The AI Trade Is Working, Everything Else Is Meh…
Executive Summary:
Macro Policy & Interest Rates: Despite hawkish messaging from the Fed regarding inflation targets, a prolonged rate-hiking cycle is unlikely to materialize due to the highly leveraged nature of the economy and the recent plunge in oil prices following the de-escalation of the Iran conflict.
Extreme Equity Market Bifurcation: Current stock market gains are historically narrow and almost entirely dependent on the AI spending craze, creating underlying fragility as just a handful of massive tech companies mask a lopsided, K-shaped economy.
Geopolitics & Portfolio Strategy: The U.S. administration's pragmatic off-ramp in the Middle East removes a major headwind, maintaining a constructive backdrop for equities provided AI earnings continue to grow, while gold remains an attractive long-term allocation supported by secular central bank buying.
Full Commentary:
Short note this week as I’m on a plane to Chicago for a couple days of client meetings. Equity markets were able to muscle higher last week, notwithstanding a hawkish message from new Fed Chair Kevin Warsh in his first press conference. The last sentence of a very brief FOMC statement aptly sums up the debate for markets: “The Committee will deliver price stability”. Well, with inflation having continuously run above the Fed’s 2.0% target for more than five years (March 2021), it begs the question of whether this is just more lip service or whether the new Fed Chair is serious about implementing what would likely be market-unfriendly steps to deliver on this declaration.
Time will tell, but at least global central banks, which collectively are delivering more rate hikes than cuts for the first time since July 2023 (chart from Michael Hartnett’s Flow Show report), will no longer be fighting spiking oil prices with the Iran conflict winding down.
Last week, West Texas Intermediate oil prices plunged more than $8 per barrel, or -9.75%, to $76.60 per barrel (as of Thursday’s closing level). Close to 80% of the war-related run-up in WTI has now been reversed, so the Fed sure did pick a great time to issue threats over the next move being a rate hike. The Fed Funds futures market has now priced in the first full rate hike to come by October 2026 – prior to the Fed meeting, the first rate hike wasn’t priced to happen until March 2027. I remain skeptical of such a view, as the economy is far too leveraged, and the credit-sensitive sectors are too fragile to withstand a series of Fed rate increases. The US economy, while solid, is completely dominated by one thing and one thing only – the AI spending craze – if and when this spending ever tails off, it’s difficult to imagine what is large enough to fill its shoes.
As for equity markets, the AI/momentum trade was in full swing with the Nasdaq Composite (+2.5% on the week) pulling the major averages higher. The S&P 500 gained +0.9%, the Dow notched a new all-time high while rising 0.7%, and the small-cap Russell 2000 rose 1.2%. Jim Bianco put out the following X post about a week ago that provides some necessary context for what is really transpiring in equity markets beneath the surface. Those investors who are solely gazing at the headline numbers of the S&P 500 +9.5% ytd, Dow +7.3%, or the Nasdaq Composite +14% are missing how narrow and bifurcated this equity performance has been. For perspective, only 35% of the constituents that make up the S&P 500 have beaten the index so far in 2026. Moreover, over the past two months, 18 of the top 20-performing stocks have been in the Tech sector, with flows into US stocks annualizing at a record pace of $739bn in 2026.
Pointing out this bifurcation doesn’t make it any less real. It’s an investor's job to recognize and take advantage of the market that ‘is’, not the one they ‘want’ it to be. That being said, with the mass adoption of passive investing and algorithmic trading dominating the market's active share, concentration has rarely been so unbalanced. Take the S&P 500 as an example – you know everyone’s favorite benchmark barometer, where 13 companies make up 43% of the 500-company index. I’d argue 10 of the 13 are Tech companies – Amazon is classified in the Consumer Discretionary sector, but let's be honest, it's Tech. Alphabet and Meta are classified in the Communications sector, but they’re also Tech. That leaves you with Berkshire Hathaway (1.39%), JP Morgan (1.35%), and Eli Lilly (1.35%) as the only non-Tech companies within this group.
It is what it is and this has been metastasizing at an accelerated pace for over a decade now, but it does create a level of fragility within the global financial system. I don’t think it's too loose an argument to connect the financialization of the US economy with this administration's retreat from the Iran conflict. Whether one is looking at an overindebted sovereign credit market that is unable to handle higher interest rates, which were being forced up by higher oil prices due to the closing of one of the world's most important shipping channels, or from an equity market standpoint, where a lopsided K-shaped economy is unable to endure a deep and protracted correction in stocks due to the negative impact it would have on consumption (nearly 70% of the US economy) and tax revenue, which would exacerbate a fiscal deficit already at tenuous levels.
