The Infrastructure Beneath the Boom

Stocks
 

The S&P 500 gained roughly 15% in the second quarter, bringing its year-to-date total return to approximately 10%.  Earnings strength carried the index to fresh highs in May before a more volatile finish to the quarter. The tech heavy NASDAQ had its best quarter in 6 years, while small company US stocks also had their best quarter since 1991, according to CNBC. One thing to note, however, is small companies that consistently lose money outperformed small, profitable companies. A classic sign of high ‘animal spirits’ in the marketplace.
 

Hampered by the war in Iran, International Developed stocks (particularly Europe) lagged US markets but still managed to turn out a very positive quarter, as well as stocks in Emerging Markets.
 

• Leadership shifted beneath the surface. The Magnificent Seven led the market through April and May, then reversed sharply in June, ending roughly flat for the quarter and negative for the year.
   

• Earnings did the heavy lifting. Analysts now expect Q2 EPS growth above 23% year-over-year, up from roughly 19% at the start of the quarter.
   

• Emerging Market stocks outside of China diverged sharply from Chinese stocks. Emerging markets ex-China extended a strong run, while Chinese equities were the only major index in negative territory this quarter (more below).

Bonds
 

The defining bond market event this quarter was not a Fed rate cut, but a change in who runs the Fed. Powell's term ended in May; Kevin Warsh was confirmed in the closest vote for a Fed Chair in modern history and arrived more hawkish than markets expected.
 

• Risk Free rates were repriced sharply. The 10-year Treasury bond yielded 3.96% when the war with Iran broke out on February 28. They quickly got as high as 4.66% in mid-May before settling down. Currently the 10-year Treasury yield is at 4.47%.
   

• Riskier corporate bonds stayed calm. The difference in interest received on a corporate bond versus a risk-free Treasury is called a spread. When spreads increase, investors demand higher interest to take on risk and often happens around periods of market or economic distress. During the quarter, spreads remained well inside recession-signaling territory throughout the volatility in rates.
  
   

Is Today’s Environment Similar to Dotcom in the 90’s?

Strategists have revisited comparisons of the current AI boom to the late-1990s tech bubble this quarter. The update, in plain terms:
 

• There are several similarities. The longer this rally continues, the more it resembles the late 1990’s bull market. Both have been fueled by an overhyped, revolutionary technology that triggered capital expenditures and potential productivity gains, stretched valuations on stocks – particularly tech, and a Fed rate environment that is viewed as being restrictive.
  
  However, the differences are considerable.
   

• The macro-economic picture still looks more reassuring than not. Profit margins remain high, corporate leverage hasn't spiked, unlike the imbalances that preceded the 2001 bust.
   

• This is an earnings story, not (yet) a valuation story. Forward P/E ratios have fallen this year despite strong stock returns, because profit estimates have increased even faster, unlike the late 90’s.
   

• Today’s AI leaders spending billions on Data Centers have fortress-like balance sheets. While we believe the money spent on data center buildout will be hard to monetize given the voracious competition in AI models, these companies are already sitting on fantastic businesses that have been selling products and services for decades, unlike many companies in the Dotcom era.
   

• Earnings growth is broader than the headlines suggest. When you look past the largest technology companies, the average S&P 500 stock is actually expected to grow profits faster than the Magnificent Seven this year, not slower. That is a meaningful shift from the past two years, when a handful of names drove nearly all of the market's earnings gains.
  
  June gave a live demonstration of this dynamic: the Magnificent Seven fell sharply even as the broader market held up. That is not the AI theme ending. It is the market starting to ask which companies, and which parts of the value chain, can continue capturing growth.