Quarterly Market Currents: Beneath the Surface of Euphoria
At first glance, markets appear unstoppable: record-high indices, falling rates, and capital flowing freely across public and private channels. Yet beneath that calm, crosscurrents are building. The Fed’s balancing act between inflation and growth has exposed fractures in policy confidence; U.S. valuations hover near historic extremes; and non-U.S. markets are regaining ground after years of underperformance. In parallel, secondary-market froth and AI’s circular capital flows reflect a system flush with liquidity but hungry for sustainable direction. The result is an inflection point—where exuberance meets exhaustion, and global diversification, discipline, and discernment are once again poised to matter most.
The Fed’s Precarious Position
The United States Federal Reserve (“the Fed”) has a seemingly straightforward dual mandate: price stability (inflation) and optimizing employment (labor market). Often, these two goals work in parallel, i.e., when the economic cycle is near or at a bottom with low inflation and high unemployment, interest rates (the Fed’s primary policy tool) must be lowered to stimulate the economy and improve the labor market. Conversely, as the economic cycle nears a peak, rates must be raised to tame inflation, with a greater margin for error in the labor market.
Sometimes, however, the Fed’s two goals operate in opposition, which triggers a difficult decision - which side of the mandate should be prioritized? Put more directly, which is the greater risk: spiraling inflation or chronically high unemployment? There is, and has never been, a clear answer, and the history of the Fed’s behavior reveals both wisdom and folly.
This environment describes the Fed’s current predicament: inflation (as measured by year-over-year CPI) is ticking upward from April’s trough, and the labor market is simultaneously showing deepening cracks. Addressing their twin mandates individually, the Fed might raise rates to tame inflation and might lower rates to juice a stagnating labor market. But the Fed can’t address each problem individually, revealing the conflict at the heart of their job. This Gordian Knot is further exacerbated by transparent and persistent political pressure from Trump to lower rates, economic data collection likely to be crippled by a government shutdown, and a slow inflationary drip from tariffs.
At this point, it appears that the Fed has prioritized the labor market over the spectre of inflation, electing to cut rates in September’s meeting and taking a posture indicative of further rate cuts through 2026. The coming months will test whether the Fed’s balancing act—caught between politics, imperfect data, and the competing halves of its own mandate—can deliver a soft landing or merely delay the next inflection point.
Checking Back In on Valuations
In last quarter’s market commentary, we touched on the increasingly euphoric aura emanating from US large-cap stocks with valuations ascending to levels not seen since meme stock-mania in late 2021 and the Dotcom Bubble in the early 2000’s (both of which were followed by protracted drawdowns, as a reminder). Since striking this cautious tone last quarter, the S&P 500 and its valuation have continued to climb, with the US large-cap indexes' forward P/E up to 22.8x (from 22.0x at last quarter end). As U.S. stocks set new record highs, the S&P 500’s valuation continues to press against its 20-year peak, in stark contrast to the steadier, more moderate valuations across non-U.S. markets, as shown in the chart below.
There is an old Wall Street saying that valuations are a lagging indicator, not a leading indicator: high valuations tend to coincide with surging markets, not the other way around. This is certainly the case now, with the S&P 500 setting successive all-time highs, dragging valuations along with it (we’ll touch on market leadership concentration and the risks that poses in our next quarterly commentary). While the S&P 500’s surge has dominated headlines, stocks in non-US developed markets have quietly outperformed the S&P 500 by 10.9% year-to-date. A weaker U.S. dollar has amplified those gains, a pattern historically tied to periods when international markets outperform, as the chart below illustrates. It also illustrates that non-U.S. equities are now converging toward relative outperformance, reversing years of U.S. dominance even as domestic valuations stretch to multi-decade highs.
Against that backdrop, non-U.S. markets appear increasingly attractive on both a relative valuation and cyclical basis. Indeed, Bank of America recently observed that the current stretch of U.S. equity outperformance now stands more than three standard deviations above its historical norm—a reminder that such extremes have rarely persisted and may be building the case for renewed leadership in non-U.S. equities.
The Silver Lining for Taxable Investors in Volatile Equity Markets
Some of the biggest AI players are using “circular” deal-making: suppliers (like chipmakers or cloud providers) invest in, lend to, or prepay their customers (AI labs and startups), and those customers then use that money to buy the suppliers’ chips or computing. In plain English, the supplier helps fund the buyer, and the buyer spends that funding back with the supplier. This can be smart business. It effectively “jumps” the cash conversion cycle—the time it normally takes for a company to turn spending on parts and servers into cash from customer sales—by pulling future demand forward and giving suppliers more certainty to build capacity.
The upside is clear: faster scale, tighter partnerships, and fewer “will the customer actually show up?” worries. But the structure can also blur what real, independent demand looks like. You’ll sometimes hear “round-tripped revenue”—that’s revenue that appears on the supplier’s books but is, in part, funded by the supplier’s own money flowing through an investee or financed customer. It’s not fake, but it can overstate the breadth of market demand if too much of it depends on insider funding rather than end users paying out of their own budgets.
Keeping the flywheel spinning often depends on steady private-market investment into the marquee AI labs—most notably OpenAI—as well as generous vendor financing (credit provided by suppliers) and long-term take-or-pay commitments (contracts where a buyer agrees to pay for capacity whether they use it or not). As long as capital is plentiful, the ecosystem can fund big compute purchases and data pipelines, and everyone benefits from rapid learning curves and scale.
The risk shows up in a downturn. If rates stay high or a recession squeezes venture and growth equity, new funding becomes scarcer and more expensive. Suppliers pull back on financing, take-or-pay deals feel heavy, and dependence on round-tripped revenue gets exposed. The takeaway for a layperson: circular deals can accelerate progress, but they’re not a substitute for broad, durable customer demand. Healthy AI growth ultimately requires outside buyers spending real budgets—and a funding environment that doesn’t vanish when the cycle turns.
Is this a type of AI-enhanced Ponzi scheme? Cynics would say “yes” and point to the need for a continual infusion of fresh capital as proof. We’d lean towards “no”… but recognize the risk inherent in this type of positive-feedback-loop financing. We all know that AI is the future - hence the hype and astonishing capital flows. The question is whether or not the hype has outrun the reality. To us, this is more like a game of musical chairs: so long as the music keeps playing, everyone gets to move. But if the music stops, we’ll quickly learn who doesn’t have a seat.
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DISCLOSURE: The information presented in this post is the opinion of the author and does not reflect the view of any other person or entity. The information provided is believed to be from reliable sources, but no liability is accepted for any inaccuracies. This post is provided for informational purposes only and should not be construed as an investment recommendation. Past performance is no guarantee of future performance. Align Impact is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration as an investment adviser does not constitute an endorsement by the SEC, nor does it imply any level of skill or training.
