Market Bearings with W. Allen Wallace, Chief Investment Officer
Is the AI investment boom reshaping our economy or creating expectations that may be difficult to meet? As artificial intelligence spending accelerates, rising interest rates, persistent inflation, and energy prices are adding new layers of complexity to today's financial markets. In this edition of Market Bearings, Basepoint Wealth Chief Investment Officer W. Allen Wallace examines the forces driving the 2026 market outlook and why disciplined investing matters in an increasingly uncertain environment.
"Most men of business think-- 'Anyhow this system will probably last my time. It has gone on a long time, and is likely to go on still'. But the exact point is that it has not gone on a long time. The collection of these immense sums in one place and in few hands is perfectly new."
- Walter Bagehot, Lombard Street, 1873
“The impossibility of prediction in economics follows from the facts that economic change is linked to change in knowledge, and future knowledge cannot be gained before its time. As soon as we permit time to elapse we must permit knowledge to change, and knowledge cannot be regarded as a function of anything else.”
-Ludwig M. Lachmann, Metroeconomica, vol. XI, 1959
Stability is often a thing we take for granted. Over many years, systems seemingly continue to operate the way they always have. Changes accumulate over many years and normally the world evolves very slowly. It is only when we reach our golden years that we look back and realize how different the world is from when we were young. Sometimes there are inflection points. History is littered with inflection points that transformed the entire fabric of society: the fall of Rome, Europe’s foray into the New World, the Protestant Reformation, wars, plagues, fallen kings, and sometimes just plain bad luck. This is not to say that we are in a constant state of fear about impending doom. There are also changes that are highly beneficial. The invention of agriculture brought us out of the savannah and allowed us to build cities. Innovation in language and writing provided the means to transfer knowledge and wisdom across generations. Electricity allowed us to extend the productive day deep into the night. The telephone and the internet freed information to be distributed instantly around the world.
Today we face the automation of reasoning. Our questions can be superficially answered in an instant, calculated with all the world’s public knowledge. The problem lies in the cost of this modern-day oracle. Trillions of dollars are being plowed into massive data centers that gorge on land, water, electricity and physical materials. We are witnessing an arms race by the largest companies in the world to build the fastest computers, using the biggest models, and making them available to billions of people. The numbers involved are unprecedented. While everything looks calm on the surface, and change is bound to be in the future, the course, magnitude, and outcome of this transformation remain widely unknown, because all knowledge of it lives in the future.
Lead Thesis:
The AI revolution is moving ahead with us or without us. Our job as allocators of capital is to continue making certain that we do not get swept up in promises that cannot be kept, while ensuring that we do not get left behind in the dust. We must weigh predictions of the future, both positive and negative, and remember that all decisions we make today are based on knowledge from the past.
Market Weather:
We are experiencing a few drops of rain, but the forecasts call for calm. Major indexes are off their highs but have bounced back from their recent lows.
AI data center spending continues to accelerate.
Domestic equity valuations have come down due to recent earnings growth and upward revisions of future earnings.
Credit spreads are still very tight. They have contracted slightly since the beginning of 2026, even though issuance is up sharply. Reports indicate $1.90 trillion issued so far in 2026, up 29.8% compared with the same eight months last year.
Long-term rates continue to rise. The 10-year has crossed 5.3%, while the 30-year remains around 5.70%. These are rates not seen in 30-year treasuries since 2001.
The dollar is up slightly year-to-date, though still off its highs of 2022.
Core inflation is moderating, but energy prices continue to soar.
Gold is down over 5% for the year after an earlier rise; silver is down over 17% YTD.
Oil prices remain elevated as the Strait of Hormuz is still not at full capacity. The Strategic Petroleum Reserve (SPR) is under 300 million barrels.
Charts That Matter:
We have been repeatedly told that inflation is moderating, and that the Federal Reserve has the situation under control, but are falling home prices really the kind of disinflation we are after? It is true that inflation can be measured many ways, but headline inflation is still elevated, and core inflation doesn’t include food and energy, two things it is difficult to live without. The CPI uses many statistical processes to turn economic signals into economic data. The CPI does not measure the cost of buying a home directly; it uses homeowners’ estimates of how much rent they could earn on their houses to establish weights, and observed rental rates to determine shelter inflation. This data has had a tendency to lag falling home prices, as can be seen in the chart above. Shelter comprises approximately 45% of the core CPI calculation. Shelter inflation has been slowing significantly since the peak of inflation. We have to be cautious about what we wish for, because at least some of the moderation in inflation may be attributable to falling asset prices.
