The Shape of What’s Coming and Q3 Market Review

Bolstered by strong September performance, both global stocks and bonds delivered solid third-quarter gains. In the U.S., equities extended their remarkable run, powered by resilient consumer spending, enthusiasm for artificial intelligence, and growing conviction that the Federal Reserve’s tightening cycle had finally ended. When the Fed cut rates by 25 basis points on September 17 — its first move lower in more than a year — markets took it as confirmation that a gentler monetary era had begun.

Equities | Size and Style

U.S. Markets

The S&P 500 closed the quarter at another record high and notched its best September performance in fifteen years. Technology stocks once again dominated, climbing more than 13 percent, while small-caps — long dormant — staged an impressive 12 percent rally. Year-to-date, the broad U.S. market is up nearly 15 percent.

Bonds joined the rally. Yields fell across maturities, credit spreads tightened, and the Bloomberg U.S. Aggregate Bond Index advanced 2 percent for the quarter, bringing its 2024 return to 6 percent. It was a powerful reminder that patience in high-quality fixed income continues to pay off as the Fed pivots from restraint to accommodation.

Developed Markets Outside the U.S.

Developed markets abroad delivered more uneven results. Europe continued to struggle under sluggish growth, and Japan’s uncertain policy backdrop kept investors on edge. Central banks moved cautiously: the Fed and the Bank of England each trimmed rates by 25 basis points, while the European Central Bank held steady.

Emerging Markets

Emerging markets were the standout performers of the quarter, gaining roughly 11 percent and extending year-to-date returns to nearly 28 percent. Large-cap growth led the way, up 12 percent for the quarter, supported by stable currencies, improving trade flows, and a favorable rate environment.

Inflation Trends

Inflation has cooled but remains above target — 2.9 percent headline and 3.1 percent core in the U.S. — leaving global bond investors divided over whether disinflation will persist or another inflationary wave will emerge in 2025. The good news: the tightening cycle appears to be behind us for now. The challenge: the next phase will test how durable this expansion really is.

For now, optimism is winning. Consumers are still spending, unemployment remains low, and corporate earnings continue to surprise on the upside. But beneath the surface, a more consequential story is unfolding — one about money, leverage, innovation, and the evolving boundaries of risk.

The Great Financial Migration

A century ago, during the speculative boom of the 1920s, financial innovation promised to “democratize” opportunity. Ordinary savers could buy stocks on margin or invest in trust companies that packaged foreign bonds and exotic instruments. What began as progress ended in calamity and produced the guardrails we know today: the Securities Act, the SEC, and the idea of the “accredited investor.”

Now, the story is echoing again. Financial innovation has returned under a new banner of “access, efficiency, and technology.” Private equity, private credit, and venture capital — once the exclusive domain of institutions — are being repackaged for the mass market. Funds promise exposure to the same opportunities that built institutional fortunes. The marketing language feels familiar.

Deregulation and clever product design are blurring the lines between public and private markets. Investment giants are lobbying to fold private credit and equity products into retirement plans and 401(k)s. Meanwhile, crypto tokens claim to represent fractional stakes in private firms like SpaceX and OpenAI, floating in a gray zone between securities law and speculative fiction.

Private credit — direct lending by non-banks — has exploded to roughly $2 trillion, five times its size in 2009. Firms such as Apollo, KKR, and Blackstone now run internal insurance arms that funnel premiums into their own funds. Because prices aren’t set by exchanges but by managers themselves, volatility can be smoothed and losses deferred — what the industry calls “mark to model,” critics “mark to make-believe.”

The appeal is obvious: yield without visible volatility. But opacity is not safety, and liquidity is not guaranteed. In the next downturn, redemption limits and valuation gaps could turn “semi-liquid” funds into traps for unwary investors.

The same self-reinforcing structures of leverage and valuation are now surfacing in a different arena — technology.

AI, Capital, and the New Circularity

Layered on top of this credit boom is the extraordinary capital cycle driven by artificial intelligence. Trillions are being poured into data centers, chips, and infrastructure. Yet as The Economist recently noted, the economics of AI are circular: capital raised by tech companies finances hardware built by other tech companies, whose revenues depend on the first group’s success. Debt finances equity; equity finances more debt.

It echoes past manias. In the late-1990s internet boom, software firms invested in web companies that promised to buy their software, creating a self-feeding illusion of demand. Today’s AI partnerships and capacity-sharing deals risk a similar loop. Productivity gains will come — but rarely in a straight line.

