AI Leaders Rebound Ahead of Pivotal Economic Week

Good Morning Investors,

Markets begin the final week of September with modest optimism as futures rise 0.4-0.6% across major indices, attempting to recover from last week's AI-driven selloff. The S&P 500's 0.3% weekly decline, its worst performance since early August, positions October as a potentially volatile transition month before what I expect will be a strong finish to 2025 driven by robust bank earnings.

Pre-market strength reflects bargain-hunting in AI leaders, with Nvidia ($NVDA ( ▼ 5.46% )) advancing 0.7% and Oracle ($ORCL ( ▲ 1.64% )) climbing 1% as investors reassess last week's skepticism. However, this bounce occurs against a backdrop of mounting uncertainties: looming government shutdown, critical jobs data Friday, and the ongoing Fed policy debate that intensified following stronger-than-expected economic data.

Today's light economic calendar features Dallas Fed manufacturing activity, allowing focus to shift toward Tuesday's JOLTS data, consumer confidence, and Wednesday's critical ISM manufacturing report that could signal cyclical inflection if it crosses above 50.

Despite last week's modest retreat, September has delivered solid gains with the S&P 500 ($SPY ( ▼ 0.56% )) up 2.8% and Nasdaq ($QQQ ( ▼ 1.21% )) advancing 2.9% for the month. The index sits just 0.8% below record highs, demonstrating resilience that validates my constructive year-end outlook while creating conditions for the October consolidation I've anticipated.

Last week's narrative shift, questioning AI infrastructure sustainability and Fed easing inevitability, represents exactly the type of healthy skepticism that prevents bubble formation while creating strategic positioning opportunities. Markets rarely move in straight lines, and this consolidation phase allows for better risk/reward entries ahead of Q4 catalysts.

Third quarter earnings season begins in earnest with major bank reports mid-October, and expectations for 8.6% S&P 500 earnings growth provide the fundamental support for continued equity outperformance. The banking sector should demonstrate operational excellence through net interest margin stability, robust capital positions, and sustained buyback programs.

Financial sector strength will validate current valuations while providing the catalyst for the next leg higher I anticipate into year-end. Strong bank results should alleviate concerns about economic deterioration and support risk asset positioning through Q4.

The Buffett Indicator reaching 217%, well above dotcom bubble peaks, has revived valuation concerns, though this metric requires modern economic context. The U.S. economy's transformation toward intellectual property, software, and data networks means GDP may systematically understate economic value creation, justifying higher equity valuations.

More telling is Buffett's own behavior: Berkshire's $344 billion cash position and 11 consecutive quarters as net seller suggests cautious positioning despite his silence on the indicator itself. However, this reflects Berkshire-specific considerations including succession planning rather than pure market timing.

The critical distinction: elevated valuations don't preclude further gains, they simply require earnings delivery. With Q3 earnings expected up 8.6%, corporate America continues demonstrating the operational excellence that justifies premium multiples.

Bank of America's latest fund flow data reveals concerning positioning extremes: third-highest equity inflows ever recorded, client allocation at 65% stocks (highest since 2022), and cash holdings at 10.5% (lowest since September 2018). These readings suggest elevated risk appetite that historically precedes consolidation.

The oft-cited $10 trillion in money market funds requires realistic assessment. I don't believe this capital represents dry powder waiting to chase markets higher. These balances reflect deliberate allocation decisions by investors satisfied with cash positions, not tactical positioning awaiting deployment signals.

While some money market capital may rotate into risk assets during year-end rallies, expecting mass migration from 5%+ yields into elevated equity valuations represents wishful thinking rather than probable outcome. This dynamic limits one frequently cited bullish catalyst.

Tuesday night's funding deadline creates immediate uncertainty, with potential shutdown imperiling Friday's critical jobs report release and complicating Fed policy assessment ahead of the October 31st FOMC meeting. Government shutdowns typically furlough 40% of workers, though the current administration's suggestion of mass layoffs rather than furloughs adds labor market uncertainty.

