Gravity Strikes Back
There appears to be a wall of worry building in the markets that is beginning to translate into some volatility. The fixed income markets spoke first back in March as
interest rates began to rise. Now some of the largest equity positions are showing some weakness. There's a disturbance in markets that could cause investors to feel like a jedi encountering a sith for the first time (sorry for the nerdy reference, but I couldn't resist). This week we gather inspiration from the 1980 film "The Empire Strikes Back." Here is some trivia about the movie:
This movie was the long-awaited follow-up to the smash-hit "Star Wars: A New Hope" released in 1977. Empire was the number one grossing movie in 1980, hauling in more than $550 million at the box office - a really big number at that time.
Following the pattern of Act 2 of a play, this movie was darker than the other two in the trilogy. The characters are isolated and thrown into dangerous situations with seemingly no good outcome. Despite the dark tones, it is generally listed among the top 20 movies of all time, according to AFI & IMDb.
George Lucas took a gamble on this film, choosing not to use a major studio to finance the project. He took out a loan himself and used his profits from "A New Hope" to fund the budget. Budget overruns pushed the cost to over $30 million, which would have ruined him if the movie was unsuccessful. He was rewarded several times over and paid employees on the production handsomely with nearly $5 million in bonuses.
One of the more well-documented behind-the-scenes dramas (I'm not going to say "spoiler alert") was the line by Darth Vader that he was actually Luke's father. The line was not in the original script. The twist was added during rewrites after original screenwriter Leigh Brackett died. Only a handful of people knew the twist beforehand - Lucas, director Irvin Kershner, James Earl Jones, and Mark Hamill. Hamill was only told minutes before the take and sworn to secrecy. David Prowse, the actor in the Vader suit was told to say a different line of "Obi-Wan killed your father." James Earl Jones, who voiced Vader in all 3 movies, recorded the actual line in the studio.
George Lucas was so impressed by Frank Oz's performance as Yoda that he spent thousands of dollars on an advertising campaign to try and get Oz an Oscar nomination for Best Actor. The campaign ultimately failed as the Academy failed to recognize a puppeteer as an "actor."
Here's what we've seen so far this week...
AI Tech Strong, Depth Thin. Near the start of the film we see Luke Skywalker in a battle on the ice planet Hoth. The Empire's walkers are unstoppable as they have thick armor that is difficult to pierce. However, they have a weakness pointed out by Luke
when he instructs the other flyers to use their harpoons and tow cables to cause the walkers to fall over when their legs get tangled. The top 5 holdings in the S&P 500 Index are all AI-related. Their market cap, as indicated in the graph, is approximately $21.6 trillion. It requires adding the market caps of 434 other stocks in the S&P 500 to equal the market cap of just the top 5. As the line graph indicates, this has not happened before going back to at least 1991. While AI, and the concentrated S&P 500 Index with it, look invincible, a pullback in any of the top 5 names could weigh more heavily on the index than in less concentrated periods. This week, Mag 7 names, which includes the top 5 in the S&P 500 Index, are down more than 3% for the largest weekly loss since mid-to-late July.1
As investors have moved money in equities at elevated levels in 2026, the breadth in the market has continued to erode. Historic market caps at the top end of the index
resemble other periods of concentration. The similar makeup of breadth today last witnessed during the late 1990s could be a cause for concern. The difference between the S&P 500 Index and its median stock contained within the index is at its largest gap since 2000.2 Just this week Blackrock downgraded its long-held "overweight" to US equities in favor of a "neutral" stance as they stated "to manage potential volatility around the AI buildout."3 J.P. Morgan issued a similar stance that investors should embrace the bond market as investor portfolios could be "over-allocated to stocks."4 As they note, "a typical 60/40 stock-bond portfolio from 2019, without rebalancing, would now be a 74/26 portfolio - meaning that investors are now unintentionally exposed to a greater amount of risk."4
AI Financing Has A Dark Side. A warning is leveled at Lando Calrissian by Darth Vader. After Han Solo is frozen, Vader instructs the group to take Chewbacca and Princess Leia
to his ship, which was not the original deal. When Lando objects, Darth Vader responds, "I am altering the deal. Pray I do not alter it any further." We are seeing some downward pressure on AI as some of the data center deals and AI profitability are coming under some scrutiny. A recent report by Jefferies, as noted in The Economic Times, stated, "The reason credit risk has become more of an issue is that it can no longer be assumed... that large language models will ever be profitable given the related ongoing collapse in token pricing."5 The value of bonds involved in US data centers has declined under pressure from profitability due to the large scale of capital devoted to the AI buildout. If AI cannot be proven to generate sufficient revenues, it is possible some data center bonds could fall short of interest payments, which could lead to default.
On the risk side of the equation, investors appear to be hedging certain AI positions as the risk of default could be growing. Some of the more notable data center concerns of
of late are rearing their ugly heads in the CDS market. Investors sometimes utilize Credit Default Swaps (CDS) to hedge against holdings of a specific issuer. A CDS references the issuer, not a single bond or security. The CDS spreads have widened on some of these issuers to 12-month highs as AI-related borrowing is converging with concerns about data-center and chip profitability.6 By comparison, other AI-related names which look more stable in terms of CDS spreads, still show a trend of higher spreads of late. The trajectory from here might need to be watched to see if concerns begin to spread to other AI names.
Fighting An Enemy That Can't Be Seen? The Star War saga involves the story of an unseen force that guides peoples actions. In the same way, sometimes the market
seems to have a mind of its own. On Wednesday of this week the September report on the Consumer Price Index showed an expected increase month-over-month of +0.6%.7 That raised the year-over-year number from 3.4% to 3.6%.8 The Producer Price Index increased more than expected in September (+1.3% vs +0.6%).9 The year-over-year reading rose from 5.6% last month to 6.3%.10
The intelligent robot C-3PO enjoys reminding others of probabilities and outcomes in the Star Wars saga. Investors might feel a little like Han Solo who rebukes the robot by
stating, "Never tell me the odds." One would think the troublesome inflation reports would signal a rate hike by the Fed in two weeks. However, that does not appear to be the case as there is now an 82% probability that the Fed will hold rates steady at the end of this month.11 If that proves to be true, according to the Dot-plot supplied by the Fed at their last meeting which indicated at least one more rate hike in 2026, that means a hike would have to come at the final meeting in December.12 Regardless, whether it's AI concerns, volatility, or interest rates, investors have much to consider when it comes to reviewing their risk tolerance and portfolio concentration. But, as the pop star who has been in the news once sang, what doesn't kill us makes us stronger.
Click here to view the iconic moment that was such a huge Hollywood secret.....
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Disclosures
The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.
Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.
Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general.
Past Performance does not guarantee future results.
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