Big Tech has led a bubble and analysts feel pretty sure it will be Big Tech that will bring it down

Outlook

Sentiment is a tangled ball of yarn. One jobs report says the sky is falling and another one says smooth sailing. This confusion places extra weight on the PCE data this morning, even though it’s outdated (Sept) and should be dismissed. Even if we see a jump in inflation instead of the usual crawl, it’s hard to see rate cut expectations pared at this late date.

But Bloomberg does note that while two more rate cuts are expected after next week’s, the first one is extended out to March and then not until Sept for the second one. See the chart. Economists get paid to make forecasts but this one is sure to get derision. For one thing, to the extent the economy sees contraction, if mostly in small businesses, it’s not because of interest rates. It’s because of uncertainty created by Trump. A rate cut is not going to change anything. Three rate cuts are not going to effect change, either.

Then there is the rise in yields expected from the Battle for the Fed, which may not be offset by revulsion at the power grab. This can start any day now when Trump needs a distraction from some other mess he has made. We are pretty sure it’s sycophant Hassett but there could still be an announcement effect, or rather a series of them.

Third is the stock market bubble blow-up. There is no doubt that Big Tech has led a bubble and analysts feel pretty sure it will be Big Tech that will bring it down. Or maybe the banking sector. Or something else. At a guess, if you polled all the pundits, you’d get a 51-49 response for a big, fat correction in Q1. This is a bit like the railroads having overspent on construction and getting a comeuppance, although it might be too soon to compare. Still, some experts say that when the data center hysteria comes to an end, watch out.

Other experts say stop being hysterical. Macrobonds says we are still okay. See the chart at the end.

The fact remains that the stock market is not all that lopsided. Even consumer discretionary is coming back after being down in the dumps for a while. And foreigners are still buying US equities. Seeking Alpha has a nice summary:

The S&P500 (SP500) is entering 2026 trading at a bubble-like valuation, with the Shiller P/E ratio above 40, just below the record of 44 reached at the peak of the 2000 dot-com bubble.

The question is whether the bubble will burst in 2026, or continue to inflate towards a Shiller P/E ratio of 44 to a new record.

The answer depends on two variables: 1) whether there will be a recession in 2026, and/or 2) the AI bubble will burst due to industry-specific variables, such as accounting issues, slow AI adoption, or AI capex debt issues.

Additional factors include whether the Supreme Court rules against Trump tariffs, a remote possibility but fun to watch Costco and other suing for tax refunds. Plus Epstein and some kind of  war on Venezuela and whatever other nonsense Trump brings. Be sure to take note that it’s not yet scaring off foreign investors. We get foreign direct investment very, very late. The most recent data for the US is from June. (For Australia, it’s a year old.) Some think FDI is a better gauge of sentiment toward a country, and that may be true but not useful when the data is so delayed. Besides, a slew of countries promised capital investment in the US in return for tariff relief and in any case, everyone knows Trump will be gone in three years, so it’s not clear his dreadful performance really much harms FDI.

If we can’t look to the stock market or FDI for guidance on the economy, we are back to monetary policy as a driver. We get the Fed next week (Dec 10). The following week it’s the Bank of England (Dec 18) and a day later, the Bank of Japan and the Swiss National Bank. 

Forecast

The correction favoring the dollar against the overbought euro and others seems to be fizzling. We got the expected gain, but it’s minor and within recent ranges. It looks like traders are watching highs against recent highs, since the euro surpassed a series of previous highs but couldn’t match 1.1694 from Oct 16. Oh, dear, another rangey period, most likely. We can’t expect a sea-change today with PCE, forecast at or near the same 2.9% and outdated, anyway. We’d pull back head of crossroads.  

Tidbit: Krugman, who has Trump derangement syndrome and plenty of reasons for it, takes likely Fed chair candidate Hassett to the cleaners. The sycophant reveals he doesn’t know the price of anything and whether it’s high or low, sprinkled with outright lies. The key question is how he can possibly build consensus among board members upon looking at true hard data?

Something we did not know: Hassett predicted very few deaths from Covid, based on his own model.

But the top Krugman question should chill us to the bone: “If AI is a bubble, what will the Fed do when it bursts?”

What is the Fed’s attitude toward the stock market? We found a piece by the NBER that leads to the economics journal article in 2001. Granted, that’s almost 25 years ago but the Fed is a slow-moving tortoise.

The paper acknowledges and tries to overcome something named heteroskedasticity, an annoying word that means a change in one of two data sets can be wildly difference from the change in the other. Note the factor in question is the change.

The economists found that the Fed policy response is significant. A 5% change in the S&P

raises the probability of 25 bp change in the Fed funds rate by about a half. Half of what?! This is not clear to our non-math mind so we assume it means that if the probability of a rate cut was 40% before the stock market event, now it’s 60% after the stock market event.

More generally, the nut seems to be that the Fed sees the stock market as one indicator of the health of the economy. Greenspan spoke of “irrational exuberance” in 1996 and we didn’t get a burst bubble for another four years. He also declined to change rates because it would be unfair to the little guy, which seemed ridiculous at the time and still does.

This would supposedly influence another key Fed component—the wealth  effect that keeps consumers spending like drunken sailors.

So, if the current bubble bursts, will the Fed cut rates? Under normal conditions, yes. Under Trump and Hassett, hell yes and maybe 50 bp.