Quick Market Thoughts…
Executive Summary:
Market Breadth Expansion and Geopolitical Relief: The recent market rally has begun to broaden beyond mega-cap technology, with the equal-weighted S&P 500 reaching new all-time highs and small caps showing notable strength. Furthermore, an anticipated de-escalation between the U.S. and Iran could reopen the Strait of Hormuz, which should ease supply chain pressures and help mitigate the recent resurgence in inflation.
The Q1 Earnings "Accounting Mirage": While robust Q1 earnings propelled the major averages, roughly $60 billion of the S&P 500's reported net income stemmed from paper gains as tech giants marked up their private AI investments. Excluding these mark-to-market adjustments from Alphabet, Amazon, and Microsoft, the index's year-over-year earnings growth drops from a headline rate of approximately 28% down to the mid-to-high teens.
The Impending IPO Supply Shock and Yield Pressures: Upcoming IPOs from private AI companies like SpaceX, Anthropic, and OpenAI threaten to inject up to $4 trillion in new equity supply, which could drain liquidity and spark a rotation out of current market leaders. This massive equity supply shock is colliding with rising global bond yields and structural inflation, reinforcing the need for a prudently diversified portfolio that includes equities, bonds, cash, and hard assets like commodities and precious metals.
Full Commentary:
The S&P 500 put in its eighth straight week of gains last week (+0.91%), while the Nasdaq Composite added a more modest +0.48%, but what stood out was seeing the rally broaden out a bit with the Small Cap Russell 2000 ripping +2.75%, and the equal-weighted S&P 500 finally notched a new all-time high. For most of May, equity gains were highly concentrated in the Mag7, Semiconductor, and memory spaces as the AI trade overwhelmed everything else. This fueled the MSCI global momentum gauge to outpace the MSCI All Country World index by 17% since the end of March – on pace for its strongest two-month outperformance on record. However, over the past week (including today's price action), we’re seeing a welcome rotation into areas that have lagged during this latest ramp to new all-time highs.
It seems as though the U.S. and Iran are closing in on an agreement to resolve the Iran conflict. I’m sure we all have plenty to say about this issue, and the details of whatever deal gets inked will only add to the debate, but any ink I spill on the subject is grounded in an economic and market framework. And on this front, markets can’t get this conflict behind them soon enough. Neither the U.S. nor the Iranian regime appears to have a clean path out of a conflict that risks turning into a war of attrition around the Strait of Hormuz. That creates room for a tactical de-escalation, even if the political settlement remains fragile. Irrespective of the details agreed to in this “95%” completed deal, odds point to at least a partial reopening of the Strait, which is what matters most to markets. Not only on a global economic and supply-chain basis, but perhaps most importantly, it should ease the budding inflation resurgence. Investors have been front-running this inevitability since the ceasefire was announced back on April 7th.
I’m not sure most investors appreciate the speed and degree of this equity rally since the end of March. Humor me as I provide some useful context. This is just the twelfth time, going back to the early 1930s, that the S&P 500 has soared +18% from a trough in fewer than 39 sessions. Normally, this sort of buying frenzy occurs after a deep bear market and oversold lows that see sentiment and valuations washed out. We got a reasonable cleansing of sentiment and positioning, but it stopped well short of what the archives would describe as a washout. Moreover, on average, a rebound of this magnitude over such a short time frame occurs after a -25% drawdown, and it has never been less than a -10% correction. This time, the war-related slide didn’t even reach -9%. Then again, never before has the buy-the-dip psychology been as intense as it is today.
Investors focused solely on the geopolitical theater and politics in general to explain the market are missing the forest for the trees. Lost in the war narrative is the reality that a stellar Q1 earnings season was the primary driver of this move to new all-time highs in the major averages. Morgan Stanley compiled a comprehensive collection of earnings charts detailing the ratchet higher in S&P 500 earnings.
It’s not a fallacy that earnings are being driven by the AI revolution and the Mag 7, but if you look closely at the tan shaded bars in the following charts you can see a steady climb over the past several quarters/years in the other 493 companies not known as the Mag7.
What’s most important for investors looking ahead is that we continue to see the lines in the chart below for 2026 & 2027 net income revisions at least maintain current estimates, or, better yet, continue to rise. If so, investors shouldn’t fear the major indices being able to maintain what are elevated valuations.
Before moving on from the Q1 earnings results, there is an important nuance investors need to recognize as to why they came in so strong. A massive portion of the Q1 2026 S&P 500 earnings "beat" was effectively an accounting mirage driven by mega-caps marking up their private AI investments. Because these massive tech giants own substantial stakes in pre-IPO companies like Anthropic, SpaceX, and OpenAI, accounting rules (specifically GAAP rule ASU 2016-01) require them to revalue those stakes on their balance sheets whenever a new funding round or a private secondary trade establishes a higher valuation.
