Weekly Investment Update (07/31/2026)

U.S. equities had a choppy week as investors weighed generally solid second-quarter earnings while adjusting to the communication style and policy signals of the new Federal Reserve (Fed) chair. The S&P 500 fell sharply after the Fed’s press conference on Wednesday, a move later attributed to forced deleveraging by a hedge fund facing a margin call. Despite the volatility, the U.S. markets ended the week slightly higher.

As we discuss in more detail below, strong earnings from the hyperscalers (Google, Microsoft, Amazon, and Meta) were overshadowed yet again by rising AI capital expenditure. Investors remain skeptical that these unprecedented investments will generate meaningful returns, or that businesses and consumers will realize commensurate productivity gains. Recent advances by Chinese chipmakers and model developers have also raised questions about how much of AI’s economic value will accrue to frontier-model providers such as OpenAI and Anthropic. Given AI’s growing importance to economic growth and equity markets, the gap between market expectations and measured productivity will likely remain a source of equity market volatility.

Separately, the Fed held rates steady and reduced forward guidance, increasing near-term uncertainty. Resilient growth and above-target inflation leave open the possibility of a September rate increase. Even so, in our view, any further tightening would likely be limited and would reflect continued economic strength rather than spiraling inflation.

Strong Hyperscaler Results Amid Continued Technology Volatility

What is happening: Hyperscalers posted strong operating results: year-over-year revenue growth ranged from 18% for Microsoft to 28% for Meta, generally meeting or exceeding consensus estimates. AI was a big driver — Google Cloud revenues grew by 82%, Microsoft Azure grew by 41%, and Amazon Web Services (AWS) by 37%.

The market’s divergent reaction shows a growing focus on whether high capex spend is translating to tangible benefits. Microsoft maintained its capex guidance while noting more efficient utilization of existing capacity, which continues to lag client demand. The stock rose over 15% on the day following the announcement. 

Amazon raised its capex estimate for the year, but AWS revenue exceeded expectations. CEO Andy Jassy said the business is likely to stay capacity-constrained through 2027, with a strong 2028 backlog. The company’s shares rose 9% in after-hours trading following the announcement. 

Conversely, Alphabet also noted capacity constraints, but it increased capex guidance as this quarter’s capex pushed free cash flow negative for the first time in its history as a public company. The stock fell by 7% the next day. Meta’s stock fell by 8% after announcing its earnings, as the company currently has excess computing power, and higher AI infrastructure spend contributed to an EPS miss.

The broader AI-related volatility continued this week. The S&P 500 technology index is down 9% from its early-June high as of today; memory-related equities are down 35% and semiconductors are down 23% from their highs. The Korea Composite Stock Price Index (KOSPI), South Korea’s benchmark equity index dominated by two memory chipmakers, is down 39% from its high.

Some of this volatility was due to concerns that China may be catching up in the technology race. This week, the strong public market debut of Chinese memory chipmaker CXMT raised concerns that a company well-funded by both the public and the government may gain market share at the expense of incumbents. Earlier this month, the introduction of Moonshot AI’s Kimi K3 model (which performed well relative to incumbent models at a lower cost) raised questions about token price trajectories. Reports that China may have started manufacturing advanced chip-making machines are raising questions about ongoing dominance of incumbents in lithography equipment production.

Why it matters: AI is a key contributor to both GDP growth and the stock market. The technology sector has a 47% weight in the S&P 500, including Amazon, Meta, and Alphabet, which are classified in other sectors, and a 41% weight in the MSCI Emerging Markets Index.

This week’s developments illustrate the evolution in the market’s approach to evaluating the AI opportunity. Broad-based initial enthusiasm has given way to a deeper focus on the durability of underlying business models and the economics of spend relative to upside potential. We believe over the long term, outcomes will be driven by the size of the overall opportunity set and the share of value generated by this transformative technology that various participants will capture. The size of the overall opportunity set may ultimately be determined by productivity gains, which can drive corporate AI adoption and spend.

