Summary of Section One
- Interest Rates: We expect the Fed to cut at the October 29 meeting; QT is likely to wind down, adding liquidity.
- Economy: The Beige Book shows a late-cycle slowdown: weaker discretionary spending and services, softer manufacturing, cooling labor, and margin pressure.
- Credit: Loan demand is slower, standards are tightening, and delinquencies are edging up.
- AI buffer: AI capex is propping up growth and helping avert recession, but it masks broad underlying economic weakness.
As I write this article, we are in the third week of the government shutdown, which means there is limited economic data to parse through. However, the Federal Reserve did release its so-called “Beige Book,” so called because of the cover color of this hefty report. Its official title is the “Summary of Commentary on Current Economic Conditions by Federal Reserve District.” It is published eight times per year and provides helpful anecdotal information from the most significant companies, bank directors, business contacts, community leaders, and market experts across the 12 Federal Reserve districts. The Fed uses this information in setting monetary policy, including interest rate policy.
The Fed’s next interest rate-setting meeting is set for October 29.
By the time this article is published, the government may have reopened and will be collecting critical economic data again. However, a significant amount of data has been lost, making the Beige Book even more important than it typically is at the Fed’s next meeting. Here is what the most recent Beige Book says and what it means for the U.S. economy and interest rate policy.
(Note: Many professional financial advisors and business owners read the “Capital Ideas” column, so I wanted to be thorough for them. However, I recognize it is overkill for some readers. If you are not making your own business and investment decisions, I highlighted and underlined the comments for you to focus on to save you some time.)
Big picture. The National Summary pegs activity as “little changed,” with three Districts up slightly, five flat, and four softening. The weak spots include eased consumer goods spending, fading international leisure demand, manufacturing facing tariff-related headwinds, and generally declining activity in agriculture, energy, and transportation.
Labor was stable but cooling (more firms were trimming via attrition, but not a lot of hiring or firing), and price pressures persisted as tariffs lifted input costs while health insurance expenses jumped. In several districts, firms held selling prices to protect their share, compressing margins.
Consumers pulling back, especially on travel and “extras.” The Sixth District (Atlanta) reported retail sales down slightly, diners skipping desserts and alcohol, and leisure travel softening with shorter booking windows and lower hotel occupancy; auto sales were buoyed near term by an electric vehicle credit expiration deadline, not underlying strength.
The 12th District (San Francisco) reported a decline in retail trade, slowed foot traffic in tourist areas, and closures of some full-service restaurants; others reduced portions or modified recipes to address ingredient inflation and customer backlash.
The Ninth (Minneapolis) cited lower foot traffic, revenue, and hotel occupancy across most of the district and noted consumers “looking for value, deals, and ways to stretch their dollars.”
The Eighth (St. Louis) went further with a telling anecdote: A Missouri hotel owner described conditions as a “middle-class recession,” with select-service properties hit hardest as food-pantry usage and buy-now-pay-later reliance rose.
Services are wobbling; the tourism mix is less favorable. The Second District (New York) flagged a decline in services overall. Retail, leisure/hospitality, and business services were all weaker, with a sharp contraction in the information sector. Domestic tourism in New York City held up, but a drop in international visitors, typically higher spending, hurt attractions and restaurants. Broadway attendance was “solid,” but other cultural venues were flat to down; hotel room demand edged up, but at very high rates, a sign that price, not volume, is doing the work. Households outside the highest income brackets have been slowing down their consumption.
Manufacturing: demand is soft, tariffs are biting, and confidence is fragile. The Seventh (Chicago) registered a modest decline in manufacturing, with machinery orders down and an employment agency citing weaker factory hiring; one trucking contact called conditions “recession-like.”
The Fourth (Cleveland) said orders slipped, explicitly tying weakness to tariffs and trade uncertainty; suppliers to industrial and agricultural-equipment producers ran roughly “25 percent” below expectations. New York manufacturers cited surging input costs (steel, packaging, imported components), and even a keg maker paused production amid high steel prices; others saw overseas demand dented by shifting trade dynamics.
Richmond manufacturers reported stepping down product specifications to meet newly price-sensitive customers (e.g., cheaper parts, refinancing equipment instead of replacing it). These are the behavior changes you see when end-market demand softens and pricing power fades.
Credit: demand softer, standards tighter, and a few cracks. The Third (Philadelphia) reported that bank lending volumes declined moderately compared to the previous year, primarily due to steep drops in commercial and industrial lending and a modest decline in commercial real estate (CRE) loans. Lenders attributed this to businesses delaying investments and paying down lines, resulting in a “slight rise” in delinquencies/defaults.
The 10th (Kansas City) reported “moderate deterioration” in consumer loan portfolios and expects more pressure over the next six months, particularly among lower-income borrowers or those tied to discretionary industries. The 11th (Dallas) saw loan demand up modestly but also a slight deterioration in overall performance; service-sector outlooks worsened on slowing demand and policy uncertainty. The 12th (San Francisco) noted steady lending but more borrower caution; an Utah contact flagged rising fraud-related losses. Together, this reads as late-cycle credit normalization; it is orderly but heading the wrong way.
