Tech boom still driving growth

But does surge in AI capital investment mask underlying weakness?

At first glance, the U.S. economy continues to look resilient. Headline GDP growth remains intact, equity markets are buoyant, and the unemployment rate is hovering near cycle lows. Yet beneath this surface strength, the picture is more nuanced. Specifically, is a concentrated boom in artificial intelligence (AI)-related capital investment masking underlying weakness?

Massive investments in data centers, advanced semiconductors, and cloud infrastructure have meaningfully contributed to GDP growth. However, outside of Big Tech, many companies remain cautious in deploying capital, citing uncertain returns from early AI adoption and ongoing cost pressures. The risk is that this tech-driven boom becomes too narrow and collapses under its own weight.

U.S. manufacturers are showing clear signs of strain. Tariffs on imported goods have pushed up input costs and squeezed margins across a range of industries, from automotive to consumer electronics. Some of these costs are being passed onto consumers, contributing to inflation in specific categories. Small businesses are disproportionately exposed, lacking the scale or pricing power to absorb tariff shocks.

Cracks in the labour market are also starting to appear. While unemployment remains low, jobless claims have started rising modestly. Job openings, hire and quit rates are falling simultaneously, signaling decreased demand for labour and ebbing worker confidence.

Key supports not to be overlooked

Despite these red flags (which have a tendency of being overly scrutinized by the media), there are numerous key supports that should not be overlooked. In terms of economic impact, services overshadow manufacturing by a wide margin. Per the chart below, services now account for roughly 70% of the U.S. economy, while manufacturing has slid to 10%. Services in aggregate continue to show relative strength, with solid earnings growth and resilient demand.

While trade policy has undoubtedly created uncertainty for businesses and consumers, other government initiatives should have the opposite effect. The passage of the “One Big Beautiful Bill” will provide a boost to domestic demand after a short-lived effort by DOGE to rein in the fiscal deficit. Deregulation initiatives should provide a tailwind in several industries. Banks are a standout in this regard, as the potential for lighter capital requirements would increase the availability of credit and boost profitability.

Monetary policy is somewhat mixed. Federal Reserve officials have recently signaled a shift in tone, with the prospect of rate cuts gaining credibility amid the cooling labour market. Lower rates could help unstick housing markets and ease financial conditions for businesses strained by higher borrowing costs. However, the likelihood of a deep rate-cutting cycle is low, considering annual inflation measures are already above the Fed’s target level and could be further exacerbated by tariffs.

Putting it all together, the U.S.’s massive AI spend continues to distort aggregate growth figures, but warning signs for the underlying economy, while concerning, should not be exaggerated. Predicting more steady policymaking from the current U.S. administration may be wishful thinking, but the destabilizing impact of on-and-off tariffs should recede as deals with major trading partners are reached. That would go a long way towards restoring hiring and spending intentions amongst U.S. businesses. While we continue to see better growth opportunities in other markets (see our recent Ask Forstrong: Postcard From Europe piece), continued resilience in the U.S. would be supportive of global growth and investor sentiment alike.

Here’s a top-line summary of our current asset strategy.

Cash and currencies. The U.S. dollar appears to be at a critical inflection point; rolling over against most major currencies from a starting point of overvaluation. At the same time, the recent change in Canadian leadership marks a shift to a more business-friendly, pro-growth political landscape. We have increased the Canadian dollar hedge on U.S. asset class exposures in client portfolios.

Bonds. Longer-term government bond yields in most major markets continue to grind higher as investors demand a larger term premium to compensate for inflation and fiscal largesse concerns. While the higher yields improve the risk/return trade-off, we believe the adjustment at the long-end of the curve has further to run. Fixed income exposure has been kept below benchmark this quarter.

Equities. Smaller U.S. companies typically have weaker balance sheets, less operational flexibility and limited lobbying influence, making them more exposed to supply chain disruption risks and elevated financing costs. Forward earnings confirm these vulnerabilities, as weakening revisions flash warning signals for the small and mid-cap cohorts. We have trimmed exposure to U.S. mid-cap equities in client portfolios.

Opportunities. With the U.S. Federal Reserve unlikely to deliver aggressive easing absent a material economic slowdown, a further bull steepening of the yield curve appears constrained. As a highly leveraged and rate-sensitive asset class, mortgage REITs are particularly vulnerable to fiscal uncertainties and tariff-related shocks, with higher hedging costs eroding potential returns. A high-yielding position in U.S. mortgage REITs has been trimmed in Forstrong’s income-oriented strategies and liquidated in balanced strategies this quarter.

Visit the Forstrong Insights page to stay informed on our global macro thinking and strategy updates.

David Kletz, CFA, is Vice President and Lead Portfolio Manager at Forstrong Global Asset Management. This article first appeared in Forstrong’s Insights Blog. Used with permission. You can reach David by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at dkletz@forstrong.com.

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