A variety of studies and surveys show that adoption is accelerating (albeit unevenly), that AI has started to show productivity gains at the task and job level (albeit with large dispersion across roles and workers), and that senior decision-makers expect larger future gains. However, aggregate productivity data have shown limited signs of broad-based AI-driven transformation so far. Translating job-level results to macro-level impact requires refinement of organizational processes, learning, and complementary investments, all of which take time. This is one reason that new general-purpose technologies are usually viewed as transformative before their effects are reflected in productivity statistics. As the noted economist Robert Solow said in 1987, “You can see the computer age everywhere but in the productivity.”

Investors’ earlier enthusiasm about the AI opportunity had created a gap between financial market optimism and reported productivity effects. Over time, this gap must narrow. Higher productivity can help close the gap upward by justifying the market’s optimism. Until and unless this occurs, some of the narrowing could come from downward adjustments in financial market expectations. The adjustment period still involves many unknowns. Although developments are moving rapidly, the current innovation cycle is still young. In the meantime, we expect further volatility.

In certain discretionary equity strategies, we remain underweight information technology relative to the applicable benchmark, including a larger underweight to technology hardware storage, while maintaining selective exposure to certain hyperscalers.

Fed Holds Rates, Warsh Offers Little Guidance on Future Policy

What is happening: The Fed left its policy rate unchanged at 3.50%-3.75%, in line with market expectations, while Chair Warsh offered little on the Fed’s policy outlook, consistent with his efforts to remove forward guidance. Three Fed regional bank presidents dissented in favor of raising rates, which Warsh characterized as a constructive disagreement. The chairman’s overall argument is that forward guidance and policy consensus can distort market signals and constrain the Fed’s policymaking flexibility. He noted that both nominal and real interest rates rose across the Treasury curve between the June and July Fed meetings. This, Warsh mentioned, was a sign of markets focusing more on data due to less forward guidance, emphasizing it as a positive development. 

Further, the chairman recognized that inflation remains above the Fed’s 2% target but emphasized the committee’s commitment to delivering price stability. However, Warsh’s press conference and the absence of policy guidance prompted a negative reaction in financial markets. The two-year yield declined while longer-dated yields rose by as much as 11 basis points (that is, the curve steepened). The U.S. dollar depreciated, and equity markets, led by cyclical sectors, fell. Such moves tend to suggest a loss of Fed credibility as a higher term premium, or compensation for holding longer-dated securities, pushes up long-term yields and weighs on risk assets.

Why it matters: Risks to Fed credibility are likely overblown, in our view, and much of the adverse market reaction following the July FOMC meeting quickly reversed in Thursday’s session. Lack of traditional forward guidance, however, may yield a period of volatility as markets adjust to a new policy regime. Moreover, what can impact Fed credibility is if the Fed remains noncommittal on raising rates but the incoming data increasingly warrant policy tightening. Amid a resilient consumer, multidecade lows in layoffs, and broadening growth, the risk of a hike is rising. 

Looking ahead, though changes are underway at the Fed, much is still the same. The committee remains data-dependent, reflected in both the three dissents in July and Warsh’s desire for market prices to respond to economic developments, not Fed commentary. The Fed will receive two labor and inflation reports between now and its September meeting, which will likely determine the direction of rates in the near term. If the trend of labor market stabilization and above-target inflation persists into the September meeting, a rate hike cannot be ruled out. However, should the Fed raise rates, it would not necessarily be negative for equity markets, but rather a reflection of strong underlying growth. The first estimate of second-quarter GDP growth displayed this. Real final sales to private domestic purchasers — the sum of real consumer spending and private investment — rose 3.9%, up from 1.7% in the first quarter, powered by strong consumer spending, AI capex, and broadening business investment. 

If the Fed raises rates in September, we do not expect a prolonged hiking cycle or hikes to derail economic activity. Notably, the U.S. economy weathered 525 basis points of rate increases between 2022 and 2023, followed by more than a year in which the federal funds target range remained at 5.25% to 5.50% — a period when economic growth was resilient and a trend we expect to continue this year.