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US MARKET CALL: AI Fatigue Weighs On The 'Lag-7'
As we predicted, the S&P 500 had a June Swoon. We expected that it would be more of a broadening rotation than a widespread correction. That's the way it played out. The S&P 500 market-weighted stock price index peaked at a record high of 7,609.78 on June 2 (chart). It fell 3.4% through Friday's close. Over that same period, the S&P 500 equal-weighted stock price index was unchanged (chart). Investors seem to be experiencing AI Fatigue. They are questioning whether the hyperscalers' massive spending on AI infrastructure will ever pay off. They see token prices falling, suggesting there might already be excess compute capacity. They see that yet another Chinese company is offering cheaper, powerful, and open-source LLMs. They worry that new technologies will rapidly make current ones obsolete in a process known as "creative destruction." Companies are experiencing "token budget hangover," where agentic AI usage is blowing up forecasted budgets. Microsoft is eyeing DeepSeek as a hyper-cheap, optional alternative to the expensive OpenAI and Anthropic models currently powering its enterprise agent tool, Copilot Cowork. To cut its own soaring internal AI token usage costs, Microsoft issued a firm June 30, 2026 cutoff deadline for its Experiences + Devices (E+D) division—the engineering teams behind Windows, Office, Teams, and Surface—to stop using Anthropic's Claude Code. As a result, the Mag-7, which includes the biggest hyperscalers, hasn't been so magnificent in June. The MAGS ETF peaked at a record high on May 26 and fell 12.9% though Friday's close (chart). It is down 6.6% ytd, while the XMAGS ETF (a.k.a. the "Impressive 493") is up 13.7%. The Mag-7s have been the Lag-7s. While the MAGS and IGV (i.e., software ETF) swooned during June, the SOXX semiconductor ETF continued to soar to a new record high on June 22 (chart). So there has been rotation even within the Information Technology sector. Now let's turn to some other market-moving developments: (1) Earnings. FEMO (Fabulous Earnings Momentum) may be starting to lose a wee bit of its mojo. S&P 500 forward earnings edged up to another record high during the week of June 25 as both the 2026 and 2027 analysts' consensus earnings expectations edged down (chart). The same can be said for the analysts' consensus earnings estimates for Q2-Q4 of 2026 (chart). However, they are still forecasting y/y growth rates in the low- to mid-20s. The forward earnings of the S&P 500, S&P 400, and S&P 600 all rose to record highs last week (chart). This confirms that FEMO continues to broaden within the stock market. FEMO is also confirmed by the percent of S&P 500 companies with positive 12-month percent changes in forward revenues (88.4%) and forward earnings (85.8%) (chart). Irrational exuberance is starting to show up in FEMO, as consensus-expected long-term earnings growth (LTEG) rose to a record 43.5% for the S&P 500 Information Technology sector last week (chart). That boosted the LTEG of the S&P 500 to a record 25.5%. Meanwhile, the combined forward earnings share of the S&P 500 Information Technology and Communication Services sectors rose to a record 44.0% last week (chart). Such FEMO has driven the sectors' combined market-cap share to 47.6%. That suggests a bubble only if the analysts who cover companies in these two sectors are irrationally exuberant about forward earnings, which have been driven by much better-than-expected earnings during the Q1-2026 earnings season. (2) Sentiment. Meanwhile, the Bull-Bear Ratios that we follow indicate greater bullishness relative to their historical averages (chart). They aren't high enough yet to provide a sell signal from a contrarian perspective. (3) Dow Theory. Both the DJTA and the DJIA have been very strong so far this year. Both are near their recent record highs (chart). So Dow Theory remains bullish. The transportation sector of the economy is showing recent improvement in ATA Truck Tonnage through April, along with a new record high in railcar loadings of intermodal containers through the week of June 19 (chart).
