Summary
•The S&P 500 slipped roughly 0.9% in October, but under the hood there was significant movement. The average stock had a very good month: the equal-weighted index rose 5%, beating the cap-weighted benchmark by 5.9 points, the widest monthly margin since April 2009, while the Nasdaq fell 5.3% in its worst month since early 2025.
•The technology selloff had nothing to do with diminishing demand for AI tools. Cloud growth was exceptional, but Alphabet, Meta, and Amazon all reported negative free cash flow and turned to outside capital to fund the AI buildout.
• The Fed held rates at 3.75%–4.00% on October 28, but hawkishly: two officials dissented in favor of a hike,the FOMC statement upgraded economic activity to “strong,” and markets ended the month pricing a December increase as the clear base case.
• Treasuries rallied—the 10-year yield fell roughly 35 basis points, its largest monthly decline since 2023—even as September inflation remains above target and Brent crude rose nearly 14%.
Market Recap: The Index Stood Still; The Market Moved
October produced one of the more deceptive headline returns of the year. The S&P 500 fell roughly 0.9%, closing at essentially where it closed in late May, which means the cap-weighted index has now gone five months with no net progress. However, beneath the flat index, there have been several violent rotations, and October delivered one of the more violent rotations in decades. The equal-weighted S&P 500 jumped nearly 5%, outperforming the cap-weighted index by 5.9 percentage points—the widest monthly gap since April 2009 and the second-best relative month since 1990 (chart below). Nine of eleven sectors rose, four of them—staples, energy, health care, and utilities—by more than 9%. What fell was the narrow slice of the market that had carried it for two years: technology and communication services (together they form nearly half the index). The tech sector fell 6.8% while the communication services sector dropped more than 15%.
We have been writing for several quarters that a durable bull market needs the average stock to carry its share, and that our positioning leaned away from the crowded mega-cap trade towards other areas of the market. And according to FactSet data, the fundamentals of the other 493 companies grew faster than the Magnificent Seven’s this quarter—roughly 33% against 23%—the first time in this cycle the rest of the market has out-earned its leadership. Third-quarter earnings season was strong in aggregate, with blended growth tracking above 30%, a third straight quarter over 25%. However, it’s worth noting that companies beat estimates by the smallest aggregate margin since late 2022, which is why good results so often failed to lift some stocks. Expectations have caught up with reality. However, as earnings have continued to grow at a solid pace while the index has largely been flat, valuations have compressed to much more attractive levels. The forward multiple on the index compressed to 18.7x—a valuation reset without damage at the price level is welcome.
The AI Trade
Hyperscaler earnings remain robust, and demand for compute continues to outstrip supply. However, despite the fundamentals, concerns around financing and costs put pressure on the sector during October. The demand side of the results was impressive—Google Cloud grew 103%, Microsoft’s Azure 48%, and Amazon Web Services 39%. But the amount of capital being spent came to the forefront during the month. Alphabet posted a second straight quarter of negative free cash flow and was punished with a 12.6% single-day decline, its worst since its 2004 listing. Meta reported its first negative free-cash-flow quarter in over a decade and announced a $95 billion equity raise—the clearest possible signal that internal cash generation no longer covers its capital spending plans. Amazon’s trailing free cash flow went deeply negative. Intel collapsed 29% on weak guidance. The interesting exception was Microsoft, which remained solidly cash-generative, trimmed its capital-spending forecast, and was largely spared from the carnage. The market is no longer selling AI spending indiscriminately, as it did in previous drawdowns. It is discriminating between buildouts funded from operations and buildouts funded by issuing debt and equity. Consensus estimates show hyperscaler free cash flow remaining negative through 2028 as they race to build out infrastructure.
The capital needs for the buildout remain enormous, and these companies continue to suck up tremendous amounts of capital—both on the equity and debt side of things. Add an IPO pipeline now absorbing equity as well, and the supply of AI securities is testing the market’s appetite to finance these ambitions.
