that intrude on their airspace. He also said that Ukraine will be able to take back Russian-controlled territory. And then added, in the most Trumpian fashion, “who knows, maybe even go further than that!” The point is that President Trump is now fully on Team Ukraine, which is bad news for Team Russia. Sure, the president is unlikely to enact any economic sanctions that endanger the U.S. macro context. But there is a lot that the U.S. can do, including providing Ukraine with long-range weapon systems and targeting intelligence, that can wreak havoc on the Russian economy with hardly any impact on the U.S. economy.
NATO has had enough. Hawkish Foreign Minister of Poland, Radoslaw Sikorski, has warned Moscow that its jets would be shot down if they encroach on that NATO country’s airspace, stating bluntly, “I have only one request to the Russian government: if another missile or aircraft enters our space without permission, deliberately or by mistake, and gets shot down… please don’t come here to whine about it. You have been warned.”
This poses a significant risk, and it will undoubtedly unsettle markets. The Polish air force is on par with what Russia has available in the European theatre, particularly when we consider Russian aircraft losses in Ukraine. Also, Moscow has already established a precedent for doing absolutely nothing when one of its aircraft is downed by a NATO member state. In November 2015, Turkey shot down a Russian Su-24 after it encroached on that NATO country’s airspace for just 17 seconds.
Ukraine still has momentum. After some positive gains on the ground in Ukraine throughout the summer, Russia has now faced its first setback of 2025. Ukrainian forces have launched a counterattack in the north, recapturing territory around Sumy. Meanwhile, Ukrainian drone attacks have continued to strike at Russian energy facilities, particularly its refining capacity, with over 1 million barrels per day (mmb/d) of refined crude now offline in strikes on 16 out of 38 refineries.
This last point, that Ukraine’s unrestrained drone warfare is crippling Russian energy infrastructure, is the most relevant from both the markets and military perspectives.
The risk to equity markets will be mostly sentiment-driven, but a sharply higher oil price could have a real economic impact. An allocation to energy and energy stocks could offer diversification for increased geopolitical tensions.
Our Portfolio Positioning
As markets continued to perform well, we have not made changes to our core portfolio allocation. In stocks, we remain slightly defensively positioned, with overweight positions in healthcare, commodities, European, and Chinese equities, to create a diversified portfolio that can profit in various market circumstances.
Within fixed income, we keep a slightly longer duration position in government bonds and in local currency emerging market debt.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The S&P 500 Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
