"safe" stocks have opened a line of credit

Happy Sunday.

Every finance class teaches the same rule about rising rates. Growth stocks take the biggest hit, because their profits sit furthest out in the future. The steady, boring companies theoretically should “hold up”.

September ran that rule in reverse. The 10-year Treasury yield went from 4.7 to 5.3 percent and the Nasdaq 100 gained 3 percent. Almost four out of five stocks in the S&P 500 fell. Utilities, the textbook place to hide, lagged the market for a second straight quarter. Somewhere a finance professor is rewriting a final exam.

You've probably seen the headline version of this. AI is sucking the oxygen out of everything else. True enough, but it skips why.

The Fed's brake only reaches companies that need to borrow, so every hike aimed at the AI boom lands on everyone else. That pushed the scared money and the greedy money into the same handful of stocks, the ones rates can't touch because they don't need a lender. Now those stocks are turning into some of the biggest borrowers in corporate America.

Somebody has to slow down

The economy as a whole can handle 5.3 percent. Nominal gross domestic income, what the country earns from what it produces, is up 6.9 percent from a year ago. Outside the pandemic, that's the fastest since 2006. The Journal's Greg Ip plugged growth like that into a simple model and got a 10-year yield between 5.5 and 5.8 percent. By that math, today's yield is a little low.

But there's no average company anymore. A rate is only high relative to how fast you're growing. AMD $AMD ( ▲ 2.95% ) more than doubled its data center sales last quarter, and Nvidia $NVDA ( ▲ 1.34% ) expects to make $100 billion a quarter for the foreseeable future. For them, 5.3 percent money barely registers. For a regional bank, a homebuilder or a trucking company growing a few percent a year, 5.3 percent plus a wider credit spread is a wall.

Bryan Whalen, who runs fixed income at TCW, put it in one line: "More than half of U.S. growth is coming from interest rate insensitive borrowers." The chief economist at UBS's investment bank supplied the other half. Take out the AI companies and capital spending is running at zero.

Now sit in the Fed's chair. Your job is to cool total demand to what the economy can supply, and there isn't much spare capacity left. If half the economy ignores your brake, the other half has to slow down for both. That's why 16 of the 18 officials who turned in projections expect another hike this year, and why the 2-year yield sat near 4.72 percent the day of the hike, well above the Fed's 4 percent ceiling.

The economy is driving with one foot on the gas and one on the brake. The gas is roughly a trillion dollars a year of AI spending from Meta, Alphabet and Amazon, and the brake is the Fed.

September showed you who feels it. The average S&P stock lost 5 percent, by the Journal's count. The Russell 2000 dropped 5 percent while the 50 biggest stocks gained 2 percent. The share of S&P stocks above their 200-day average went from 75 percent this summer to 49 percent. Spreads on bonds from the weakest junk borrowers, the ones rated CCC, widened more than a full percentage point, past their peak from the April 2025 tariff selloff.

What hasn't sunk in yet is that every new dollar of AI spending nudges up the rate the trucking company pays. The 400 or so S&P stocks that fell last month are paying for the boom's room to run.

Fear and greed bought the same stocks

Most big stock funds can't go to cash. Their mandates say stay invested. So when managers get nervous, they move into whatever acts most like a bond: utilities, real estate, staples, the steady dividend payers. Dave Keller walked through this playbook on his show Friday, and it's been the standard move for as long as I've watched markets.

The playbook breaks when bonds are what you're scared of, because stocks that act like bonds fall with them.

A nervous manager who has to stay invested is left with one place to go: the companies with the most cash and the least need for a lender. Those are the AI giants.

That's how the Nasdaq set a record last month while 53.3 percent of individual investors told the AAII survey they were bearish, the most since May 2025. It's how consumer sentiment can sit below 60 for over a year while the Nasdaq runs. Phil Rosen went back 40 years and found only 13 months with sentiment that low and the Nasdaq up 20 percent or more on the year. Twelve of them were the last 13.

The professionals are doing the same thing with better vocabulary. The Journal asked six big money managers how they're trading 5 percent yields, and the answers form a barbell. On one end, Rick Rieder at BlackRock is collecting over 7 percent in his funds with about three years of duration, something he says he waited four decades to see. On the other end, Morgan Stanley's Mike Wilson is sticking with large-cap quality and asset-light stocks. Nobody wants the middle, where the rate-sensitive companies live.

A big piece of the money in the AI giants isn't betting on AI, which is why the bubble debate keeps missing it. It's hiding there, because these stocks looked like the one place rates couldn't reach.

That works as long as it's true.

The bunker has a mortgage

A company is safe from rates when it pays for things with its own cash. Rate insensitivity is really a statement about free cash flow, and the AI giants are spending theirs about as fast as it comes in.

