As we head into September, the investment team at Carnegie continues to monitor key data that will impact market conditions. Interest rates remain elevated; inflation continues to be a concern, and the enormous investment behind artificial intelligence is creating opportunities as well as risks. At the same time, the strength of the consumer is becoming more difficult to assess, and markets continue to rotate beneath the surface.
Against that backdrop our focus remains on understanding what is driving portfolio performance, maintaining diversification and being selective about where we take risk.
The Federal Reserve will once again be a major focus. With inflation still an issue, interest rates remain an important part of the market equation, and higher borrowing costs are beginning to matter more for companies as well as the federal government.
For businesses this is particularly relevant as companies invest heavily in artificial intelligence infrastructure. The amount of capital required for this buildout is significant and investors should pay close attention to whether companies have the free cash flow and balance-sheet strength necessary to support that spending.
Debt is no longer free money. As borrowing costs rise companies that depend heavily on outside financing may find it increasingly expensive to fund ambitious growth plans.
The same issue applies on a much larger scale to the federal government. With government debt continuing to grow and interest expense approaching $1 trillion a year, the cost of servicing that debt is becoming increasingly difficult to ignore. At some point higher rates may force greater discipline around spending simply because issuing additional debt becomes too expensive.
Artificial intelligence remains one of the biggest forces driving the market, but investors should be careful not to assume that diversification simply means owning companies outside the technology sector.
AI spending now reaches well beyond traditional technology companies. Industrials and utilities can benefit from the infrastructure required to build data centers, while energy companies benefit from rising demand for the natural gas and electricity needed to power them.
Healthcare may provide another example of where the next phase of the AI story could emerge. The industry generates enormous amounts of data, and AI is particularly well suited to analyzing large datasets, potentially improving areas such as drug development and diagnostics.
We have already seen the market move from the so-called Magnificent Seven to the “picks and shovels” companies supporting the AI buildout. The next rotation could favor businesses that are able to use AI to improve productivity and profitability within their own operations.
The important takeaway is to understand what is truly driving the investments in a portfolio. An index fund may be more concentrated than investors realize. Owning a broad market index does not necessarily mean owning a broadly diversified portfolio when a relatively small group of companies represents an increasingly large portion of that index.
The current interest-rate environment continues to offer attractive opportunities for fixed-income investors without requiring them to reach far out on the risk spectrum.
Treasuries remain an important part of our fixed-income allocation, and investment-grade corporate bonds can also offer compelling yields. Investors can earn more than 5% on some intermediate-term investment-grade bonds.
With those yields available we do not believe investors necessarily need to pursue lower-quality or more complicated securities simply to generate additional income.
As always credit quality matters. Buying an investment grade (or AAA corporate bond) means lending money to a company and investors should have confidence that the underlying business has the financial strength to repay that obligation.
For investors who believe longer-term rates may be near their peak, extending maturities can also provide an opportunity to lock in attractive yields and reduce future reinvestment risk.
The health of the consumer remains one of the more complicated parts of the economic outlook.
Earnings results across retailers and restaurants continue to vary widely. Some businesses are performing extremely well while others are struggling, which reinforces the importance of company-specific execution in an uncertain environment.
At the household level, however, there are signs worth watching. Consumer spending has been growing faster than income while the savings rate continues to decline. If households continue spending more quickly than their incomes grow eventually, something has to give.
One factor helping support spending may be demographics. Many baby boomers have accumulated significant savings and wealth, and their spending patterns may make traditional employment data less useful in explaining the strength of consumption.
At the same time new forms of borrowing can make the picture more difficult to measure. “Buy now pay later” services allow consumers to make purchases today and repay them over time, which is a form of credit that may not always appear in traditional revolving credit statistics.
That raises an important question: Is the consumer stronger than expected or are some households simply borrowing in ways that are harder to see?
For now, spending continues but declining savings and the expansion of alternative credit are trends we will continue to monitor closely.
Much of the recent rise in bond yields has been attributed to large federal budget deficits and mounting government debt. The national debt recently crossed $40 trillion, and after excluding roughly $8 trillion in intragovernmental holdings, Treasury debt now stands at 100% of nominal GDP, shown as the red line in the chart below.
That figure is elevated, but it does not tell the whole story. The rise in Treasury debt has been offset by a decline in the comparable private-sector debt ratio, leaving total nonfinancial debt relative to GDP broadly stable since 2010, aside from a temporary spike during the pandemic (the green line on the chart).
It is a trend we continue to watch closely, particularly as the AI buildout drives hyperscalers to issue increasing amounts of debt to fund their infrastructure spending. Should that borrowing accelerate meaningfully, it could begin to pressure the total debt picture in ways investors have not needed to consider in recent years.
As we move toward the final months of the year, the investment environment remains filled with crosscurrents. AI continues to create opportunities across industries, but the enormous capital requirements behind the buildout deserve careful scrutiny. Higher interest rates offer attractive fixed income yields while also increasing pressure on borrowers. And consumers continue to spend even as savings decline, and alternative forms of credit expand.
In this environment, diversification remains especially important. Investors should understand not only what they own but also the underlying forces driving those investments.
At Carnegie Investment Counsel, we remain focused on high-quality businesses with strong balance sheets, thoughtful diversification, and a long-term approach. Markets will continue to rotate, and volatility will eventually return, but staying disciplined through those shifts remains one of the most important parts of successful investing.
This commentary is for informational purposes only and includes general economic and market conditions. Forward-looking statements cannot be guaranteed. Past performance is not a guarantee of future results. Data and other market and economic information referenced is from sources believed to be reliable and opinions are subject to change. All investments involve risks, including the loss of principal.
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