Stocks Under Pressure From AI Trade and Rising Rates
HIGHLIGHTS
- Stocks: The second half of the year started on a mixed note for stocks. Large-cap growth was under pressure, which generally sent stocks lower for the month. However, value stocks stood out as a pocket of strength in July.
- Bonds: Rates rose in July as inflation concerns mounted. The 10-year U.S. Treasury yield closed at 4.75% by month’s end, a level matched only a few times since the end of the credit crisis.
- U.S. Economy: Inflation data declined in June, but July saw oil prices move higher once again as the conflict with Iran intensified. Initial estimates show that GDP growth slowed to a 1.5% annualized growth rate in Q2.
- Federal Reserve: Kevin Warsh chaired his second meeting of the FOMC in late July. After a consensus vote for no change to rates in June, three dissenting votes occurred in July, but policy rates remained unchanged at that meeting.
Equity Markets
Large-cap growth stocks have been under pressure in recent months as the market has been scrutinizing the massive spending on the AI buildout. The on-again, off-again nature of the Iran conflict has also created elevated volatility as oil prices have swung wildly based on the day’s headlines. Interest rates rising to multi-year highs added to the pressure on stocks. With all that said, stocks have been very resilient. The S&P 500 Index stands just a few percent below all-time highs, and the S&P 500 Equal Weight Index hit all-time highs the last week of July. Broadening continues as small caps and value stocks have taken a leading role so far this year. See Table 1 for July, Q2, and YTD returns.
Table 1 | Equity Markets
| Index | July 2026 | Q2 2026 | YTD |
|---|---|---|---|
| S&P 500 | -0.06% | 15.20% | 10.14% |
| S&P 500 Equal Weight | 1.01% | 11.39% | 13.26% |
| DJIA | 0.38% | 13.38% | 10.17% |
| Russell 3000 | -0.47% | 15.44% | 10.35% |
| NASDAQ Comp. | -3.19% | 21.60% | 9.53% |
| Russell 2000 | -3.03% | 21.49% | 18.85% |
| MSCI ACWI ex U.S. | 0.34% | 14.49% | 14.08% |
| MSCI Emerging Mkts Net | -3.07% | 24.05% | 20.04% |
The Nasdaq Composite is the only major index in Table 1 with year-to-date gains below 10%, proving it has been a strong year so far for stocks. Small caps have led U.S. indices year to date but were among the weakest pockets in July. The equal-weighted S&P 500 Index had the best gains during the month, which reflects broadening away from the largest growth areas and into parts of the market like value. The conflict with Iran deteriorated midway through the month and oil prices spiked, but another late-month pause in hostilities sent oil prices tumbling and helped stocks stage a month-end rally.
One consistent narrative supporting the stock market has been very strong earnings growth this year. Expectations are calling for earnings to grow north of 20% in 2026 and in the mid-teens in 2027. While subject to revision, we are at a point in the market cycle where earnings have been accelerating and supporting gains in the stock market. The S&P 500 has become cheaper as we have moved through the year as stock price gains have not kept up with earnings growth expectations, which are advancing at a stronger pace. We are mindful of potential volatility developing as we move toward midterm elections and continue to get used to the new leadership at the Fed – two scenarios that historically have tended to heighten volatility in the market. With that said, the fundamental backdrop of strong earnings growth continues to keep us constructive on the stock market moving through the balance of 2026.
On the international front, emerging markets struggled in July but continued to be one of the best performing areas in the stock market this year. Some countries with heavy tech weights (like Taiwan and South Korea) were hit as the broader AI trade came under heightened scrutiny last month. Overall, stocks, both U.S. and international, have turned in impressive results so far in 2026.
Fixed Income
The 10-year U.S. Treasury closed July at 4.75%, a level seen only a few times since the end of the credit crisis. The 30-year closed over 5.25%, a level not seen in almost 20 years. This rise in rates put clear pressure on the bond market in July and bond sectors struggled across the board. See Table 2 for July, Q2, and YTD bond returns.
Table 2 | Fixed Income Markets
| Index | July 2026 | Q2 2026 | YTD |
|---|---|---|---|
| Bloomberg U.S. Agg | -1.30% | 0.67% | -0.69% |
| Bloomberg U.S. Credit | -1.60% | 1.33% | -0.76% |
| Bloomberg U.S. High Yld | -0.25% | 2.47% | 1.71% |
| Bloomberg Muni | -1.85% | 2.50% | 0.43% |
| Bloomberg 30-year U.S. TSY | -4.39% | 0.88% | -3.68% |
| Bloomberg U.S. TSY | -1.11% | 0.32% | -0.84% |
It was a tough month for bond returns as rates moved higher. Some modest movement in spreads occurred, but spreads remain tight, and bond weakness was more driven by the general move higher in rates. Credit seems solid and there is not much stress in the bond market. High yield was least affected by the move in rates, had the best relative results for the month, and is the clear leader year to date. Interest-rate sensitive U.S. Treasuries were harder hit during the month. Munis gave back a big piece of their year-to-date performance in July but still show gains for the year. Weakness in the bond market in July sent several of the bond indices into negative year-to-date territory.
