What's the Market Missing About Rates, inflation, and S&P 500 Earnings?

The current investment landscape has inverted the post-2008 financial crisis dynamic, leaving bonds undervalued and stocks overextended. Long-term real interest rates are rising despite a weakening labor market and cooling inflation, driven by a deteriorating U.S. fiscal outlook and declining foreign demand for Treasuries. While AI-related capital expenditure has reached approximately $700 billion annually, this boom accounts for only 15% of private non-residential investment, suggesting it is not the primary driver of high yields. Furthermore, the AI narrative faces significant structural risks as token prices fall faster than volume growth and hyperscalers like Microsoft reveal that much of their AI revenue is circular. With non-AI earnings growth expected to slow following the exhaustion of one-off tariff refunds, the market remains vulnerable. Investors should approach bonds cautiously, favoring 5-year Treasuries as a hedge, while remaining skeptical of the long-term economic sustainability of the current AI infrastructure build-out.