Housing and CRE: uneven at best, more price discipline. Residential markets generally cooled. Atlanta reported home sales down and more buyers failing to qualify as credit profiles deteriorated; inventories rose in parts of Florida. San Francisco experienced longer listing times and higher inventories, with developers relying on incentives; meanwhile, some northern California prices eased. Philadelphia’s realtors noted that would-be home buyers were pushed into rentals.
On the commercial side, Richmond brokers are worried that Class-B offices will tumble into receivership because “the math doesn’t work.” Kansas City logged a moderate decline in CRE development and construction employment, with data-center builds soaking up scarce skilled trades in a few pockets. Dallas found apartment leasing competitive, rents under pressure, and office leasing “more stable” but still cautious with short-term deals.
Prices and costs: tariffs up front, health insurance in the back. Multiple districts highlighted tariff-driven input inflation, ranging from beef, coffee, and chocolate at Cleveland retailers to electronics, auto parts, and appliances in New York. Meanwhile, employers across regions reported significant increases in health insurance premiums, which pressured labor costs despite cooling wage growth. Some firms are absorbing more of these costs to avoid alienating price-sensitive customers; others are selectively passing them through or adding surcharges. That pattern of rising costs and weaker pricing pass-through compresses profit margins and typically precedes slower hiring and capex.
Transport, energy, and agriculture: soft. Freight volumes weakened in several districts (Richmond reported an “unseasonal” August decline and a carrier describing a price “race to the bottom”), and Atlanta trucking firms saw an “acceleration” in consumer-goods shipment declines. Dallas energy contacts kept rigs parked and warned breakeven prices are rising; 10th District oil and gas activity fell modestly with lower capex plans. Agriculture was a drag in Minneapolis (low crop prices despite record harvests, China turning away soy purchases) and St. Louis (weather-hit crops and strained farm finances), with Kansas City bankers seeing deteriorating agriculture credit in crop-heavy areas.
Quotes from business contacts
- Richmond, trucking/freight: Competition described as a “race to the bottom until it breaks.”
- St. Louis, hotel owner: Travel demand from middle-class consumers has dipped, calling it a “middle-class recession.”
- Richmond, CRE brokers: “These buildings, in their current condition, won’t sell for yesterday’s prices” … and for some projects, “the math doesn’t work.”
- Minneapolis, MWBE manufacturer/retailer: The downturn in demand was described as “drastic,” with consumers cutting back on non-necessities.
- New York, services: Firms in the information sector reported a “particularly sharp contraction.”
- New York, banks: “Credit standards tightened. Delinquency rates worsened slightly, especially for business loans.”
- Richmond, residential real estate: “Forty-five percent of listings experienced price reductions due to initial overpricing.”
- Richmond, small-business strain: A jeweler is “contemplating closing due to economic uncertainty and declining demand.”
- St. Louis, household stress signals: Rising “food pantry usage”; more “buy now, pay later” reliance; and “elevated credit card delinquency rates.”
- Kansas City, consumer credit: Banks noted “moderate deterioration in consumer lending portfolios” and expect more challenges over the next six months.
- Richmond, borrowers and rates: Many borrowers still have a “sideline mentality” waiting for “more certainty in the overall economy and rates.”
- Minneapolis, agriculture: Contacts were “extremely concerned” after China’s decision not to order U.S. soybeans, with low crop prices “weighing down producer incomes.”
Bottom line. The Beige Book does not scream recession, but it sketches a late-cycle slowdown: consumers trading down and traveling less far; services wobbling where international tourism matters; manufacturers squeezed by tariffs and soft orders; banks reporting softer loan demand and a touch more delinquency; housing cooling; and freight, energy, and agriculture under pressure. I believe the capital expenditures by artificial intelligence (AI) companies will support the economy and keep the U.S. economy out of recession. (U.S. Gross Domestic Product growth for the second quarter of 2025 was 3.8 percent, and approximately 40 percent of that could be attributable to AI spending.) However, the top-line growth from the AI boom is masking a meaningful, broad-based loss of momentum underneath.
The Beige Book survey supports further interest rate cuts by the Federal Reserve. However, inflation is becoming a problem again. The Fed should not cut rates later this month, but I believe they will.
Further supporting the idea that the Fed will cut rates again is that Chairman Jerome Powell has signaled that it will wind down its quantitative tightening as early as December 2025. The Fed has not been buying new bonds when bonds on its balance sheet mature. It is now considering buying more bonds with proceeds from maturing bonds in response to tightening liquidity in financial markets, once bank reserves are at a level deemed “consistent with ample reserve conditions.”
Cockroaches are threatening banks
Summary of Section Two
- Signal, not a crisis (yet):
- A one-day six percent plunge in the KBW Regional Bank Index, along with a cluster of fraud-linked charge-offs, serves as a credit warning.
- M&A tailwind: Conditions are set for the most significant regional/community bank consolidation since the 1990s.
- What we’re watching for a pivot: A pickup in layoffs, further fraud/charge-off clusters, and deal flow acceleration.