The Inverse Economics of AI

Despite the “AI supercycle” rhetoric, the math is upside down. Unlike the advertising-driven model that made Google profitable by lowering unit costs, AI costs rise with each user request. Every prompt consumes electricity, servers, and cooling capacity. As one analyst put it, “AI doesn’t compound; it consumes.”

Bloomberg Intelligence estimates AI companies will need roughly $2 trillion in annual revenue to fund the computing power required to meet future demand; current revenues are about half that. David Einhorn of Greenlight Capital put it bluntly: “Some of these numbers are so extreme it’s hard to make sense of them. There’s a reasonable chance that a tremendous amount of capital destruction is coming through this cycle.”

Debt-Fueled Growth in Disguise

That destruction may begin in credit, not equities. Meta Platforms has borrowed roughly $22 billion; Oracle, $18 billion — massive figures showing that the AI build-out is increasingly debt-financed. Chipmakers finance data centers that buy their chips; cloud giants pre-purchase capacity from each other. It’s a tight, leveraged loop.

Meanwhile, credit spreads between high-yield bonds and Treasuries have fallen to their lowest levels since 2007. Even top-tier borrowers issue debt at yields barely above those of the U.S. government, while private-credit funds show mounting strain. If AI’s extraordinary capital demands collide with a deregulatory wave and a credit market priced for perfection, the feedback loop of leverage and optimism could amplify losses well beyond Silicon Valley.

If technology and credit are pushing risk forward, another market — gold — is pulling it back.

Gold, Deficits, and the Dollar Dilemma

Gold has surged above $4,000 an ounce, up more than 50 percent this year — its strongest rally since the 1970s. Part of that reflects portfolio re-hedging amid shifting real-rate expectations, but it also reveals deep unease about America’s fiscal path. The federal deficit remains 5 to 6 percent of GDP even with full employment — a peacetime anomaly.

Investors face cognitive dissonance: equities soar, Treasuries rally, gold screams debasement. All three cannot be right forever. The bond market suggests confidence that inflation will stay anchored; the gold market suggests the opposite. Perhaps the truth lies somewhere in between — a quiet diversification away from dollar-denominated assets as the world acknowledges that the U.S. can no longer be the sole safe haven.

The Fed’s Tightrope

The Federal Reserve is trying to walk a narrow path — cool inflation without cracking the labor market. Chair Powell calls the current stance “restrictive but cautious.” Another 50 basis points of cuts are expected by year-end, yet even that may not offset fiscal drag or global weakness. Business investment fell 5 percent last quarter beneath headline GDP growth of 3.8 percent. Consumers remain resilient, but savings are being drawn down and delinquencies are rising.

The Fed’s challenge is structural as well as cyclical. When risk migrates from regulated banks to private lenders, monetary policy loses traction. Lower rates lift asset prices but transmit less to real-world activity. If history rhymes, we may again be in an era where market exuberance masks systemic fragility.

What It Means for Investors

For disciplined long-term investors, these contradictions are nothing new. Markets always balance fear and faith — fear that excess will end badly and faith that innovation will outpace the damage. Today demands both humility and perspective.

At Cardiff Park, our focus remains what it has always been: separating signal from noise and fundamentals from fashion. We continue to build globally diversified equity portfolios around index-tracking funds, paired with high-quality fixed income — including Treasury and municipal ladders — to manage volatility and preserve liquidity.

We don’t chase fads or bet on opacity. The appeal of “alternative” credit or crypto-wrapped products is understandable, but they often solve the wrong problems. What matters is clarity of purpose — a portfolio that can withstand inflation, recession, or speculative euphoria without losing its anchor.

The long view is encouraging. The U.S. economy continues to grow, productivity is improving, and innovation is real. But every cycle tempts us to believe that risk has been engineered away. It never has been — and never will be.

Even so, until proven otherwise, the bull market lives on. It has endured rate shocks, political turmoil, and geopolitical conflict. It has absorbed the highest borrowing costs in a generation and shrugged them off. That resilience deserves respect. The U.S. stock market remains a resilient and forceful engine of wealth — but one that must be handled with care. In the long run, markets reward those who resist illusion and trust the arithmetic of compounding over the chemistry of speculation.

If you have questions about your current allocation or would like to review your overall approach, please reach out. We’re here to help you navigate uncertain times with clarity and confidence, staying focused on the future.

Regards,