This fiscal fragility is particularly acute when factoring in the structural realities of the federal budget following the passage of the One Big Beautiful Bill Act (OBBBA) last July. Because the framework established by the OBBBA has fundamentally altered the baseline for U.S. tax revenues, any cyclical hit to consumption or capital gains from a market downturn would rapidly compound these deficit pressures, leaving the government with very few levers to pull.
As for the Iran conflict, details aside, it looks as though after more than three months of bombing and blockades, the U.S. and Iran are back to square one: negotiations over limits to Tehran’s nuclear ambitions. Although this time, the Iranians will come to the table armed with the valuable knowledge that they can survive the worst the Americans can throw at them, outside of bombing them into oblivion. Look, I’ll admit I was in support of this administration when it went into this conflict, and for the reasons they said they took such actions – to rid a terrorist regime from oppressing its people and making the world a safer place by eliminating its ability to procure nuclear weapon capabilities, but things changed and changed quickly. The Iranian regime, by attacking neighbors, civilian infrastructure, and closing an international waterway that held the global economy captive, showed it was more committed and desperate to prevail than the US was.
The US showed it didn’t have the stomach to escalate the conflict further, which would have required troops on the ground, more casualties on both sides, and devastating destruction to Iran’s civilian infrastructure. Couple this with falling public opinion polls at home, a mid-term election cycle around the corner, and intensifying inflation pressures (a campaign promise this administration made to win the election), and it makes sense why Trump took the nearest off-ramp he could find. All the former “red lines” have been completely violated in this quest to move onto the off-ramp – let’s call it a very expensive ransom payment to an evil regime. And what does the U.S. get in return? A reopening of the Strait of Hormuz – that’s it. Back to where we were pre-March.
I’m aware that there are many less cynical views on the outcome, and I’m open to hearing them. At the end of the day, this was a pragmatic outcome for President Trump – lick your wounds and go home. This administration bit off more than they were willing to chew. Sure, their plan had the best of intentions in mind, but as they got into the thick of it, circumstances and constraints changed. I give them credit for having the flexibility to adjust in real time and find the quickest off-ramp they could, rather than getting bogged down in another protracted and costly Middle East conflict that does very little for U.S. citizens and changes very little on the global stage. When you find yourself in a hole, stop digging. This administration deserves both blame and credit for getting into and out of this quagmire.
As for my closing thoughts on markets, with the Iran conflict in the rearview and oil prices in retreat the coast is clear for the prevailing trends to continue on until something changes. Which means as long as earnings growth continues on its path of +24% for 2026 ($340/share) and 13% for 2027 ($385), and the economy remains resilient, equities should perform just fine. Even with the hawkish talk by new Fed Chair Warsh, I don’t think the Fed is going to follow through with a rate-hiking cycle. Moreover, I think we’ve seen the high print for inflation with the May CPI report that was released two weeks ago, and as a result, interest rates are more likely to be at current levels or lower than they are to rise.
Such a backdrop should breathe some life back into the precious metals space. Even though it looks like the dollar wants to take one more leg higher before it rolls over, when/if it does, it should reenergize the debasement trade that was doing really well earlier in the year. The chart of gold looks far from stellar, to be sure, but at the same time, sentiment levels have done a round trip from the 100 peak in late January to 0 as of mid-June. So, the chart pattern is less than encouraging, but sentiment is also washed out, and the weak hands have already vacated the gold market.
I have said before and I’ll say it again, I believe that gold’s ongoing pullback is a correction in a secular uptrend, and the recent Central Bank Gold Reserves Survey by the World Gold Council supports this view. The quotes below show that global central bank trends continue to favor gold purchases, providing a long-term catalyst for growth in the asset class, which is further supported by my expectations of a weakening U.S. dollar:
“Respondents overwhelmingly (89%) believe that global central bank gold reserves will increase over the next 12 months.”
“This year, a record 45% of respondents expect their own gold reserves will also increase over the same period.”
“The majority of respondents (74%) see moderate or significantly lower US dollar holdings within global reserves over the next five years. Respondents also believe that the share of other currencies, such as the euro and renminbi will remain unchanged over the same period, while gold holdings will increase.”
All that said, with mid-terms approaching and weak summer seasonality ahead, investors should be prepared to look through some episodic, non-trending downside volatility that inevitably concludes with another solid year of market returns when all is said and done. The most important thing I’ll be watching for, in terms of a change in equity market character, would be a meaningful shift in the AI capex cycle and profit expectations. There is a lot riding on this theme, not that a downshifting in capex spending would be a bad thing, but it would be a major pivot that markets would have to reprice – both good and bad. Otherwise, investors owning a well-diversified portfolio across the gamut of asset classes, overlaid with a prudent risk management strategy should take solace that the investment backdrop is more constructive than not.
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