Investors Parse AI Spending in a Choppy Market

Every morning before the opening bell, the Schwab Market Update sets the stage for the day ahead, covering key market movers, economic developments, and emerging themes. Each edition includes "Three things to watch" while Thursdays feature a weekly section, "Crypto currents." This recap revisits select items for those who may have missed them, helping traders head into the weekend better informed.

Volatility—already on speed dial after last week's crude spike and AI sell-off—could stay elevated until the November 3 U.S. election. "Democrats are heavily favored to win the majority in the House and have a realistic shot at capturing the Senate as well," said Michael Townsend, managing director of legislative and regulatory affairs at Schwab, in his latest WashingtonWise podcast. Whatever the outcome, a key issue for Congress is addressing the debt ceiling, which could be reached by mid-2027. "With an annual budget deficit approaching $2 trillion and the federal debt having crossed the $40 trillion milestone in August, investors are increasingly worried about the impact that will have on the economy and the markets," Townsend said. Traditionally, major indexes often climb post-midterms, but past isn't precedent, especially with rate hikes possible. The poster child was the 2018 midterms, which occurred during a hiking cycle and saw stocks nearly descend into a bear market. The Cboe Volatility Index (VIX) clawed above 20 late last week after touching that mark just three times in three months.

In addition to the September Personal Consumption Expenditures (PCE) price index, investors eyed the government's first estimate of third quarter gross domestic product (GDP) Thursday morning. "GDP was the bright spot, up 3.4% vs. 3.2% expectations, driven mostly by personal consumption," said Cooper Howard, director of fixed income research and strategy at the Schwab Center for Financial Research. Though consumption rose on a nominal basis, spending softened in real terms, coming in flat. This suggests consumers are spending more for the same or less output. GDP, calculated on a seasonally adjusted annual basis, rose from 2.2% in the second quarter. The GDP chain deflator, which measures price increases across the economy for domestically produced goods, rose 2.2%, less than the 3.5% Briefing.com consensus and far below the 6.1% second-quarter increase. The headline PCE price index rose 0.5% from a month earlier, accelerating from a 0.3% jump in August, and 3.4% from a year earlier. Energy prices were the main driver. Core PCE rose 0.3% month on month, the same pace as August's increase. Energy prices drove headline PCE growth, no surprise considering crude's strength. The goods PCE rose 3.9% year over year and services rose 3.5%. Under the surface, about 48% of the subcomponents of PCE are still rising at 3% or more.

Investors seem intent on rewarding AI spending funded within cash flow and punishing spending that pushes free cash flow negative. Microsoft's quarterly free cash flow fell but stayed positive while Alphabet's (GOOGL) hit negative $9 billion. Shares went opposite directions. Oracle, another big spender, rose after promising positive free cash flow soon. Microsoft didn't completely escape punishment for heavy AI spending, however, as shares retreated on plans to raise $25 billion from a U.S. investment-grade bond sale. It's now a trend, as Alphabet issued a similar offering in August. The beneficiaries of this spending—chipmakers and AI infrastructure firms—got rattled yesterday on concerns that tough financial conditions and negative free cash flow might hurt demand. Stocks like Caterpillar (CAT) and Bloom Energy (BE) also fell, because the AI spending impact goes well beyond tech to industrials and energy firms. However, slower AI spending growth might help ease yields if it means falling competition for debt. It could even slow inflation.

Bitcoin has pierced $85,000 three times over the past month, only to reverse direction, and the cost basis of many long-term holders offers clues as to why. About 4 million bitcoin—around 20% of the total supply—was bought at $85,000 or higher, with most bought in 2025, according to Glassnode data. So after waiting a year or more for a price recovery, many of those long-term holders may be happy to sell at break-even, providing resistance to additional gains. The average cost basis of active investors, on the other hand, sits just below $78,000, potentially providing short-term support if previous buyers decide to defend that price level. Meanwhile, volatility has hit a long-term low. A Glassnode gauge of the size of daily price moves has hit the lowest level in more than three years.

Credit spreads, which had been relatively narrow despite market volatility, began to rise last week, a concerning sign. The average spread of the Bloomberg U.S. Corporate Bond Index closed at 0.89% last Friday, a more than six-month high, while the average spread of the high-yield index closed at 3.37%, surpassing its March high. While spreads can rise without threatening the stock market, there were times when rising spreads gave an early hint of Wall Street troubles. Current spreads—while higher than earlier this year—remain below the 1.22% average for the corporate bond index over the last 15 years and the 4.15% average for the high yield index. Still, the rise drew attention, coinciding with concerns about AI-related firms possibly having less access to capital and their interest costs rising. A sudden surge in borrowing costs can make it tougher for debt-dependent companies to stay afloat. One metric on the loan and credit outlook arrives early next month with the Fed's Senior Loan Officer Opinion Survey on Bank Lending, which tracks bank lending standards and loan demand.