Any employees losing jobs would face challenging re-employment prospects in a softening labor market, potentially pressuring unemployment rates higher and accelerating Fed accommodation, a paradoxically supportive dynamic for risk assets despite near-term disruption.

The ongoing legal battle over Governor Lisa Cook's board position adds complexity to Fed dynamics, with former chairs Bernanke and Yellen filing amicus briefs supporting her retention. Her potential removal and replacement with a Trump appointee would likely shift the FOMC toward more aggressive accommodation, as evidenced by Governor Miran's continued advocacy for 200 basis points of additional cuts.

However, stronger economic data, 3.8% Q2 GDP revision and declining jobless claims, complicates the accommodation case. Oxford Economics expects Friday's jobs report to show 85,000 payroll additions, sufficient to "reassure the Federal Reserve that the labor market isn't deteriorating, allowing the central bank to keep policy on hold at its October meeting."

This data dependency creates near-term volatility while maintaining medium-term accommodation prospects as real rates remain restrictive.

BMO Capital Markets' Brian Belski raised his S&P 500 target to 7,000 Friday, calling it potentially "too low" while reiterating his 25-year secular bull market thesis. His team's willingness to "gladly accept the unabashedly bullish label" reflects confidence that "with the Fed cutting interest rates, earnings solidifying, AI not ANYWHERE near bubble territory and stock market performance broadening out, the believability and comfortability of US stocks is back in full swing."

I share elements of this constructive view while maintaining more disciplined near-term targets. My 6,800 year-end objective allows for the October consolidation I anticipate while positioning for strong Q4 performance driven by bank earnings strength and broadening market participation.

This week's calendar intensifies significantly beyond today's quiet start:

Tuesday brings JOLTS job openings and consumer confidence, providing labor market and sentiment insights ahead of Friday's payrolls report.

Wednesday's ISM manufacturing reading becomes crucial, a move above 50 would signal cyclical inflection supporting risk assets, while continued sub-50 readings maintain growth concerns.

Friday's jobs report represents the final labor market assessment before the Fed's October 31st meeting, with 43,000 payroll additions expected and unemployment holding at 4.3%. However, government shutdown risks may delay this release, creating additional uncertainty.

Wednesday's Nike ($NKE ( ▲ 0.87% )) report provides critical insights into consumer spending patterns and tariff impact on imported goods. The company faces market share losses to competitors and must articulate marketing strategies for the coming year's major sporting events.

Nike's results offer a window into discretionary spending resilience among middle-income consumers, complementing Costco's recent insights on value-seeking behavior across wealth cohorts.

I maintain conviction in strong year-end performance while using October's anticipated volatility strategically. The combination of elevated valuations, extreme positioning, and mounting uncertainties creates conditions for 5-10% consolidation before the final Q4 rally.

Bank earnings will provide the catalyst for the next leg higher, validating operational excellence and supporting premium multiples. Use October weakness to position in quality names demonstrating pricing power, domestic exposure, and secular growth positioning.

The secular bull market thesis remains intact despite near-term tactical challenges. Corporate America continues demonstrating the earnings growth that justifies current valuations, while Fed accommodation, however debated, provides monetary support for risk assets.

We enter October with markets near record highs but facing multiple tactical headwinds: government shutdown uncertainty, critical economic data, Fed policy debate, and extreme positioning that suggests vulnerable near-term sentiment. This combination creates the consolidation setup I've anticipated.

However, the fundamental case for equity strength remains compelling: 8.6% Q3 earnings growth expectations, eventual Fed accommodation, and operational excellence that justifies premium valuations. October pullbacks should be viewed as strategic positioning opportunities rather than secular trend reversals.

Bank earnings season will prove critical in validating current market levels and providing conviction for year-end strength. I expect financial sector results to demonstrate the quality earnings growth supporting continued equity outperformance into 2026.

Dan Sheehan

[email protected]

This newsletter is for informational purposes only and should not be considered investment advice. Please consult with your financial advisor regarding your specific situation.