Fed Still Has An Inflation Problem Despite Plunging Oil Prices
The FOMC’s policy stance is determined by the balance of risks to its dual mandate of price stability and full employment. In the current environment, those risks remain firmly skewed toward inflation, justifying last week's FOMC pivot from an easing bias to a tightening one. Today's plethora of May economic data shows that the economy and the labor market are in great shape, while both headline and core PCED inflation rates rose further above the Fed's 2.0% target (chart) . June's plunge in oil prices will certainly reduce the headline inflation rate, but the core rate is now up to 3.4% y/y. Before the war, it was stuck just below 3.0%. In his press conference last week, Fed Chair Kevin Warsh acknowledged that inflation has exceeded the FOMC's target for more than five years and committed the Fed to restoring price stability. Accordingly, we remain inclined to expect at least one rate hike before year-end, with July a live possibility. Falling energy prices may slow core inflation. However, the AI spending boom is driving up electricity bills and consumer electronics prices. Today, Apple announced significant price increases because of soaring memory chip prices. The Cleveland Fed's Inflation Nowcasting projects that June's headline inflation fell to 3.9%, while the core inflation rate remained stuck at 3.4%. Let's have a closer look at today's inflation report and economic indicators: (1) Inflation. Headline PCED inflation surged to 4.1% y/y in May, the highest since April 2023. Core PCED also spiked to 3.4%, its highest since October 2023. Goods inflation was 4.8%, led by a 5.6% increase in nondurable goods (chart). The latter should moderate quickly if the recent plunge in oil prices sticks. Durable goods inflation remained elevated at 3.3%, suggesting that the effect of last year's tariff hikes hasn't fully abated yet. Housing services inflation edged up to 3.2% y/y (chart). More importantly, services excluding energy and housing inflation rose to 3.9% y/y, the highest since September 2023. This so-called "supercore" inflation rate is a key measure of underlying inflation. It is well above the Fed's 2.0% inflation target. (2) Consumer Spending. The consumer remains in good shape despite rising inflation. Real consumer spending rose 2.1% y/y to a new record high in May (chart). Real disposable income posted its first monthly gain since January 2026. But it has been basically flat for the past year. We attribute this to the retirement of Baby Boomers, who collectively have a record $89 trillion in net worth and are using it to fund their spending now that they don't have paychecks. May's saving rate held at 3.0%, the lowest since 2022 (chart). We expect it will continue to fall as more Baby Boomers retire. The advance in real consumer spending during May was broad-based, reflecting healthy underlying demand across many categories (chart). Interestingly, higher gasoline prices did reduce consumers' gasoline usage, but didn't reduce spending in other categories during the month, with the exception of food services & accommodation and transportation services. These should rebound now that gasoline prices are falling. Meanwhile, capital spending remained very strong in May, as new orders for nondefense capital goods, excluding civilian aircraft, jumped to yet another record high (chart). (3) Labor Market. The labor market continues to show signs of improvement. Initial jobless claims fell to 215,000 during the week of June 19, confirming that layoff activity remains remarkably subdued. Continuing claims are also low (chart). (4) GDP. Q1-2026 real GDP growth was revised up to 2.1% from 1.6%, driven by a downward revision to import growth from 21.1% to 11.8% (chart). Consumer spending growth, however, was revised down to 0.5% from 1.4%, largely due to adverse weather weighing on Q1 activity. The Weekly Economic Index moderated to 2.5% for the week of June 19 (chart). This is consistent with the latest update to the Atlanta Fed's GDPNow model. The Q2-2026 real GDP growth estimate was revised down from 3.1% to 2.5%, reflecting downward revisions to real consumption growth from 2.8% to 2.0%, while business equipment spending was revised up from 13.8% to 14.% (chart). Both point to stronger consumer spending and robust capital investment, supported by AI infrastructure spending, during Q2.
On SpaceX, Google & Tesla's Patent Filing
Shortly after its IPO, SpaceX now has sold a $25 billion bond offering, with no shortage of takers. Today, Jackie examines the reasons that the company, after racking up major losses last year, was granted investment-grade ratings on the new debt. … Also: Alphabet has recently been on a losing streak in the stock market and so has the Communication Services sector broadly. Multiple factors have weighed both down, including a drop in Alphabet’s prospective 2027 growth owing to its huge Q1-2026 MTM accounting gain. Will the stock’s DJIA inclusion reverse its bad luck? … And: Tesla has filed for a new patent on what sounds like a mobile, modular AI data center, the Megapod.
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