Shutdowns, Market Highs: Investor Q&A

Market Momentum Amid Government Shutdown and AI Investments

Stock markets are surging to record highs, with the S&P 500, Nasdaq-100, and Dow Jones Industrial Average reaching new peaks despite softer employment data and a government shutdown. This unexpected market momentum is largely driven by significant investments in artificial intelligence (AI) by major tech companies like Meta and Microsoft, which have expanded their computing capacities through data center development and increased chip production.

The current market performance reflects a broader narrative of a cooling but resilient economy. Investors are optimistic about potential interest rate cuts, as equities continue to climb, U.S. Treasury yields decline, and the U.S. dollar weakens. Private markets are also buoyed by this sentiment, with OpenAI’s valuation reaching $500 billion, surpassing SpaceX as the most valuable startup.

Impact of the Government Shutdown

The government shutdown, affecting 25% of federal spending and furloughing 40% of federal civilian employees, has historically had limited impact on markets. Past shutdowns have not significantly disrupted the positive trend of the S&P 500 or U.S. Treasury yields. However, each week of a shutdown is estimated to reduce quarterly GDP growth by 0.1 to 0.2 percentage points, though much of this is typically recovered in the following quarter.

Economic data releases, such as jobless claims, have been delayed due to the shutdown. Alternative data sources, like the Federal Reserve Bank of Chicago’s unemployment index, are being used to monitor the labor market. While the economic impact is generally temporary, concerns about potential permanent job cuts are being closely watched.

Federal Reserve Policy and Economic Outlook

The Federal Reserve is prioritizing the weak labor market over gradual inflation increases caused by tariffs. The three-month average of jobs added has declined to around 29,000, down significantly from last year. The Fed is expected to ease financial conditions gradually, with inflation being closely monitored. Energy prices remain stable, and shelter inflation has decreased, reducing the likelihood of accelerated overall inflation.

Policymakers are focused on the labor market’s role in shaping inflation trends. Consumers are expected to absorb about two-thirds of tariff costs, but this is not anticipated to significantly impact services inflation or inflation expectations. Without stronger wage growth, overall inflation is unlikely to accelerate in the current labor market conditions.

AI’s Role in Market Growth

AI leadership is driving market dynamics, with the top 10 S&P 500 companies accounting for 40% of the index. Nvidia alone represents about 8% of the index, reflecting the dominance of AI-focused companies. Tech stocks now make up 50% of the S&P 500 and contribute 60% of the market’s year-to-date return. AI investments are essential for U.S. economic growth, with capital spending on software and IT equipment playing a critical role.

Major hyperscalers like Microsoft, Meta, and Alphabet have strong balance sheets and substantial cash reserves, supporting AI development. As AI models improve and require more computing power, infrastructure development continues to grow. Despite the government shutdown and policy changes, markets remain focused on strong fundamentals and a resilient economy, with AI as a key driver of future growth.