Record Highs, Thin Ice

The S&P 500 and Nasdaq ended the week near their highs, and at first glance little seems amiss. Beneath the surface, the market is telling a more nuanced story, and the next three weeks of earnings will put it to the test.

Bonds are the natural starting point, since they have set the tone for equities all autumn. After weeks of persistent selling, Treasuries finally attracted genuine demand. The 10 year auction cleared below expectations, with a strong bid to cover and minimal dealer takedown, and the 30 year auction was equally well received. Call open interest on long duration Treasuries reached a record. We interpret this as a soft ceiling on yields rather than a turning point, because positioning this crowded can unwind just as quickly.

That confidence does not extend to every sovereign. In France, $241 billion of corporate bonds now yield less than government debt, up from just $14 billion in January. Credit markets are showing strain at the margins as well. Yields on CCC bonds, the weakest tier of high yield debt, have climbed above 12% and broken away from the rest of the asset class, while spreads continue to widen.

Monetary policy offers little comfort. Oil is holding near $100, and diesel is approaching $200 a barrel as refining capacity remains tight. Policymakers are now signalling a December rate hike, with another possible thereafter. The cost pressure is already visible in corporate results: Delta Air Lines grew revenue 16%, yet free cash flow fell 44% and management lowered guidance.

Then there is AI. A report questioning OpenAI’s revenue sparked a sharp but short lived selloff, a reminder of how fragile sentiment remains. Skeptics argue that trillions in capital spending require roughly tenfold revenue growth, even as token prices fall and power infrastructure lags. Optimists counter that AI agents represent an entirely new source of demand, that compute remains scarce, and that some suppliers are sold out through 2029.

Whichever view prevails, returns have been remarkably concentrated. Only 18% of utilities and 12% of autos trade above their 200 day moving averages, compared with more than 60% of technology stocks. Small caps and financials are approaching correction territory, defined as a 10% decline from recent highs.

Our assessment is that the trend remains intact, though it rests on a narrow base. We are focused on three signals: credit quality in bank earnings, the durability of hyperscaler capital spending, and whether yields stay below recent peaks. A diplomatic resolution in the Middle East remains the single largest upside catalyst for both bonds and equities.