When the underlying private valuation rockets up, the public company has to book the difference as raw profit under "Other Income" on its income statement, even though no actual stock was sold and zero cold hard cash entered its bank accounts. In a nutshell, the S&P 500 generated roughly $630 billion in earnings in Q1, but roughly $60 billion of that represented purely paper gains. This included Alphabet booking a $37.7 billion gain (which completely skewed the entire Communication Services sector), Amazon padding its EPS with $16.8 billion from Anthropic, and Microsoft recording $5.9 billion from OpenAI.
Investment gains from just those three companies accounted for roughly 9.6% of the entire S&P 500's net income for the first quarter. If we strip that $60 billion out of the pool, the aggregate operating earnings for the S&P 500 drop to $569 billion, shifting the YoY index growth rate down from ~28% to the mid-to-high teens. It is a stark reminder of how heavily private market valuations for AI infrastructure are currently dictating public market headline profitability.
Keep in mind that these three massive private companies are in the process of finalizing their S-1’s to go public later this year. As a result, it's unlikely there will be any further marking-to-market of these companies until they go public, which means we should get a cleaner look at unadjusted operating earnings growth from the S&P 500 going forward.
It’s worth noting that this knife cuts both ways once these companies go public. When the shares convert from private to public, the hyperscalers will have to mark their stakes to the closing public market price at the end of that quarter. If the IPOs price aggressively and pop on their debut, we could see another massive, one-time injection of paper profits into the S&P 500 earnings pool, similar to Q1. However, if the stock price of SpaceX, Anthropic, or OpenAI drops 20% in a subsequent quarter, Amazon, Alphabet, and Microsoft will be forced to book multi-billion-dollar pre-tax losses on their income statements. This is the exact dynamic Amazon experienced in 2022 after the Rivian IPO. Amazon's headline earnings were crushed for consecutive quarters simply because Rivian's stock price plummeted, masking the fact that AWS and the retail core were still generating tremendous cash flow.
This is yet another layer to the AI cake that is matriculating its way through pricing of markets at the moment. And perhaps lost in all the excitement over these companies coming public as early as this summer is the fact that they are estimated to have a combined IPO valuation of up to $4 trillion. That would represent a potential +6% expansion of U.S. public equity supply, the kind of issuance wave that could start to challenge a rally already dependent on narrow AI and semiconductor leadership.
SpaceX’s planned listing could target a valuation above $2 trillion, despite skepticism that this would amount to roughly 100 times revenue based on reported sales of about $20 billion last year. The bullish case rests less on conventional valuation and more on the story of “optionality” around Starlink, launch dominance, space-based data centers, moon infrastructure, and Mars ambitions. The retail angle is striking as well: if SpaceX sells as much as 30% of a $75 billion share sale to individual investors, that would mean a $22.5 billion retail allocation – larger than all individual-investor net inflows into stocks and ETFs over the past month. Investors should be asking themselves: Where does the money come from to buy this new equity supply? The capital required to absorb this historic float must be reallocated from somewhere. Mechanically speaking, to fund these multi-billion-dollar IPO purchases, institutional and retail investors will likely need to sell existing assets, potentially sparking a rotation out of the very Mag7 and semiconductor leaders that have carried the market thus far.
I’m going to touch on the bond market before signing off on this week’s missive, as I believe it was the recent break higher in yields that was starting to unnerve markets in the early part of last week. Below is a chart of the yield on the 30-year T-note, which has since reversed lower after rising to 5.18% last week.
It’s a similar story for the 10-year T-note which climbed to 4.69% last week, but has since backed off to 4.5%.
The rise in interest rates isn’t just a U.S. phenomenon. Yields on long-term government bonds across the globe have climbed to their highest levels since the GFC in 2008.
This could be both a blessing and a curse for investors. A blessing in that investors more interested in income and capital preservation rather than capital appreciation and ‘number go up’ strategies have an investment option with a risk/reward profile that hasn’t been available to them in nearly two decades. Admittedly, I’m finding some areas of the bond market too enticing to pass up. The curse would be if the current resurgence in inflation doesn’t prove to be transitory. The combination of higher inflation, deglobalization, and indulgent fiscal policy is a toxic cocktail for bonds if left unchecked. As global supply chains continue to fragment and nations prioritize domestic industrial resilience over cheap foreign labor, the resulting deglobalization inherently drives structural inflation. This shift directly supports the necessity of holding hard assets to protect purchasing power.
Our work continues to suggest that 10-year Treasury yields north of 4.75% and 30-year yields above 5.25% are a problem for the global economy and capital markets. Last week, we were flirting with these levels, which started to cause agita in markets, and repeated announcements by officials within the administration that a deal with Iran is all but done. A sustained breakout above these levels would compel me to change my tune on all risk assets, but until then, I think investors holding a diversified mix of U.S. and global equities, bonds, commodities, precious metals, and some cash will be well positioned for the environment we’re in. It’s not the time or place to be greedy or fearful. It’s a time to be disciplined, prudent, and optimistically skeptical.
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