Markets and Economy Above the Noise: Look beyond AI pullback

This month, I had the opportunity to watch my nephew pitch in front of college scouts at Yogi Berra Stadium in Montclair, New Jersey. Allow me a quick uncle moment: He threw two innings without allowing an earned run. Sitting in the stands, I noticed a sign displaying what the stadium describes as Berra's most famous quote: "It ain't over 'til it's over."

That’s an apt way to think about today's bull market, notwithstanding the recent drawdowns in different parts of the technology sector.¹ Bull markets typically have ended when corporate earnings began to disappoint in a meaningful way, and earnings revisions moved decisively lower. That isn’t the environment we see today.

To be fair, Berra also warned that "It's hard to make predictions, especially about the future." Fair enough. But investors still must make decisions based on the evidence in front of them. Right now, the evidence has pointed to healthy rotation within the market rather than a regime change.

What we’re experiencing seems more reminiscent of a midcycle slowdown in the artificial intelligence (AI) trade. Periods of explosive growth can create their own challenges. Earnings surge. Companies repeatedly exceed expectations. Analysts raise estimates. Investors become accustomed to extraordinary outcomes. Eventually, growth can remain strong while the rate of acceleration begins to slow. The second derivative (the change in the rate of change) moderates. Markets adjust.

We’ve already seen this play out. The so-called hyperscalers — the massive technology companies that build and operate vast, globally distributed data centers to provide scalable cloud computing services — experienced corrections despite continuing to deliver strong results.² More recently, pressure has shifted to semiconductor and memory-related companies.³ Importantly, this appeared to be more about sentiment and positioning than earnings deterioration. Markets have transitioned from a phase driven by upside surprises to one that has increasingly been focused on the durability of future growth.

Meanwhile, the rest of the market has been holding up well.⁴ Broader leadership is often a positive sign for the longevity of a bull market. That brings me to another Berra quote: "Nobody goes there anymore. It's too crowded." The hyperscaler and chip trade became crowded because the fundamentals had been so compelling. Today's correction appears to reflect investors recalibrating their expectations, not abandoning the story. So until earnings tell a different story, it ain't over, in my view.

It may be confirmation bias but…

… the momentum-driven unwind in the so-called Magnificent 7 stocks appears to have run its course. The Bloomberg Magnificent 7 Index recently closed below its 200-day moving average for the fourth time since 2022.⁵ In each of the three prior instances, the subsequent rally ultimately pushed prices to new highs. That pattern can be typical of a secular bull market, where periodic sentiment resets and position unwind occur within a broader uptrend. Consistent with our view, this looks less like the end of the bull market and more like a mid-cycle pause driven by an unwinding of excessive enthusiasm, a common feature of longer-term advances.

Since you asked

Q: How sustainable is a K-shaped economy, where growth is unevenly distributed between the highest and lowest income Americans?

A: I’ll answer this question strictly from an economic perspective, not from the perspective of social outcomes or policy preferences.

A K-shaped economy can be more sustainable than many assume because spending power has been increasingly concentrated among higher-income households. The top two income quintiles account for roughly 74% of total income in the US and generate about 60% of consumer spending.⁶ So, when lower-income households come under pressure, such as from higher gasoline prices or other costs, their spending can slow sharply and create pockets of economic weakness. However, the aggregate impact on economic growth is often more limited because higher-income households continue to spend, even at a somewhat slower pace. 

It’s worth noting that household balance sheets remain fundamentally different than before the 2008 Global Financial Crisis. Importantly, the bottom two income quintiles have experienced asset growth over the past five years that has significantly outpaced growth in liabilities.⁷ That’s in stark contrast to the period leading up to 2008, when liabilities were rising faster, and household balance sheets were becoming increasingly fragile. 

It was said

"I expect overall inflation to decline to around 3.25% by year-end, then continue on a glide path toward our 2% goal."

– John Williams, Vice Chair, US Federal Reserve

It’s encouraging to see him sounding less hawkish again. The doves missed him! I agree that inflation remains on a glide path towards 2%, and the bond market appeared to agree. The 5-year breakeven inflation rate sits at 2.29%,⁸ a level consistent with price stability. The continued adoption of AI should act as a deflationary force over time by improving productivity and increasing supply across the economy.

The recent uptick in oil prices is likely to prove temporary, much as it did earlier this year,⁹ and markets seem to be treating it that way. As a result, I expect the Federal Reserve to remain on hold throughout the rest of this year before resuming interest rate cuts next year. 

Phone a friend

We’re increasingly being asked for our views on the US midterm elections, and their implications for markets. I reached out to Jennifer Flitton, Head of Government Affairs at Invesco. Her response:

“The policy outlook after the midterms could have meaningful implications for markets, particularly around taxes, deficits, regulation, and government spending. A divided government would likely produce legislative gridlock, limiting the chances of major policy changes and shifting the focus toward oversight and investigations. While political dysfunction is rarely celebrated, markets have often responded favorably to periods of gridlock because it reduces policy uncertainty and lowers the risk of significant changes to the economic backdrop. 

By contrast, if Republicans retain control of both chambers, investors could see additional tax legislation, increased defense spending, and other fiscal initiatives advanced through the reconciliation process. That could provide support for sectors tied to defense, energy, and industrial investment, while also raising questions about the longer-term path of federal deficits and Treasury issuance. 

Beyond the immediate policy implications, the election may also shape the regulatory environment surrounding AI, energy infrastructure, and US competitiveness with China, issues that are increasingly important for capital spending, productivity, and long-term earnings growth."

Think/Rethink: Where familiar beliefs meet inconvenient evidence

Think: There has been an exodus of New Yorkers to other parts of the country.

Rethink: The facts suggest otherwise.

• New York City’s 8.6 million population in 2025 was virtually unchanged from the prior year.¹⁰
• The 1.41% overall rental vacancy rate is at a historical low while rental costs are at or near an all-time high.¹¹
• The median home price in Manhattan is $1.225 million, a post-pandemic high.¹²

On the road again

Summer tends to be a slower period for client travel, providing a welcome opportunity to step back and reflect. My next trip is to Hong Kong and Beijing, where I look forward to meeting with clients and gathering perspectives from the ground. I'll be sure to share my key observations and takeaways next month.