Ketu Desai
By Ketu Desai
The economy is in a period of transition. The current backdrop is uneven growth and restrictive monetary policy, which will give way to accelerating growth in 2026 with accommodative policy. The drivers of this will be fiscal expansion, a manufacturing renaissance, AI, and a Fed cutting cycle.
The administration pivoted over the summer from contractionary policies such as DOGE and onerous tariffs to fiscal expansion from the “One Big Beautiful Bill” and deregulation. The deficit is already tracking ahead of last year. The “One Big Beautiful Bill “will add another $2.75 trillion to the deficit, according to the Wall Street Journal. Much of the Bill has to do with tax incentives and immediate expensing to drive capital expenditures. These incentives combined with the tariffs are meant to drive domestic manufacturing. There have been $5.1 trillion dollars in investment commitments to bring manufacturing back. While not all of it will come through, there should still be a significant increase. Corporates will make those decisions later this year and into Q1 2026, driving a growth acceleration.
We’re starting to see signs of corporations’ plans for 2026. The latest ISM Manufacturing PMI showed the New Orders Index moved from contractionary to expansionary. Durable goods orders were up 2.9% last month. Goods orders, less defense and air (a proxy for business spending), are running at an annualized level of above 5%. The credit impulse shifted to a net positive, which usually precedes growth acceleration. The AI data center CapEx boom remains a large part of this expansion. The major hyper-scalers will spend nearly half a trillion dollars next year on the buildout and place GDP growth for the economy at 1.67%.
This spending won’t stop any time soon. According to reports Larry Page said, “I am willing to go bankrupt rather than lose this race.” Mark Zuckerberg said he would rather risk, “misspending a couple of hundred billion dollars” than miss out on developing super intelligence.
A new housing cycle will be another key driver of growth. The administration will want to boost overall growth ahead of mid-term elections next year. As a part of this, they are likely to declare a housing emergency and tap into $35 trillion dollars of housing equity built up. Housing makes up only 15-18% of the economy, but it punches above its weight through a multiplier effect of additional amenities homeowners can purchase.
Federal spending will diminish via a Fed cutting cycle. The Fed cut 25 bps in September and is likely to reduce this further at least once more this year and multiple times next year. The current expectation is to reach around 3% on the Fed funds rate by the end of next year. This cut is possible due to an expansion of AI with productivity per worker at all-time highs.
Evidence from academic studies and company anecdotes suggest that AI is already boosting labor productivity by over 26%. This will only increase as more sophisticated models emerge and drive wage disinflation. It will also likely lead to lower job creation, allowing the Fed to cut further. This quote from Palantir’s CEO Alex Karp sums why the Fed will be able to cut for productivity, inflation and employment, “We’re planning to grow our revenue, while decreasing our number of people. This is a crazy, efficient revolution. The goal is to get 10x revenue and have 3,600 people. We have now 4,100.”
The markets are starting to sniff out this acceleration of growth. Cyclical names such as steel maker Cleveland Cliffs are up over 15% in the past month. Caterpillar is up 43% over the last six months. Contrarily, it’s both boom and bust for semiconductor names such as Micron who is up 42% over the past month. The metal and mining ETF is up 65% in the past six months. Copper looks like it could break out. Asian markets are up 38% for the year, Africa up 56%, Latin America up 37%. The yield curve has steepened. Financial conditions are loosening as the American dollar loses value. Most importantly, earnings expectations are accelerating upward with growth into double-digits this year and more predicted for next year.
Financials are in the process of re-rating due to benefits from a steeper yield curve, increasing IPO and M&A activity, deregulation, lower capital requirements, and margin improvement from AI & technology. Their balance sheet and income statement are levered to improved rates. They trade at just 15x in cash flow, compared to 20x for S&P (a 25% discount). Earnings are expected to grow substantially by the beginning of 2026. There is an upside to these numbers. M&A and equity capital market deal volumes are up 40% compared to last year. The leveraged buyout of Electronic Arts this month was also the largest in history by a wide margin.
This means risk-taking is back on the menu. Basel III endgame will make capital requirements lower. Bank mergers have risen to a four-year high. Morgan Stanley’s co-head of the financial institutions group sees the possibility of $100 billion in bank consolidations within the foreseeable future. Margins have expanded by 20%, trailing only tech within S&P and will continue to expand as technology and AI merge further.
Goldman’s CEO said, “the initial registration prospectus for an IPO might have taken a six-person team two weeks to complete, but it can now be 95% done by AI in minutes.” Virtual assistants like Wells Fargo and Bank of America’s Erica automate 80%+ of customer inquiries, reducing staffing costs and improve overall satisfaction. In the long-term, this could trade as a growth sector with new financial infrastructure on the blockchain, stablecoins and tokenization.
Looking forward, the market will focus on third quarter earnings, the economic data, geopolitics, and the latest from D.C.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