The Fed: A Hawkish Hold
The Federal Reserve held the funds rate at 3.75% to 4.00% on October 28, pausing after September’s hike, but nearly everything around the decision leaned hawkish. The vote was 10–2, with Cleveland’s Beth Hammack and Governor Lisa Cook dissenting in favor of an immediate increase. The statement upgraded its description of economic activity from “solid” to “strong.” And Chair Warsh’s press conference gave no ground—inflation is still too high, energy prices moved higher again, and the economy is growing above 3%. His explanation for the pause was timing, not direction. Odds of a December hike rose to roughly 80–85% after the meeting. The pattern of a hawkish, dissent-marked hold followed by a hike at the next meeting is the same way last July’s hold resolved into a September hike. A December increase to 4.00–4.25% is both our base case and the market’s.
The two dashed lines in the chart above show how market expectations shifted during October. At the end of September, the OIS curve peaked near 4.85% in mid-2027, but by late October the peak had dropped to about 4.65%. In other words, the market took roughly one hike out of the path over the month, even as it kept the December move largely priced. Both curves still peak in the summer of 2027 and then drift lower, so the market view is a short tightening cycle followed by a plateau, not a sustained hiking campaign like in 2022-2023. The September FOMC projections show a median for 2026 that sits around 4.1% and for 2027 around 4.1–4.4%, so the committee’s own forecast is for one or two hikes and then a hold. There is a wide range among the dots for the end of 2027—from about 3.1% to 4.4%—which tells you the committee is divided on whether this is a one-off recalibration or a new cycle. The market is slightly above the median dot for 2027, so if the Fed delivers on its own projections, the long end could rally.
Bonds Rally, Oil Climbs, and the Data Run Hot
The bond market delivered October’s most counterintuitive move. After touching roughly 5.35% intraday in early October, the 10-year Treasury yield fell about 35 basis points to finish near 4.94%, its largest monthly decline since December 2023. The 30-year Treasury peaked near 5.67% and ended around 5.31%. For portfolios, it was the month duration finally earned its keep: Treasuries had their best month in nearly three years just when equities wobbled. Credit markets told a more cautionary story—spreads widened from their cycle tights mid-month, with the pressure concentrated in AI-linked issuers while the rest of investment grade stayed rich.
The paradox is that the data argued rates should move the other way. September CPI re-accelerated to 3.7% as gasoline jumped 9% in the month, producer prices rose at their fastest monthly pace since 2022, and core PCE ticked up to 3.1%, moving further away from target. Third-quarter GDP came in at a strong 3.4%, led by a 19% surge in private investment as the AI capex boom remains the growth engine. Against that, hiring has nearly stalled—September payrolls rose just 29,000, and unemployment ticked to 4.2%—leaving the Fed facing strong output, weak hiring, and rising inflation at once. Oil remained the swing variable: Brent gained roughly 14% in its fourth straight monthly advance as tanker attacks in the Strait of Hormuz hit record frequency and Houthi strikes reached Saudi facilities.
The Midterm Elections
Americans went to the polls and delivered a decisive victory for the challengers as the Democrats took control of both chambers of Congress. Two years ago, a Red Wave put Republicans in power, and these midterms brought the Democrats back into power in both houses of Congress. In the populist regime of the time, it is not surprising for the incumbents to cede power.
On the first full day of trading after the results, the market was positive. Equities rallied, rates fell, and oil fell as the prospects for winding down the conflict with Iran increased. The war was clearly a negative in the minds of the voters. A divided government—a Democratic Congress and Republican White House—is often seen as a positive for markets. The opposites provide brakes on each other’s policies and lower the risk of policy surprises. Gridlock is often the preference of markets. That said, the December 11th funding deadline will be a test, as it falls to a lame-duck Congress and a newly divided government. At the margin, it likely increases the risk of a shutdown. The other concern that markets may surface in the coming months is opposition from the Democratic Party with regard to the AI buildout and data centers. The risk of heightened scrutiny could slow down the massive investment cycle that has been powering the economy over the last few years.
Investment Implications
In equities, the rotation was the story of October. We remain invested and deliberately broader than the index, with AI exposure below its benchmark weight—a stance rewarded in October. In fixed income, the front end of the curve continues to pay nice all-in yields. But the longer end of the curve gained attention as it provided ballast to equities for the first time in a while. The December FOMC meeting is the next macroeconomic market event. A hike is the base case, and the signposts that would change it are a weak November payrolls print or a durable Iran de-escalation that takes oil lower.
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