Weekly Investment Perspective

U.S. stocks finished higher last week as strong corporate earnings outweighed renewed volatility in AI-related investments and a less reassuring message from the Federal Reserve. The S&P 500 gained 1.05%, the Dow Jones Industrial Average rose 1.04%, and the Nasdaq Composite advanced 1.59%. Those headline returns masked considerable movement beneath the surface as Microsoft and Amazon rallied sharply following earnings, while semiconductor stocks declined and several other tech leaders struggled. Treasury yields also sent a mixed signal, with short-term yields falling but the 30-year yield climbing above 5.25% for the first time since 2007.

Corporate earnings provided the clearest source of support. With a majority of S&P 500 companies now having reported, the index is tracking toward second quarter earnings growth of 47%, the highest rate since the second quarter of 2021. That growth rate is flattered by large valuation gains for Amazon and Alphabet from their investments in Anthropic, but the index earnings growth is still trending toward 29%, even excluding those two companies. The median S&P 500 company is on pace to deliver earnings growth of roughly 12%, compared with 9% expected at the start of the reporting season. This suggests the strength is broader than a handful of the market’s largest technology companies, even if those companies remain the most visible drivers of index-level results.

Microsoft and Amazon offered encouraging evidence that the initial wave of AI investment is translating into strong growth and attractive returns. Microsoft reported 43% growth in its Azure cloud business, while Amazon Web Services grew 37%, its fastest pace in more than four years. Both companies indicated that demand continues to exceed available capacity, supporting further investment in data centers. The longer-term question is whether similarly strong returns can be sustained as the industry’s invested capital base grows from hundreds of billions of dollars to potentially several trillion over the next few years. That concern was more pronounced for Meta, whose shares came under pressure as it increased its capital-spending outlook without providing the same visibility into near-term returns that investors can see in the cloud businesses. The week’s results therefore reinforced both sides of the AI debate: the early investments are producing tangible growth, but the cost and scale of the next phase will raise the bar for future returns.

That scrutiny contributed to another volatile week for semiconductor stocks. The selling appears to have been intensified by the unwind of an AI-focused hedge fund called Situational Awareness that had built concentrated positions using significant borrowed money. After steep losses triggered demands for additional collateral, the fund sold most of its publicly traded holdings to Citadel and eliminated its leverage. Forced selling of this kind can push prices down more rapidly than changes in business fundamentals alone would justify, particularly when many investors hold similar positions. The episode does not establish that AI demand has deteriorated, but it is a reminder that elevated valuations, crowded trades, and leverage can magnify otherwise routine shifts in sentiment.

The Federal Reserve added another layer of uncertainty following last week’s meeting, in which the committee opted to keep the Fed Funds rate unchanged at 3.50%–3.75%, despite three policymakers dissenting in favor of a hike. Chair Kevin Warsh emphasized the Fed’s commitment to restoring price stability but offered little guidance on what would prompt the next move. The apparent gap between the Fed’s firm inflation rhetoric and its decision to hold rates contributed to a selloff in longer-term Treasury bonds, even as expectations for additional rate increases this year eased modestly. The response suggests investors remain concerned not only about near-term policy but also about the Fed’s credibility and the longer-run inflation outlook.

Meanwhile, the ever-changing status of the conflict in the Middle East continues to muddy that outlook. Hostilities resumed during the week, but President Trump postponed additional strikes over the weekend after appeals from Iran and regional allies, raising tentative hopes for diplomacy. Iran subsequently denied that direct talks were underway, underscoring how quickly the narrative can change. Oil prices declined last week and continue to slide in this week’s early trading, easing some immediate inflation pressure, but the conflict remains an ongoing risk.

This week’s July employment report will provide the most important test of whether the labor market is stabilizing or losing additional momentum, while another round of earnings will offer further insight into AI infrastructure demand and corporate spending. Investors will also watch the yen after the United States and Japan took the unusual step of jointly intervening in currency markets on Friday to counter its slide to a 40-year low. Recent volatility has highlighted the importance of separating fundamental changes in the demand and corporate earnings outlook from moves amplified by leverage, positioning, and rapidly changing geopolitical headlines.

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