The US Strategic Petroleum Reserve (SPR) is supposed to be a reservoir maintained in case of economic calamity. At capacity, it can hold over 700 million barrels of oil to be distributed to keep the economy running. Recently we have been using the SPR to reduce oil prices due to the closure of the Strait of Hormuz. We are nearing the end of our ability to take distributions, and we also have to refill the SPR in the future, meaning we pushed current demand into the future. Energy is a very important component of every cost that we face in the entire economy. It will be interesting to see how the price of oil reacts to slowing distributions from the SPR, and future activity to refill our capacity.
What We're Watching:
Inflation continues to drive the conversation, and consequently, rates continue to rise. Talk of recession has been put on the back burner while AI datacenter capex inflates the economy. Oil continues to be elevated, and metals have fallen from their highs.
Inflation measures have begun to moderate, especially when looking at inflation without food and energy costs, both things all of us spend money on. Core inflation for August printed at 2.4%, while headline inflation remains at 3.4%. There is an important distinction between rate of change and absolute change. Slower inflation still means prices are rising, but at a lower rate than before. Shelter comprises approximately 45% of the core CPI basket, which has been slowing over the past several years, and although shelter uses Owner Equivalent Rents instead of sale prices, declining sales prices eventually work their way into OER costs. Some of the moderation in inflation may be related to high rates causing housing prices to decline. While core inflation removes food and energy, most of what we buy is still affected by rising energy costs. The cost of transportation, the cost of production, and the cost of raw materials are all impacted by energy costs. We may strip energy out of some of our measures, but its costs usually find their way back in.
Interest Rates have continued to rise. The initial increases were at the long end of the curve, but recently the Federal Reserve began increasing short-term rates. Short-term rate increases are intended to moderate inflation, as higher rates increase the cost of borrowing money over short periods of time and also increase the willingness of lenders to hold cash. The long end of the curve is set by markets. Although the US Treasury has begun repurchasing bonds in the market to reduce the long-term rate, this action has had little meaningful impact so far. Higher long-term rates increase the cost of things like mortgages, commercial loans, auto loans, and eventually by act of Congress, student loans. High long-term rates create friction in purchases of very large ticket items.
AI Data Center spending continues at a furious pace. Frontier model developers, including OpenAI and Anthropic, continue to spend large amounts of capital on model training and computation. The hyperscalers, Amazon, Microsoft, and Google, continue to spend a lot of money on equipment. Equipment manufacturers all continue to generate substantial cash flow and are priced as if this spending will not only endure, but will continue to accelerate. Capital needs for this build-out continue to grow, supported by an increasingly complex web of off-balance-sheet vehicles that tap the public debt markets, the private debt markets, and the equity markets.
Oil and Gas continue to be elevated. The Strait of Hormuz remains below full capacity. We have exposure to Oil and Gas companies, and these have been some of our best performers over the past two years. While these are long-term investments, we do need to be conscious of the price of oil to help us determine our position size. The US has distributed significant reserves from the Strategic Petroleum Reserve (SPR) over the past few years. We are below 300 million barrels, in a reserve that has a capacity of over 700 million barrels. We will eventually have to stop these distributions, and this may cause further increases in oil prices. Further, the borrowed oil must be repaid, with interest, and this will increase future demand for oil while the SPR is being refilled.
Portfolio Positioning:
We are currently updating allocations.
Equity exposure remains approximately the same, but our allocation to international equities is increasing slightly, and more exposure to utilities, health care, and small-cap stocks is being implemented. Utilities will continue to drop if interest rates continue to rise. However, the business fundamentals are solid. We are earning a 3.3% dividend yield, and if rates fall due to a deteriorating economy, our utilities should provide gains in a falling interest rate environment.
Alternatives remain consistent. Metals have dropped from their highs, and catastrophe bonds and merger arbitrage continue to be key components of our alternatives allocation. We reduced our exposure to metals last year, and we are increasing merger arbitrage as rates rise.
We recently switched our short-term bond allocation to include more exposure to corporate bonds and less exposure to asset-backed securities due to the duration profile of the funds that we use.
We have interviewed several potential new fund managers to add additional diversification by investment strategy.
Our individual stock portfolio continues to perform well, and we will rebalance this allocation based on recent market volatility, giving us better prices in some companies we would love to own.
We continue to own very little in the AI space, even though forward earnings multiples have declined. We will wait to see if the earnings that they are anticipating materialize before committing capital to this experiment.
