August @DallasFed Services Index fell to 4.2 vs. 7.2 est. & 6.6 prior; company outlook down to 3.0 vs. 10.4 prior; revenue down to 6.6 vs. 9.5 prior; employment down to 0.8 vs. 2.6 prior

Last wk, oil +9% & ylds +11-26 bps across 2/30 curve w/ S&P/Nas/R2K -0.3%/-0.7%/-2.4%. This wk, I am watching reaction to 1) oil/rates, 2) calls to slow down AI development & 3) Fed on 9/16. I remain on the cautious side till US mid-terms on 11/3. This weekend, the CEO of Anthropic called for a slowing of frontier model development over safety concerns. This follows comments along similar lines by the CEO of OpenAI to employees last week if other companies were willing to do the same thing. The fundamental issues I have with this is 1) foreign adversaries would welcome the US slowing down AI development, 2) I view this as an attempt to slow down open-weight model development which would help the market dominance of OpenAI and Anthropic which are currently in the lead and 3) I do not see other companies agreeing to anything that slows down progress catching up to these two market leaders. Having said that, I could see 3rd party evaluators to limit liability risk going forward and some sort of executive order from the White House. But I hope the longer-term result of these actions is broadly distributed personal AI capabilities for all individuals versus having it become concentrated in the hands of a few companies. Along this vein of AI competition, after releasing their paid API of Muse Spark 1.3 two weeks ago with open-weight versions coming later, $Meta launched their personal AI agent Muse last week with the stock gaining 5%. With 3.6 billion daily active users, a hit product could yield large results. Meta is increasingly showing other ways they can monetize their AI capex spend. This should help the stock to re-rate from a 17x CY27 PE to a multiple closer to peers trading in the low 20s. Meta Connect on September 23–24 is another potential catalyst given their leading frontier model Watermelon should be coming at the latest by October. On the front of broadly distributed AI capabilities, $AAPL stock gained 4% last week on their new product launch. The foldable Duo will provide a personalized AI agent in your pocket with a 50% larger screen than a Pro Max. I continue to see a big upgrade cycle next year. The change from a 4” screen to 5.5” screen with the iPhone 6 drove revenue growth from 7% in FY14 to 28% in FY15. The Android ecosystem has had a foldable Samsung phone since 2019. As for the Fed on Wednesday, I believe Warsh will raise by 25 bps and echo his hawkish statements from Jackson Hole on August 28th that “Price stability is not self-executing… 65 months of sustained, elevated inflation sits squarely with the Central Bank.” The ECB statement last week when they hiked might provide some hints: “For inflation excluding energy and food, the baseline foresees 2.5% in 2026, 2.6% in 2027 and 2.3% in 2028. Compared with June, the baseline projection for inflation in 2026 is unchanged, while it has been revised up for 2027 and 2028… The outlook remains highly uncertain, with risks to the upside for inflation and to the downside for economic growth.” In summary, my caution between now and the US mid-terms on 11/3 remains for reasons I have fleshed out in prior posts including: 1. Don’t fight the Fed: The market historically under-performs during a hiking cycle with the bond market discounting 2 raises by year-end and 3.5 raises by mid-June of 2027. 2. Seasonal headwinds: September is down -0.5% on average and up only 48% of the time since 1957. 3. Historical volatility: S&P drawdowns of 10% between 7/31 and 11/9 have occurred in the lead-up to mid-terms since 1990. 4. Regulatory friction: There is bipartisan pushback against datacenter expansion that could hurt the AI buildout in the near-term. 5. Geopolitical risk: Despite US efforts to de-escalate, I believe Iran drags out hostilities at least through the 11/3 US mid-terms, keeping oil prices elevated. 6. Macroeconomic pressure: Long-term government bond yields are hitting multi-decade highs for several countries, slowing down growth and providing a reasonable alternative to stocks. I believe in not fighting the Fed, the bond market or seasonality. I like the odds stacked in my favor which should improve at least seasonally following the mid-terms.

I was wrong about the Fed and its rate policy this year, but not simply because M2 is rising. Over the past year, M2 money supply has shifted from a modest recovery into sustained expansion, rising $1.26 trillion, or 5.7%, from September 2025 to September 2026. More importantly, the pace is accelerating. Over the past six months, M2 has been growing at roughly a 7.2% annualized rate, well above the three-year average of 4.1%. But M2 growth by itself isn’t sufficient reason for the Fed to raise rates. Money can sit idle, velocity can change and deposit growth does not necessarily translate into excess demand. The more important signal is what is happening alongside it: accelerating credit creation, record corporate issuance, enormous AI-related capital spending, resilient growth and renewed inflationary pressures. Investment-grade issuance has already set a full-year record, fuelled in part by enormous AI-related borrowing, while technology CapEx is making an outsized contribution to economic growth. Companies are raising and spending hundreds of billions on data centres, power, chips and infrastructure. Then there’s inflation. Energy has become a major near-term driver of producer and headline inflation. PPI for final demand surged 6.3% year over year in September, while core CPI remains at 2.6%. The challenge for the Fed is that monetary policy can restrain demand, but it can’t produce more energy. That side of the inflation equation increasingly rests with the White House and energy policy. When money and credit are expanding at the same time that capital spending is booming and inflationary pressures are re-emerging, the combination becomes much harder to dismiss. Meanwhile, markets are behaving as though none of this matters. Equity returns remain heavily concentrated in technology and AI-linked names, while parts of the commodity complex, including wheat, lumber, and gold, silver and uranium equities, are being sold despite what in many cases appear to be supportive underlying fundamentals. Put it all together and the backdrop looks considerably less benign than I previously thought. M2 isn’t the reason to tighten. It’s the combination of expanding money, booming credit creation, massive AI-related capital spending, resilient growth and renewed inflationary pressure that changes the calculus. And yet technology stocks are behaving as though higher rates pose virtually no threat. Perhaps that’s precisely the opportunity for the Fed to turn more hawkish. When markets stop fearing the hawks, it becomes much easier for the hawks to start eating the doves.