Earnings Trumping the Noise (Pun Intended)…
Executive Summary:
Beneath the Volatility, Resilience Remains: Despite one of the sharpest momentum unwinds on record in July, global equities finished the month essentially flat. This stability was driven by a textbook sector rotation, remarkably strong corporate earnings, and macro data that continues to point to a resilient, rather than breaking, economy.
Earnings Unforgiving, Yet Historically Strong: Q2 earnings are tracking for the broadest beat rate in five years, but the market's reaction has been highly discerning. Investors are aggressively rewarding companies that demonstrate tangible operating leverage and clear paths to AI monetization, while severely punishing those with even slight execution disappointments.
Navigating Rate Friction Amidst Long-Term Tailwinds: An intentionally opaque Federal Reserve, combined with massive fiscal deficits and hyperscaler debt issuance, has pushed long-term Treasury yields to multi-year highs, creating near-term market friction. However, the foundational long-term trend of asset prices compounding alongside global money supply growth remains firmly intact, providing a highly favorable backdrop for investors willing to ride out the volatility.
Full Commentary:
The last several weeks have delivered one of the sharpest momentum unwinds on record, turning many of this year's favorite trades into one of the biggest sources of pain in July. Yet beneath the volatility, and validated by resilient economic data and remarkably strong earnings results, it doesn't seem like the broader story driving market outcomes has changed nearly as much as the price action might suggest. Earnings continue to surprise to the upside, AI investment remains firmly intact, and macro data continues to paint a picture of an economy that's slowing only at the margins rather than breaking beneath the surface. As I type, the S&P 500 is threatening the topside of the 7,400 – 7,600 range it's been trading in since early May, where it wouldn’t take much in the way of positive catalysts to break it out to new all-time highs. Markets are funny like that – test investor conviction before rewarding it, and perhaps that's exactly what the past two weeks have been about.
Without question, the month of July had its share of fireworks, but when all was said and done, global equities were essentially flat on the month (-0.3%). The same was broadly true for the S&P 500 (-0.1%) and Rest of World (ROW) stocks on a dollar basis (-1.1%). The U.S dollar weakened somewhat last month (DXY Index -1.4%), so on a local currency basis ROW was down about -2.5%. What kept the major averages afloat during what was an elevated bout of volatility in the Tech, Media, and Telecom space was a textbook rotation month, where headline returns belie dramatic activity just under the surface. After a strong Q2, Tech-related parts of the global equity market (US large caps, EM stocks) gave up some of those gains. And, because the US/global economy is still growing, that capital flowed to other sectors and geographies (non-Tech US large caps, Europe).
Adding to the intrigue is the ongoing standoff in Iran where both sides are heavily incentivized to save face (the IRGC in particular). But perhaps we’re finally nearing an end to this winless war. President Trump flexed his military muscles over a two-week period and unleashed more damage on Iranian infrastructure and pledged to do even more. Iran does its retaliatory strikes. Next thing you know, the back channels are being worked with Pakistan as mediator yet again, and the two sides are talking. I know each side has a different interpretation of what constitutes talks, but it's more reasonable than not to think they are ongoing. Who is talking for the Iranians, nobody really knows, but what we do know is that the economy there has really cratered, and it is getting worse.
It’s become obvious that all the regime wants to do is survive, buy time, and deter any nation from thinking about attacking Iran in the future. All the bluster aside, Trump appears to be okay with accepting the easiest and quickest solution while also being fine with kicking the can down the road on the nuclear (and ballistic missile) file, so long as he gets the Strait of Hormuz open. These Iran-Oman talks are likely to do exactly that while also extracting shipping fees, and the oil market realizes what is going on. Plus, the President has said he will continue to have “eyes” on Iran as a check. It’s pretty clear this administration kicked a hornet's nest that it can’t extricate itself from without getting stung, but pragmatism should prevail in the end. The U.S. can’t proclaim victory without putting troops on the ground, which would require decimating critical Iranian civilian infrastructure and military casualties. And, then what? What benefit would such a victory mean to the U.S.? It would pale in comparison to the loss of status on the global stage.
In other words, the war is probably over, notwithstanding the shenanigans by the IRGC – the U.S. can’t match the motivation of what it means for them vs. what it means for us. Iran gets its survival and no more U.S. bombing, and Trump gets lower gasoline prices as the midterms approach. And given how far left some Democrats have tilted, with the Independents cringing at the notion that Socialism is the desired outcome by many of these candidates, the GOP now senses it has a window to hang on to at least one of the chambers of congress, if not both. Indeed, that is the case. The far-left in the Democratic Party has opened the door for the Republicans (the far-right of the GOP elicits a similar opposition), and the GOP brass do not want Trump to blow it with another round of bombing that sends energy costs back up.
That’s all I have to say on politics, and I’m already fearful of putting that in print, but politics and policy are material for markets. While I’d like to ignore them in the interest of not upsetting a reader or a client, I simply can’t. The outcome of who retains or loses power in November will matter. It won’t be as important as some think it is, but it's far from irrelevant either.
While geopolitical and political theater dominates the headlines, the actual engine of market performance—corporate earnings—tells a much more resilient story. We’re coming off the biggest week of Q2 reporting season – 307 S&P 500 companies representing 70% of index earnings are in the books. What I think investors should take away from last week’s results is that perseverance (not perfection) is a more valuable edge for investing results. Roughly 86% of S&P 500 companies have exceeded EPS expectations, putting this on pace for the broadest earnings beat rate in five years, while aggregate earnings growth expectations have continued to move higher. 2Q S&P 500 EPS growth is tracking 26% YoY excluding investment mark-ups at Google, Microsoft, and Amazon, a 4% beat vs. consensus at the start of earnings season. Including one-time gains at Google and Amazon, S&P 500 EPS growth is tracking 45% YoY (see the chart below from Goldman Sachs).
