Markets Lean Risk-On as Policy and AI Drive the Late-Cycle Trade

Synopsis

This week’s Lenses explores a market leaning risk-on even as late-cycle cracks widen. Value is outperforming Growth, ESG and Republican-policy themes are gaining on lower yields and pro-industry headlines, while AI momentum continues to drive optimism—but with rising fragility beneath the surface. With tariffs threatening to stoke inflation and cyclicals stretching higher, investors face a market priced for perfection where even a modest policy or earnings slip could trigger a sharp unwind.

Lens 1: Surprise Metric

Our “Surprise Metric” reveals factor movements outside of their historical return distributions for different horizons (Surprise 1W, 1M, 3M columns below). Values above 1 (below -1) standard deviation suggest outsized strength (weakness) relative to history (data sourced from our open ecosystem of risk model providers).

End Date: 10/3/2025

^{* Arrows represent directional change in 1W Surprise Metric. Single arrows indicate 1X or larger difference from previous week and double arrows indicate a 2X or larger difference. Horizontal arrows indicate minimal change.}

Highlights

• Late-cycle rotation takes hold: Value outperformed as Growth and Quality lagged, signaling investors are leaning risk-on despite mixed economic signals. With ADP and ISM jobs data diverging, a delayed payrolls print could spark volatility if labor weakness resurfaces.
• ESG rebounds on rate-cut bets: Falling yields boosted long-duration, capital-intensive sectors like clean energy, utilities, and infrastructure—suggesting ESG’s rally may have more to do with macro positioning than renewed conviction in sustainability.
• Cyclical momentum accelerates but risks mount: Vol and Beta climbed alongside market highs driven by AI and tech cap-ex. While near-term strength persists, stretched valuations and bubble-like dynamics leave room for a sharp sentiment unwind if growth expectations cool.

Lens 2: Thematic Crowding

This snapshot reveals thematic hedge fund exposure by measuring the beta of a Wolfe Hedge Fund Crowding factor portfolio to key market themes, calculated from residual return data. Higher beta indicates greater crowding in the theme, while lower beta suggests contrarian or avoided positioning to the theme. Data used for this analysis extends back to Jan 1st, 2024. 

How to read this graph

Highlights

• AI momentum rebuilds—but fragility looms: Institutional flows are creeping back into large-cap tech and AI infrastructure, reviving the trade on strong earnings and optimism. Yet stretched valuations and rapid hardware obsolescence mean any slowdown in AI buildout could erase wealth quickly, triggering broader market and capex reversals.
  
• Tariff pressures mount: The theme slipped as new duties on autos, trucks, textiles, and home goods deepened uncertainty. With import costs only partly passed through, rising margin strain could re-ignite inflation risk and challenge rate-cut expectations.
  
• Republican policy gains traction: The theme advanced toward cycle highs amid optimism for deregulation and onshoring. The Trump-Pfizer deal—exempting U.S.-made drugs from tariffs—underscored support for domestic manufacturing and lifted sentiment in health care, industrials, and energy tied to pro-business policy.

For Further Discussion: 

As you digest this week’s Lenses, consider further discussion on the following points:

Are we underestimating the fragility beneath the AI boom?
With institutions re-entering high-valuation AI names, could even a modest slowdown in datacenter buildout or earnings momentum trigger a broader reversal in tech-led wealth effects and capital spending?

Will policy divergence reshape market leadership?
As Republican-linked sectors benefit from pro-industry deals and ESG rallies on lower yields, is the market pricing a durable policy shift—or just reacting to short-term rate and headline noise?

Can markets sustain risk-on momentum amid rising inflation pressure?
With Value outperforming, cyclicals surging, and new tariffs threatening to re-ignite cost inflation, are investors leaning too heavily into optimism before labor and pricing data confirm a soft-landing path?

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Omega Point can help you surface and explore these questions with data-driven clarity. Reach out if you'd like to dig deeper into any of these themes.