All That Matters: Can’t Keep a Good Market Down

How is AI driving market growth?

Ross: The stock market is sitting near all-time highs this month, even as recent headlines paint a less-than-rosy picture of the economy. Mike summed up the short-term future of the market perfectly in the Wall Street Journal last week: “Heads, we get an AI boom. Tails, we get rate cuts and a borrowing boom.” These two forces – innovation and monetary policy – are like opposite ends of a barbell, both helping to balance the economy and fuel the current bull market.

Mike: The S&P 500 is up 12.5% year-to-date, which is a strong return, especially considering it’s only mid-September and we have already weathered April’s tariff volatility. AI is clearly one of the primary drivers of this growth. Every now and then, the market latches onto a theme. In the past it’s been housing, technology, consumer spending – and now, it’s AI.  Steve Jobs said that it’s not the customer’s job to know what they want, and AI companies are living this mantra by pouring money into a technology they are betting we won’t want to live without. Open AI recently signed a massive $300 billion deal with Oracle for cloud space, which sent Oracle’s stock soaring about 35%. The infrastructure that will be needed to power OpenAI’s systems is equivalent to more than two Hoover Dams or the energy consumed by about 4 million homes. These kinds of investments don’t just move tech stocks, but have ripple effects across the entire market. Like any emerging technology, AI’s future is uncertain, but the potential to drive major growth is undeniable.

Ross: There’s a narrative that the AI boom is only lifting Big Tech, but the reality is broader. A variety of industries – utilities, financials, industrials – are growing as a result. Utility stocks, for example, are surging as they prepare to meet the power demands of AI. And what sets this moment apart from the 1990s tech boom is the presence of solid fundamentals. These companies are seeing real cash earnings, signing real contracts, and delivering results, which gives investors confidence to lean into the biggest and smartest companies in the world. Meanwhile, the “real” economy – labor, healthcare, manufacturing, and construction – is poised for its own tailwind. These sectors could experience renewed momentum as a result of rate cuts in the coming days. So, while headlines may focus on volatility, the underlying dynamics show resilience and opportunity.

What do rate cuts mean for the economy?

Mike: The stock market tends to respond to a few key economic indicators: How’s the overall economy doing? How are companies and the major indexes trending? What’s happening with interest rates? Falling interest rates are generally a positive signal for the market. When consumers can borrow at cheaper rates, home sales start to pick up and costs drop, both of which stimulate the economy. The weakening labor market has been the clearest signal that the Fed needs to cut rates. For years, inflation has been the primary concern, and the Fed kept rates elevated to fight it. One could argue that while inflation might still not be where we want it to be, the deteriorating labor market poses a more immediate threat to economic stability. Once rates are cut, we’re likely to see home equity unlock, consumer spending rise, and companies increase their investments. Paired with the AI boom, this economic activity could be a powerful combination for the markets.

Ross: The S&P 500 Equal Weight Index recently hit an all-time high – a strong signal that this market rally isn’t just about Big Tech. Because this version of the S&P 500 removes the outsized influence of a handful of huge companies, an all-time high there shows that this is a broader and more inclusive rally than we’ve seen in the recent past. Ross Yarrow, Managing Director of U.S. Equities here at Baird, created a chart that illustrates what happens when the Fed cuts rates and the economy avoids a recession. He focused on those two conditions because, historically, rate cuts are often a response to economic downturns like during the COVID crisis in 2020. But when rates are lowered and the economy stays on solid footing, the market tends to respond very positively. This scenario has only played out a few times in modern history -- notably in the late 1980s and again in 1995. In those instances, lower interest rates unlocked consumer borrowing while employment remained strong, which created a sweet spot for economic growth. And it’s not just consumers who benefit. Companies also take advantage of lower rates to access capital, build new facilities, and invest in emerging technologies. All of this drives both economic expansion and market performance.

What risks are we looking out for?

Mike: Market conditions look promising, but it’s important to remember that the market can fall at any moment. The AI boom and the potential for rate cuts give us plenty of reasons to be optimistic -- but history reminds us that surprises are inevitable. As strategists, we’re always scanning for the unexpected. And while we don’t know what that might be, we keep a close eye on key indicators: How is the average consumer doing? Are people spending? What’s their housing situation? Do they have jobs? Is consumer confidence holding steady, or starting to slip? We’ll continue asking ourselves these questions and watching the labor and housing markets closely.

Ross: Just think back to April’s tariff volatility. Most investors knew the administration was planning to implement tariffs, yet the announcement on April 2nd still caught the market off guard. There will always be unknowns, even when we think we’re prepared. Whether it’s a once-in-a-generation global pandemic or a breakthrough company like DeepSeek that rattles giants like Nvidia and Google, the market is constantly vulnerable to surprise. That’s why staying informed, diversified, and connected with your Baird Financial Advisor is more important than ever.