Weekly Market Update: The Bigger Picture Behind July’s Turn
July delivered the third major shift in financial markets this year, following the turns in March and April. The AI and semiconductor trade that had led all year reversed sharply, sliding into a bear market as investors moved from rewarding capital spending to scrutinizing it.
At the same time, the re-escalation of the U.S.-Iran conflict reopened the channel that runs from oil to inflation to Fed policy. Major indices pulled back from record highs, the VIX drifted toward 20, and the Fed turned more hawkish. The damage, though, has been relatively concentrated.
AI stocks have entered correction territory, but credit spreads remain near cycle lows and breadth has improved, making this something close to a mirror image of early in the second quarter.
Our base case is for volatility to stay elevated, with wide dispersion and continual rotations as the market works through two open questions: whether the AI pullback is the first crack or a healthy mid-cycle reset, and whether the oil-inflation-Fed risk builds or fades.
The setup carries wide tails in both directions, and we are positioned to stay flexible.
Looking further out is harder given the pace at which markets are moving. Yet for all the swings in sentiment this year, major indices remain near record highs, and the consensus still calls for a soft landing, a reflection of the economy’s resilience even through a global oil supply disruption.
The bull case is now driven more by corporate earnings than by expectations for lower rates, with AI-related investment the dominant structural force behind earnings growth. Much of that is already viewed as priced in, and expensive valuations paired with unresolved tensions in the Middle East introduce real downside risk.
The next twelve months likely turn on whether earnings can grow into elevated valuations and whether inflation and energy prices stay contained.
Current Market Themes
Federal Reserve Policy: The Fed remains on hold but continues to shift hawkish, with markets now pricing in two rate hikes (September 2026 and early 2027).
Corporate Earnings: A strong second quarter, with the S&P 500 posting its seventh straight quarter of double-digit year-over-year growth and record margins.
Artificial Intelligence: AI capex is powering both economic and EPS growth, though expectations are very high and the industry looks set to stay volatile.
Economic Factors
U.S. GDP Growth: Q2 growth slowed from the first quarter, though core growth (real final sales to private purchasers) held up solidly despite the oil disruption.
Inflation: The oil supply disruption pushed inflation higher, and with oil prices still volatile, there is a risk it stays above target.
Employment: Labor conditions are improving after weakening in late 2025, with the market still relatively tight and “low-fire, low-hire.”
U.S. Consumer: Supported by strong equity and labor markets, but facing headwinds from slowing income growth and inflation pressure.
Interest Rates: Rate volatility has come down from recent years, though rates should stay volatile given oil prices and economic uncertainty.
Long Duration Bonds: Neutral to modestly overweight, driven mainly by inflation risk and economic uncertainty; favor Treasuries over corporates.
