Back to the Future

Michael Grant

The US equity market’s recovery from April lows has been exceptional by any standard. Two explanations dominate: the first is one of US economic resilience led by AI-driven mega-caps, where the profitability divergence between the Magnificent Seven and the broader corporate world has defined this decade. Here, the central question remains timing the peak of investor euphoria around this super-cycle.

The second explanation concerns the revisionism of Donald Trump. Throughout the spring, most assumed his agenda would bring disruption. These fears weren’t mistaken, but the emphasis was misplaced: Trump 2.0 represents multifaceted reflation rather than disruption for the US economy. His latest hunger for Fed acquiescence adds another tailwind. We emphasize this distinction—reflation versus risk—because Trump’s polarizing presence creates a polemical dust storm that can obscure fundamentals.

Our anticipation has been for late summer weakness in equities to create buying opportunities ahead of an S&P 500 rally toward 7,000 in Q1 2026. The problem: this is virtually consensus thinking. Investors have fallen over themselves seeking pullbacks to buy. Meanwhile, the crosscurrents multiply. Financial liquidity appears abundant while economic liquidity feels tight. The Federal Reserve has again been proven “behind the curve” and an incipient growth scare has emerged.

AI Everything

Our largest worry is the extraordinary over-investment and over-enthusiasm surrounding AI. The scale of today’s mania upon activity and profitability is undeniable and sets it apart from the dot-com boom. Hyperscaler capex is running at an annual rate of $400 billion and is estimated to reach a cumulative total well north of $3 trillion by decade’s end—equivalent to 10% of US GDP. To cover this cost of capital, annual sales exceeding $3 trillion must emerge from somewhere.

Consider the scale: OpenAI generated a paltry $4 billion in revenue in the first half of 2025. And yet, Oracle’s >$317 billion increase in RPO backlog* in the latest quarter (largely driven by OpenAI) was 70% of the quarterly increase in US GDP. These companies are sinking trillions into AI because it represents a classic Innovator’s Dilemma: today’s new technologies will likely drain the competitive moats surrounding their extremely profitable, monopoly-like businesses.

For now, this spending enjoys a positive feedback loop between rising investment and rising profits. Those selling AI infrastructure enjoy profits in full, while buyers depreciate expenses far into the future rather than the present. This is viable because these businesses possess monopoly-like characteristics. Until the “losers of AI” are understood, the party continues. What remains to be seen is what level of returns will come out of all this spending.

The likelihood is that AI will either create more losers than winners among today’s technology leaders, or the incremental revenue opportunity is mightily overhyped, pointing to a spending collapse. Both scenarios imply an inevitable transition in investor mood, yet timing this shift is hard. The most likely catalyst may be growing awareness of the limitations of the newer training models —ChatGPT-5, for example, is a dud.

Until then, investors will run with the herd—as banks did ahead of the Global Financial Crisis and as European mobile companies did in the late 1990s when they grossly overbid for 3G licenses. The pattern is familiar even if the particulars differ. Much of this is uncontroversial, but recognizing a mania doesn’t immunize against its continuation. Still, it should be a cautionary signal for portfolio concentration.

The Agitation That Never Rests

This narrative of rising secular risk for the dominant but concentrated part of the equity world is conjoined by a second (and positive) narrative: multifaceted reflation for the broader economy after several years of profit recession. Here, investment advisors must filter a deluge of over-excited and over-politicized commentary. Apprehension about the stagflationary consequences of Trump’s revisionist agenda has proven exaggerated.

While a few segments of the US economy are under stress, major macroeconomic figures have unfolded largely according to trend. The inflationary repercussions of tariffs are barely perceptible. Meanwhile, Trump has removed the roadblock of Fed intransigence. The recommencement of easing by the Federal Reserve, combined with the administration’s focus on housing, suggests the broader economy still has support.

In the absence of a dramatic end to the AI spending boom, some spillover from technology to nontechnology areas of the economy point to revived leadership by cyclical parts of the market. Put simply, there is more to a business than a GPU. This creates opportunity even as mega-cap concentration creates risk. The investment challenge lies in maintaining exposure to both narratives while managing their distinct and differing risk profiles.

Outlook

Equities need US economic activity to moderate just enough to support Fed rate cuts, but not so much as to strain corporate earnings. Global growth appears resilient while inflation remains subdued. Concerns about global trade are fading while AI euphoria could persist into early 2026. The removal of Fed Chair Powell in late spring will be discounted as a backstop for economic activity.

By that time, much of the good news will be discounted amid unsustainable AI assumptions and the likelihood of a more difficult economic setting in 2027. Today’s setup argues for balanced positioning: rising wariness toward AI-driven momentum stocks given valuation extremes and sustainability, but healthy exposure to cyclicals on the assumption of sustained US expansion into 2026.