We maintain our longstanding position favoring credit versus pure rate exposure in this interest rate environment. We believe the role bonds play in a portfolio, to provide stable cash flow and to help offset the volatility of stocks in the long run, has not changed. With uncertainty ahead, we believe having an active bond management approach makes sense. Furthermore, the recent move higher in rates provides attractive opportunities for bond investors with rates at levels not seen in some time.
Economic Data Highlights and Outlook
The memorandum of understanding between the U.S. and Iran was signed in mid-June and it sent oil prices tumbling to near pre-conflict levels. However, in July, hostilities increased between the two countries once again, and oil prices reversed course, which added to inflationary pressures. Importantly, gasoline prices, which tend to directly impact consumer confidence, had been trending lower but bounced higher. Monitoring how oil prices react to ongoing events between the U.S. and Iran (both positive and negative) will be an important factor in the direction of inflation and consumer confidence moving forward. Chart 1 shows the strong relationship between oil prices and gas prices.
Chart 1
The drop in oil prices in June led to an improvement in inflation data for that month. The Producer Price Index (PPI) for June declined by -0.3% leading to an annual increase of 5.5% compared to the prior month’s level of 6.0% and expectations of 6.2%. The core PPI (which excludes food and energy costs) rose by 0.2%, better than the expected 0.3% increase. However, after the May level was revised lower, the annual increase of 4.7% for June was still modestly higher than the 4.6% mark in May.
The Consumer Price Index (CPI) had one of its largest monthly declines since April 2020 during COVID, falling by -0.4% in June with the annual increase falling to 3.5%. Core CPI was flat for the month, which led to a drop in the annual increase to 2.6%. All categories of the CPI were better (lower) than expected in June. The headline Personal Consumption Expenditures (PCE) price index fell by -0.1%, while the core reading rose by 0.1%. Both the annual headline PCE reading (3.7%) and the core reading (3.3%) matched expectations for June, and both improved from May levels.
We will watch inflation readings closely to see the impact from volatile oil prices. (This is one reason Fed officials focus on core inflation readings when making policy decisions due to the volatile nature of oil prices.) Clearly, inflation has been heading in the wrong direction in recent months, but this trend improved for a time in June as hostilities paused. Unfortunately, oil prices reversed course once again and increased when fighting resumed. Chart 2 below shows the rise in headline inflation readings since the conflict with Iran began as well as the subsequent decline after the memorandum of understanding was signed in June. Pressure could be on prices to move higher once again in July as the conflict resumed.
Chart 2
Broader economic data has remained solid. Although job market data was mixed in June, labor market momentum has increased the last few months. Nonfarm payrolls increased by 57,000, well below estimates of 113,000, but the unemployment rate fell unexpectedly to 4.2% from 4.3%. Job openings have been robust and sit near a two-year high. Job data has been stronger in recent months and could be supportive of ongoing consumer spending activity.
The Institute for Supply Management (ISM) Manufacturing Index remained positive in June for the sixth consecutive month. The ISM Manufacturing Index showed expansion with a reading of 53.3 compared to estimates of 53.9. For July, the reading came in at 55.6, the strongest reading in years, easily surpassing estimates of 53.9. The ISM Non-Manufacturing Index, which covers the much larger service industries in the U.S. economy, continued to reflect expansion. This reading matched expectations of 54.0 in June, but that was a modest drop from the 54.5 reading in May. As a reminder, ISM readings above 50 represent expansion and below 50 reflect contraction.
Consumer spending held up in June, as well. Retail sales (ex. auto and gas) increased by 0.4%, as expected. This reading was revised higher for May to a 0.8% increase from the prior estimate of 0.5%, reflecting stronger consumer spending than initially reported. Consumer sentiment readings have been weak for some time, but the preliminary University of Michigan Consumer Sentiment reading improved in July to 54.4 from 49.5. Since the May reading, which was the worst in this survey’s history back to 1952, sentiment has been improving as progress was made in the Iran conflict from mid-June through much of July – but we know hostilities have increased once again. Lower gasoline prices also tend to help consumers’ mood, and as previously discussed, we will watch how gas prices react in the weeks ahead. Despite broadly weak confidence readings, consumers have continued to spend, and this “hard” data has lined up better with consumer actions versus the “soft” data of sentiment surveys.
The first reading of Q2 GDP showed an annualized growth rate of 1.5% compared to expectations of 2.0% and the Q1 pace of 2.1%. The personal consumption component was stronger than expected and improved from Q1, so it reflected ongoing strength in consumer spending. Additionally, the biggest drag on GDP was a rise in imports, which subtracts from GDP growth and can reflect healthy domestic demand for foreign products. While very early on and certainly subject to revision, the GDPNow forecast from the Atlanta Fed for Q3 2026 GDP shows expected growth at a 6.2% annualized rate (as of Aug. 3, 2026). Chart 3 shows quarterly annualized GDP growth over the last five years.