Meta, Alphabet and Amazon plan to keep spending roughly $1 trillion a year for five years. Cash flow doesn't cover all of that, so the gap goes to the bond market. Whalen calls these companies the biggest issuers of debt in this economy and says their profits and balance sheets let them shrug off higher rates. Sonal Desai, who oversees more than $300 billion of fixed income at Franklin Templeton, is looking at bonds from Microsoft $MSFT ( ▲ 0.92% ) , Meta, Amazon and Alphabet because they pay sizable yields for investment-grade debt. "These are sound companies, sound balance sheets," she told the Journal.

I believe both of them. But if bonds that safe pay sizable yields, the bond market is already making the safest companies in America pay up, and the biggest bond shops are lining up to collect.

Every bond they sell ties them a little more to the same rates grinding down the other 400. Joe Little, chief strategist at HSBC Asset Management, calls the bigger picture crowding out: big government deficits and enormous AI spending budgets competing for a pool of global capital that's scarcer than it used to be. The giants are the shelter from higher rates and one of the reasons rates are higher.

The lenders they're turning to aren't calm, either. Hedge funds now hold around $2 trillion of Treasurys, more than Japan, much of it bought with short-term borrowed money. On Thursday, unwinding hedge fund trades knocked French bonds around and sent money scrambling into Treasurys and German bonds. The MOVE index, which tracks bond volatility, closed Tuesday at its highest since spring. The VIX, the stock market's version, sat at 16. Stocks are calm and bonds aren't.

For now, the market reads all of this as good news. Keller showed this week that over the past year the S&P 500 and the 10-year yield have moved together with a correlation of 0.81. Translation: the index and the interest rate have been the same bet, a bet that AI demand keeps running hot.

The day higher yields start hurting the giants instead of moving with them, that correlation flips. And if the bunker stops looking safe, the scared money and the greedy money leave through the same door at the same time.

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The other side of 1999

Little calls the late 1990s the natural parallel: a Fed hiking into a tech boom with long yields near 5 percent. Everybody remembers what the Nasdaq did next. Fewer people remember what happened to the stocks the boom left behind.

The Fed raised rates six times between June 1999 and May 2000, taking its target from 4.75 to 6.5 percent. In 1999 the S&P 500 returned 21 percent and Berkshire Hathaway $BRK.B ( ▲ 0.43% ) lost about 20 percent. That December, Barron's put Buffett on its cover under the headline "What's Wrong, Warren?"

Nothing was wrong with Warren. He owned insurers, banks and Coca-Cola in a market that only wanted what rates couldn't reach.

Then the leaders cracked, and the stocks nobody wanted got their turn. In 2000 the S&P fell about 9 percent and Berkshire gained almost 27. From 2000 through 2002, Berkshire rose roughly 30 percent while the index lost about 38.

Rob Arnott is betting on a version of that. He told the Journal he sees a bubble in large caps, pumped by index fund flows in a way that wasn't possible in 1999, and expects smaller companies to beat the giants in the years ahead.

This time the leaders print real earnings, and I wouldn't hang a forecast on a 26-year-old analogy. But remember where the turn came from. In 2000 the gap closed from the top, once the leaders stopped looking untouchable.

The other 400 need a way out

Can stocks outside tech keep rising with borrowing costs this high? Some can, mostly the ones selling into the buildout. The rest can't, not while the boom keeps outbidding them for capital, workers and power. They need the brake to ease.

Oil is one way out. It's the other tax on the 400. On Friday the G7 agreed to release up to 100 million barrels of diesel and crude over four months, and Brent slipped under $100. Transports, which Keller called a train wreck in September, were the best group on his board Friday, up over 2 percent. That tells you how coiled the rate-sensitive side is. The release is a bridge, though. It adds no refining capacity, and Russia just extended its own diesel export ban through October.

Almost nobody is positioned for the other way out. If the giants' borrowing starts to bite, the boom slows, the Fed gets room to back off, and the gap between the giants and the other 400 closes. It just closes the 2000 way, with the top coming down to meet the bottom. At the CMT Association's fall summit in Bethesda this week, Keller said he heard absolutely no one argue that rates would go lower. When a room full of professionals agrees that completely, I keep the other side in my back pocket.

To see which way this breaks, I'm watching spreads on the giants' bonds, the correlation between stocks and yields, and that 49 percent of S&P stocks above their 200-day average. If those spreads widen while the correlation falls, the borrowing has started to hurt.

Usual reminder, I'm not a financial advisor and none of this is advice.

Most of you reading this own both halves. The index in your 401(k) and brokerage account is the bunker. The private business, the commercial real estate and the bank stock you've held for 25 years are where the brake lands. It's worth knowing which half is paying for the other.

Everyone ran into the same few stocks to get away from higher rates, and it made sense. Those were the companies that didn't need a bank.

They're opening a line of credit.

Stay curious 😎

John

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