Principles and Philosophy:
“The map is not the territory”
-Alfred Korzybski
The section quote is one of those sentences that seems obvious and resonates quickly, but when you deeply contemplate its meaning, it changes your entire perspective. It is easy to understand how a map of Germany gives you no real ability to physically affect the land mass of Germany. That is an intuitive connection. The problem is that our entire model of the world is mostly made of maps. Not maps drawn on paper, but mental maps created in our minds and based on incomplete information. No one has ever seen inflation, interest rates are numbers in tables, stocks are squiggles on charts, and money is mostly digital. Any connection between these concepts is purely cartography. Worse, data is not a primary object. It is exhaust collected from the remnants of real financial activity that happens in boardrooms and living rooms every day. There are measurement problems, collection problems, completeness problems, and reporting problems that need to be taken into consideration when making decisions about the future.
Our system is designed to make decisions based on the best information available today. We do not try to predict the future because “knowledge of the future cannot be gained before its time”. We measure, we track, and when needed, we change our minds. Our investments are based on how much cash flow we are generating. This is true in bonds, and it is true in equities. Prices give us no extra information about where we will be in 20 years. We will continue to examine economic data because it tells us, within a reasonable margin, where we have been, at what speed we are traveling, and in what direction we are heading; but no matter how good we are with data, or how powerful our computer, AI or PC, it will never tell us where we will end up. This is the very nature of uncertainty, and it is the main problem we are trying to solve for you.
Many investors have committed a significant amount of their capital based on the assumption that AI infrastructure spending will earn a high return on capital over the coming decades. While we are in no position to determine if this will happen or not, we can estimate what it would take. A recent article in the Wall Street Journal estimates that AI spending will have to reach almost 9% of the economy by 2032. It is important to note that we currently spend about 9% on food. Further, Anthropic’s recent draft IPO prospectus indicates that they have committed to $518 billion in spending over the next 10 years on 2025 revenue of $4.6 billion. A large portion of those commitments are currently indirectly included in the future earnings estimates of Alphabet, Amazon, and Microsoft. In addition, Nvidia’s current forward estimates include projections of a large portion of that spending being used to purchase chips. The entire ecosystem is dependent on generating revenue that hasn’t materialized yet. If you own the S&P 500, you are betting over 40% of your money on these numbers working out.
Many people confuse risk and uncertainty. G.L.S. Shackle did a significant amount of work in the middle of the 20th century trying to disentangle the two. Risk assumes that potential outcomes and their likelihood are known. If you flip a coin, it will either be heads or tails. The physics that govern our current universe make it very, very unlikely that a normal coin will ever land directly on its side. Uncertainty means that not only do we not know the likelihood of outcomes, but we do not even know what all the possible outcomes are. Economic systems are more reflective of uncertainty than probability. Shackle called it “possibility”. He argued against using mathematics to assign probabilities with spurious rigor. Looking at history, evaluating previous large technological changes, and evaluating the current economics of the present situation lead us to believe that much has to go perfectly, and there is no room for error. It is similar to a coin landing on its side, and that is not a bet we are willing to make.
Our response to making decisions under uncertainty is not to retreat or rely on hope. We follow Bertrand Russell’s advice to make decisions with vigor despite uncertainty, but maintain doubt, and adjust decisions when it appears that circumstances have changed. This is why we pay such close attention to the present. The present allows us to draw a tangent point to the curve of reality and make assessments of when things are changing. While there is inertia in financial systems, they can also move violently in a short period of time. By focusing our attention on cash flow, which is a relatively easy metric to observe and measure in the absence of fraud, we increase our ability to face uncertainty with vigor.
Closing:
The bond market is currently in robust disagreement with the stock market. The bond market is telling us that capital should be more expensive, and that future returns should be lower than we expect. The stock market is telling us that trillions of dollars in infrastructure spending are going to earn very high returns on capital, and that AI will not only revolutionize the economy, but will become a significant portion of it, while generating cash flow for suppliers, providers, and customers. While we have no idea how the future will play out, we do know that in the past when the bond market disagrees with the stock market, it is usually the bond market that gets it right.
Thank you again for the trust that you give us to help you reach your goals. We will continue to keep our eyes on the present, and our goals in the future.
Basepoint Wealth LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Past performance is not indicative of future performance. Therefore, no current or prospective client should assume that future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by Basepoint Wealth), or product referenced directly or indirectly in this presentation, will be profitable. Different types of investments involve varying degrees of risk, & there can be no assurance that any specific investment or investment strategy will be suitable for a client’s or prospective client’s investment portfolio. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
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