Chart 3
The second Federal Open Market Committee (FOMC) meeting under Kevin Warsh in July had a bit more drama than the first. The FOMC voted unanimously for no change in policy rates at his first meeting in June, but his second meeting in July had three dissenting votes from members who wanted an increase to rates. The market sold off dramatically the day of the FOMC announcement as Warsh continued to resist providing forward guidance on how the Fed is thinking about future actions. The market seemed to want more information from Chair Warsh, which he did not give, and it reacted negatively. (The market did rebound in the days following that meeting.) It is not a surprise that there will be an adjustment period for the market as it gets used to the leadership approach Chair Warsh is implementing at the Fed.
This could result in some elevated volatility and is one reason we historically tend to see stock market volatility in the months following a leadership change at the Fed. The market is still pricing in a rate hike at the September FOMC meeting (a 67% probability) with an additional hike likely either late this year or early in 2027 (per the CME FedWatch tool as of July 31, 2026).
July turned out to be a challenging month for the stock market. Concerns developed around the AI trade and particularly the amount of capex spending by some of the largest companies in the AI space; the conflict with Iran heated up again and oil prices subsequently rose; and interest rates moved higher as well. It is noteworthy that the 10-year U.S. Treasury closed July at 4.75%, a level not seen consistently since before the credit crisis. It is yet to be seen whether this increase is sustainable or if rates will move back down, but higher rates could become a headwind for economic activity. However, outstanding earnings growth by S&P 500 companies continue to be an ongoing tailwind for the market. This creates a strong fundamental backdrop for the stock market. Furthermore, consumers continue to look strong based on spending activity and the job market even as they say they are not overly optimistic about their situation. The U.S. economy continues to be resilient. Inflation is elevated, but if the conflict with Iran improves and oil prices retreat, inflation pressures could subside. With midterm elections looming, elevated market volatility would not be surprising, but that is not impacting stellar earnings coming out of corporate America. As always, we believe it is imperative for investors to stay focused on their long-term goals and not let short-term swings in the market, which could materialize at any time, derail them from their long-term objectives
Economic Data
| Event | Period | Estimate | Actual | Prior | Revised |
|---|---|---|---|---|---|
| ISM Manufacturing | June | 53.9 | 53.3 | 54.0 | — |
| ISM Services Index | June | 54.0 | 54.0 | 54.5 | — |
| Change in Nonfarm Payrolls | June | 113k | 57k | 172k | 129k |
| Unemployment Rate | June | 4.3% | 4.2% | 4.3% | — |
| Average Hourly Earnings YoY | June | 3.5% | 3.5% | 3.4% | — |
| JOLTS Job Openings | May | 7296k | 7594k | 7618k | 7585k |
| PPI Final Demand MoM | June | 0.0% | -0.3% | 1.1% | 0.6% |
| PPI Final Demand YoY | June | 6.2% | 5.5% | 6.5% | 6.0% |
| PPI Ex Food and Energy MoM | June | 0.3% | 0.2% | 0.4% | 0.1% |
| PPI Ex Food and Energy YoY | June | 5.1% | 4.7% | 4.9% | 4.6% |
| CPI MoM | June | -0.1% | -0.4% | 0.5% | — |
| CPI YoY | June | 3.8% | 3.5% | 4.2% | — |
| CPI Ex Food and Energy MoM | June | 0.2% | 0.0% | 0.2% | — |
| CPI Ex Food and Energy YoY | June | 2.8% | 2.6% | 2.9% | — |
| Retail Sales Ex Auto and Gas | June | 0.4% | 0.4% | 0.5% | 0.8% |
| Industrial Production MoM | June | 0.2% | 0.1% | 0.1% | __ |
| Building Permits | June P | 1403k | 1367k | 1410k | __ |
| Housing Starts | June | 1310k | 1427k | 1177k | 1199k |
| New Home Sales | June | 607k | 628k | 580k | 618k |
| Existing Home Sales | June | 4.20m | 4.09m | 4.17m | 4.19m |
| Leading Index | June | -0.1% | -0.2% | 0.1% | __ |
| Durable Goods Orders | June P | 1.8% | 0.3% | -4.5% | -4.0% |
| GDP Annualized QoQ | 2Q A | 46.0 | 48.9 | 44.8 | — |
| U. of Mich. Sentiment | July P | 51.0 | 54.4 | 49.5 | — |
| Personal Income | June | 0.3% | 0.2% | 0.7% | — |
| Personal Spending | June | 0.4% | 0.3% | 0.7% | 0.9% |
| S&P Cotality CS 20-City YoY NSA | May | 1.30% | 1.63% | 1.14% | 1.18% |
Source: Bloomberg; P=Preliminary, T=Third Reading
For illustrative purposes only. Past performance is not indicative of future results. Neither past actual, projections, nor other forward looking statements regarding future financial performance of markets are only projections and actual events or results may differ materially.
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