The most fascinating aspect of the Q2 earnings season is seeing how discerning the market has been in the face of what are very strong aggregate results. Microsoft (MSFT) reaffirmed the AI investment cycle with stronger Azure growth and accelerating cloud demand (stock rips +15% the day after it reports). Amazon (AMZN) followed by delivering another decisive cloud beat (stock surged +15% on Friday), raising its long-term capex outlook as management described demand extending well into 2028. Those results reinforced the durability of the compute buildout and sparked renewed optimism across semis and networking. At the same time, Apple (AAPL) beat revenue but disappointed on Services growth (stock declined -7%), while Meta Platforms (META) reminded investors how little room remains for even modest disappointments (stock fell -8%). It increasingly feels like this earnings season is rewarding execution while punishing anything short of certainty – a high bar, but perhaps an understandable one after another year of exceptional AI-driven gains.
If anything, this earnings season is reinforcing that differentiation matters more than ever. CapEx alone is no longer enough to impress investors; the companies demonstrating tangible operating leverage and clearer paths toward AI monetization appear increasingly well positioned to lead the next phase. There will undoubtedly be more difficult weeks ahead, but perseverance has always been one of the market's more underappreciated advantages. Sometimes the strongest trends aren't defined by how they begin – they're defined by who is still willing to believe in them after the hardest stretch has already passed.
We also had a Fed meeting last week where the FOMC held rates steady, but three voting members dissented in favor of a hike. The markets' initial reaction to the pause was favorable, but the press conference went off the rails with Warsh's reluctance to provide forward guidance or any basis for the Fed’s reaction function going forward, leaving many of us with more questions than answers. His evasiveness during the Q&A created more volatility the longer he talked as investors attempted to interpret a reaction function that appears intentionally opaque. Perhaps it’s just growing pains for the new Fed Chair and a bit of a ‘getting to know you period’ for investors. Markets are still assigning meaningful odds to a September hike, but it increasingly feels as though the bar has shifted higher than initially feared. The challenge going forward may not be inflation itself but navigating a policy framework where uncertainty has become a feature rather than a bug.
Which brings me to interest rates, where I think if there is to be an August surprise, I believe it will most likely come from the U.S. Treasury market. Last week we saw the yield on 10-year T-notes go above 4.71%, and the yields on the 30-year Treasury rose to their highest level since 2007. The yield on 10-year Treasuries is in a window of 4.70%–5.0%, which has caused stress for stocks over the last 3 years. The catalysts will most likely be either higher oil prices and/or a Treasury market that continues to readjust pricing at the long end of the curve to incorporate a silent Fed rather than its prior, more loquacious iteration. During his press conference, Chair Warsh said the bond market is doing some of the Fed’s work for it. While that’s true, it does create incremental rate volatility and possibly lower equity valuations as a result.
On the other hand, perhaps there is more to the rise in interest rates than the market throwing a hissy fit because the Fed is no longer willing to spoon-feed it what its next policy move is going to be. I can think of three other factors that help to explain why long-term interest rates are at their highest level in 20 years: inflation, fiscal indebtedness, and the AI capex cycle fueling massive hyperscaler debt issuance. Let me remind you what the debt profile of the Federal government was back in 2007 (the last time long-term yields were here): total Federal debt outstanding was $8.95 trillion (62% of GDP) compared to nearly $40 trillion today (~120% of GDP). Annual deficits back then were running at $163 billion versus ~$2 trillion today. It goes without saying that the interest burden for today's debt load should not go unnoticed or underappreciated. We’re talking about a 4.5x increase in Federal debt outstanding and more than a 12x increase in the annual deficit. The bottom line is that we're not going back to the 2010s, and this is good news for everyone cutting coupons in high-quality fixed income.
Let me try to pull this altogether with some closing thoughts. The markets are in the process of feeling around in the dark a bit, and with that comes friction. But with the new Fed Chair in his post, Q2 earnings validating elevated valuations, and the Iran/U.S. conflict becoming normalized (if not nearing its end with no resolution), I get a sense that some rays of light are breaking through the darkness. What is important for investors in order to be on the right side is the broad thrust of policy direction, flows, and fundamental drivers. No, they are not always rowing at a synchronous rhythm, but more times than not they are rowing in the same direction. I think that is the case today, where the rhythm is a bit out of sync, but enough oars are going in the right direction that those that are out of sync aren’t stopping the boat from moving forward. The economy continues to be resilient, earnings are incredibly strong, flows are set to turn more positive, deficit-fueled spending remains a tailwind, and nearly $1 trillion of AI capex spending is sloshing around in the system.
I’m not saying there aren’t mounting risks (long-end yields, debt levels, rising levels of financing needs to fund the AI capex revolution…), but there are enough tailwinds with adequate force to skew the game net positive. Not to mention positioning and sentiment have become considerably cleaner after the big reset we’ve seen in the high-flying momentum names throughout July. In a nutshell, the outlook for most asset classes (stocks, bonds, precious metals and commodities) is still favorable, but the risk/reward is balanced.
I’ll leave you with the following chart, which measures the compound annual growth rate (CAGR) of asset prices (global value of stocks and bonds – blue bars) and global money supply (yellow line) over the past three decades. What you see is the yellow line going from the lower left to the upper right, illustrating that global money supply has increased at an annual rate of +6.9% over the past 33 years. It’s not an accident that asset prices have responded accordingly – compounding at an +8.0% annual rate. This is a trend that no investor should fight over a long-term holding period. If it changes, then everything changes, but until then, ride the trend and risk-manage the hiccup.
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