The KBW Regional Banking Index crashed six percent on one day in October 2025, which was its worst day since the April tariff chaos earlier this year. Regional banks are not the giant banks known across the country, and they are not the small-town banks making mom-and-pop loans. Think, somewhere in the middle, but on the smaller end of that range.
One regional bank announced it would take a $50 million charge-off to cover two loans taken out by borrowers facing legal actions. (A “charge-off,” sometimes referred to as a “write-off,” is an accounting term used by a creditor, like a bank, to indicate that a debt is unlikely to be collected.) Another bank filed a lawsuit against one of its customers, alleging that it committed fraud. Locally, Barron’s reported that clients are suing Berkshire Bank for its alleged ties to a $50 million Ponzi scheme.
Then, going up to the national level for banks, JP Morgan reported a $170 million charge-off connected to the bankruptcy of an auto-loan lender that was accused of fraud. Jamie Dimon, the CEO of JPMorgan, warned investors that “when you see one cockroach, there are probably more.”
Will Dimon be right? Well, it seems odd that there were so many fraud-related loan write-offs and other shenanigans in such a short period of time. But I won’t only be looking for cockroaches; I will also be on the lookout for other warnings as well as opportunities.
Two strategic implications follow from these cockroaches potentially crashing the economy. First, bank stocks are classic cyclical barometers that remind investors that commercial credit is where cracks appear first. We should watch employment next; real trouble typically shows up after layoffs bite, but we are not there yet.
Second, the setup favors consolidation, which presents an opportunity. The large banks are doing well, including JPMorgan. JPM’s charge-off amounted to 6.6 percent of net charge-offs this quarter; without that exposure, charge-offs at JPM would have beat expectations just like every other money center bank that reported so far this quarter.
With merger and acquisition burdens relatively light and technology allowing for easier operational integration, I would not be surprised to see the most significant M&A wave in regional and community banks since the 1990s. That is a tailwind for the best-run capital-markets banks now, and a likely exit route for weaker institutions.
A few more words on the stock market bubble
Summary of Section Three
- Not a bubble…Yet: The S&P 500’s P/E is rich, but prices have fundamental underpinnings.
- What would confirm a bubble: A parabolic run-up followed by large, fast swings. A plain correction from here would not prove bubble; a melt-up would.
- If a true bubble forms, we aim to ride the upside and manage the exit.
I believe a bubble is forming in the stock market, but it is not a bubble yet. The forward 12-month price-to-earnings ratio of the S&P is very elevated at 22.4, above its 10-year average of 18.6. However, the P/E ratio is up only one percentage point year over year, while earnings are up 11 percent. Stock prices appear to be more fundamentally driven than anything else. Or, if it is a bubble (we all have different definitions of “bubble”), it will get bubblier before it pops.
For quite some time, before the ubiquitous question of whether the market was in a bubble, I had been saying that there was a non-zero chance of a bubble forming. That had been my clever way of saying that this is going to get good, maybe too good. So, is it “too good” now? Not yet, at least not if you are defining “too good” by bubble standards.
The most obvious comparison of today’s stock market has been to the dot-com bubble of 1999, when the global economy was experiencing its Third Industrial Revolution. There have actually been several major bubbles over the centuries, and many of them were not associated with the stock market. But for now, let’s focus on 1999 and the bubble in technology stocks and compare the stock market to what is occurring now, during the world’s Fourth Industrial Revolution. And let’s use the Nasdaq stock index as a proxy for the stocks participating in these revolutions.
The Nasdaq is up about 18 percent year to date and has averaged almost 28 percent over the last three years. That is amazing, but are those the types of returns we should expect in a bubble? Yeah, kinda.
The Nasdaq compounded annually at 31 percent from 1995 to 1998—that is not too different from the 28 percent of the most recent three-year average.
The Nasdaq shot up 35.3 percent from January 1999 through October 1999, compared to about 18 percent year to date in 2025. That is not as similar as the previous three years, but it is directionally correlated.
But then things really got crazy in November and December 1999, when the index jumped 37.3 percent. That is not a type—37.3 percent in two months. It then rallied another 24 percent until its peak in March 2000.
Then it got hard from there. The index fell 34 percent in five weeks, then rallied 29 percent in three months, then fell another 42 percent by year’s end. In the middle of it all, investors struggled to determine whether the 29 percent rally marked a new bull market or merely a head fake. But it was nont the pullback that signaled the end; it was that blow-off top. The returns up until November 1999, like those of the last few years, were robust, but not excessive. The second sign was indeed that massive downside volatility. The Nasdaq could decline significantly from here. However, a clearer signal that we are in a bubble is not a decline, but rather if it experiences a blow-off top.
So, what is my investment strategy? There is a bubble in talking about bubbles, but not in the stock market. The pervasive concern of a stock market bubble is an investor worry, and the stock market climbs a wall of worry. The concern is a behavioral tailwind for the stock market, suggesting it is not yet in a bubble.
Will there be a bubble in the stock market? I hope so. Sure, there will be a massive crash on the other side of it, but that gives us opportunities to make money on the way up and to (hopefully!) get out later.
