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AI investment enthusiasm cooled in July as investors questioned whether massive spending would generate adequate returns, pressuring hyperscalers and leaving the S&P 500 essentially flat.
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Seven of the S&P 500’s eleven sectors delivered positive returns, led by the Energy and Financial sectors.
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The Fed maintained its policy rate, but multiple dissents and continued inflation concerns suggested a more hawkish outlook than markets previously expected.
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Sticky inflation persisted despite stable economic growth, with tariffs and geopolitical uncertainty contributing to rising costs and increasing political focus on affordability.
Great stock market enthusiasms often face a period of reconsideration. July saw a continuation of this phenomenon as investors worried that unbridled AI investment might not convert to commensurate return on investment. This put pressure on the hyperscalers who are building costly data centers across the country, and these stocks, in turn, kept the major averages flat or negative for the month. The S&P 500 Index dipped -0.1% in July, with the year-to-date return at 10.1%. Losses in July were far from universal, as seven of the eleven S&P sectors were positive, led by the Energy and Financial sectors. The equal-weighted S&P eked out a positive return for the month, while losses in smaller stocks nibbled at their major gains so far this year.
The Federal Open Market Committee (FOMC) met late in the month and announced no change to its key interest rate, although three of the twelve members dissented, preferring a quarter-point rate increase. This was Kevin Warsh’s second meeting, and one notable element was the tension between President Trump’s repeated calls for rate cuts and the Committee’s concern over sticky inflation, which had it leaning in the opposite direction. The futures market shows expectations for a rate hike in September. This meeting proved to be an opportunity to consider the often conflicting economic trends we are facing.
The Federal Reserve (Fed) stated, “economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East.” Their assessment found the employment situation stable, leaving price stability as their major challenge. At the press conference, Warsh was repeatedly asked how inflation could be tackled, but he was short on specifics (in accord with his promise to curtail Fed guidance). His admission that the Fed has no “magic bullets” was hardly encouraging.
Every American who grocery shops or buys gas is acutely aware of the realities of inflation. The cruel truth is that these increases, along with rent and utility hikes, have a minor effect on the affluent while delivering a punishing blow to the large number of Americans living paycheck to paycheck. While massive AI spending is generally stimulative, it directly touches a slim percentage of Americans in construction and the trades. The roiling impact of tariffs and the elusiveness of a Middle East resolution have been key factors in rising prices. As a result, affordability has become a political hot potato and is likely to play an outsized role in this fall’s elections.
The setbacks in the AI trades and the broadening of the market fit into our long-standing skepticism of speculative buying and our belief in the benefit of investing based on proven results rather than often overly optimistic hopes for potential payoffs. The outsized and breathless spending on AI infrastructure suggests to us a race towards enticing progress and profits, which is unlikely to be shared equally. Most recently, technology companies that have resisted the siren of going all-in on AI spending have been rewarded for their patience.