Bullet with Butterfly Wings
The Smashing Pumpkins
Bullet with Butterfly Wings – Live

Despite all my rage
I am still just a rat in a cage

It was Lollapalooza weekend in Chicago which means thousands of music fans descended on the city to listen to their favorite bands and discover up and coming artists. Similar to past years, the acts range from relative unknowns who play in front of small crowds in the know on the next big thing to major headliners who are already widely followed. Typically, there is also a band or two that had a strong following years ago that may be now rediscovered by a new generation of festival goers. This theme is similar to what has happened across markets in the last couple of months. The AI boom has launched many new companies that have captured the attention of markets with high flying stocks driven by massive growth rates and soaring multiples. These companies benefit from the supply chain cycle that comes from the mega cap companies ramping up capex. History shows us that some of the rising stars may prove to be the dominant companies of tomorrow, leading markets into the next new era. Others will flame out as they are discovered to have more “sizzle than steak” to their story. The difficulty is predicting the path for these new companies before it becomes obvious which trajectory they are on.

Interestingly, the AI boom has also reintroduced investors to some older companies that suddenly started to behave like these highflyers. Their long-forgotten or simply overlooked products became critical components in the next chapter of the AI story. This newfound fame caused many to quickly turn from boring, low multiple value stocks to explosive growth stocks. Then the market, as it often does, started to question the duration of the story by asking if the stretched valuations can be sustained or if the capex needed to meet demand would deliver an appropriate return on capital. Similar to the new highflyers, the older companies having a resurgence can be quickly brought back to reality by skeptics (or realists?) who help keep the market from becoming too overstretched and separated from the fundamentals that drive long-term returns.

In July, investors were challenged with an array of news events and company announcements that led to elevated volatility and shifting sentiment across broad market indices. Re-escalation of the Iran Conflict and continued fighting in Ukraine, growing questions about future monetary policy actions of the new Fed, and many earnings surprises and some notable disappointments created an unsettled market environment for much of the month. A few of the big names in the S&P 500 were down for the month as analysts looked deeper into the changing fundamentals of companies that were once huge free cash flow generators that now are spending on massive capex projects. New AI related companies also were faced with a dose of reality with questions about future earnings levels required to support speculative valuations.

And some of the older companies such as memory chip and semiconductor companies that rallied on the AI buildout story sold off sharply from peak valuation levels that may not be sustainable in the future.

All was not lost in the month as non-AI dependent sectors rose on solid earnings growth or rising energy prices. Financials, led by global banks, reported strong earnings buoyed by rising corporate lending and investment banking revenues and shook off concerns about potentially higher interest rates. Their balance sheets are stronger and better positioned to weather potential rate turbulence. Energy stocks rose as oil prices increased nearly $15/barrel during the month. Other more value-oriented sectors also held up well during the month, helped by solid earnings growth and a market rotation away from tech and select consumer stocks.

Looking at returns for the month, the S&P 500 was flat at -0.06%, benefiting from a strong rally in tech the last couple of days of the month. Continuing a recent trend, the S&P Equal Weighted index (1.01%) outperformed the Cap Weighted index, extending the recent broadening of the market late in this cycle. Small cap stocks were down -3%, hurt by growth stocks while small value stocks were flat. Non-U.S. developed stocks outperformed the S&P due to their larger exposure to better performing non-tech sectors. Emerging Markets fell more than 3%, brought down by the big declines in South Korean and Taiwanese markets as chip stocks sold off. U.S. bond markets declined -1.30% due to steadily rising interest rates across the curve. The U.S. 10YR Treasury yield rose 27bps in July as investors assessed the potential of the Fed to raise interest rates before the end of the year to temper inflation.

Here are observations on what occurred across market segments in July:

Broad Market Performance¹

Domestic Equity²

• U.S. broad market indexes were flat to down during the month with the S&P at -0.06% and the Russell 2000 down -3%. The NASDAQ 100 declined -6.6%.

• Value stocks outperformed growth stocks consistently across all capitalization ranges. The Russell 1000 Value outperformed the Russell 1000 Growth by 8.6% in the month.

International and Global Equities³

• International developed markets were positive in the month, boosted by European stocks that were less exposed to the AI selloffs elsewhere. Similar to the U.S., value stocks handily outperformed growth stocks.

• Emerging market stocks fell more than 3%, pulled lower by the big AI names in South Korea and Taiwan. China was an outlier, rising 9% in the month.

Fixed Income Markets⁴

• The steady but small rise in interest rates was enough to push U.S. bond market returns to the negative for the month.

Specialty Markets⁵

• REITs delivered positive returns in July as demand continues to improve across multiple real estate segments. Commodity index returns were positive, largely due to the rise in oil prices and select agricultural products.

Sectors⁶

• Energy (+12.6%) was the highest performing sector in July, driven by the jump in oil prices. Other positive sectors were Financials, Real Estate, and Healthcare. Technology and Industrials were both down more than 3%.

Though Q2 earnings came in very strong, with the beat rate (earnings surprises to disappointments) at 86% at the end of July, investors have become more focused on the sustainability of forward earnings and how the capex spending that will support future earnings will be financed. The increased attention on fundamentals generally should be good for long-term investors who recognize when stocks become overextended and exit before taking all the pain of the downfall. Unfortunately, some investors stay too long with the highflyers and feel trapped by their “success”, left asking “What do I get for my pain? Betrayed desires and a piece of the game”.

^1-6 All data referenced in the table and comments supplied by Morningstar as of 07-31-2026

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