Investors hoping for a quiet summer have instead been reminded that markets and geopolitics rarely take a vacation. The Middle East conflict has re-escalated, semiconductor stocks have wobbled, and high-profile IPOs have slipped below their IPO prices.
In our view, this is typical summer volatility. Especially in July, the Iran conflict continued to roil markets. While there is still no real resolution in sight, we do not expect either oil prices or the 10-year Treasury yield to break out to new highs.
Currently, Straight of Hormuz crossings are extremely depressed, but if the current ceasefire continues, the next step will be a resumption of traffic. We continue to believe that the most likely outcome is de-escalation, even if the path remains volatile. Recent signals from both sides indicating a willingness to explore de-escalatory steps reinforce this view. We expect a resolution but probably not a quick one.
Separately, we saw a sharp sector rotation in July, especially in semiconductor stocks after their massive rally in Q2. This meant that the NASDAQ 100 Index did not have a good month in July, falling by 6.6%.
The Federal Reserve remained on hold at its July FOMC meeting, but financial markets responded poorly to the new chair’s unwillingness to reveal his take on the future direction of monetary policy or earmark specific factors that might influence it.
However, investor sentiment reversed again when companies started reporting second-quarter earnings, which again were better than expected. More importantly, investments in AI infrastructure proved to be highly profitable for the large tech companies. This means it is very likely that companies will continue to invest heavily in AI infrastructure. This capital investment cycle is so strong that it added more than 0.8% to Q2 U.S. GDP growth, which is significant.
This is one of the key reasons why we think a recession remains unlikely over the next 12-18 months, clearing the way for potentially higher equity prices.
- AI Returns Are Beginning to Emerge
- The Earnings Expansion is Going Global
- A Goldilocks Productivity Scenario
- The Iran Conflict
- The Fed will Stay on Hold
- What’s Next for Europe?
- China’s AI Momentum
- Fixed Income Starts to Look Attractive Again
- Time to Buy Gold
- Our Portfolio Positioning
AI Returns Are Beginning to Emerge
Investors remained sceptical about the profitability of the AI buildout. However, this earnings reporting season indicated that the ROI (return on investment) has begun to show up, giving the bull market a green light to run further. The July earnings season has confirmed the AI capex engine is still running hot, just as U.S.-Iran tensions peaked. Cloud revenue at the three largest hyperscalers grew 43% on a $364 billion base, prompting them to raise investment plans again.
The market has underestimated the return on investment for hyperscalers. As a result, these companies were bound to surprise investors. In addition, earnings growth and economic strength are broader than just the AI complex, and this strength is showing up in corporate earnings across different sectors.
The Earnings Expansion is Going Global
The Q2 earnings season has reinforced our constructive view on global equities, with results stronger and considerably broader than expected. In the U.S., 88% of S&P 500 companies have beaten earnings estimates, with EPS growth running at 25% year-over-year and seven of eleven sectors delivering double-digit growth. Importantly, earnings are broadening beyond mega-cap technology, with Mag-7 earnings growth excluding Nvidia now slightly below the rest of the S&P 500 for the first time since 2022. This broadening is also global: European earnings are growing 23%, close to the 25% U.S. pace, while ex-Energy European EPS is still up a healthy 13%. Japan has also delivered a strong earnings season, with broad-based profit growth across 13 of 15 sectors and revenue growth of 14% year-over-year. Cyclical sectors are also generally outperforming defensives, suggesting the improvement is becoming more economically broad-based. Taken together, Q2 increasingly looks like a global earnings expansion rather than simply another U.S. mega-cap technology cycle, providing a healthier foundation for further equity-market gains. Moreover, the improvement extends beyond corporate earnings. Economic growth is broadening beyond the AI complex, with the global consumer remaining resilient and economic surprises and earnings revisions improving outside the U.S.
A Goldilocks Productivity Scenario
Stronger U.S. productivity and cooler unit labor costs point to favorable cyclical dynamics. Preliminary Q2 nonfarm productivity beat estimates, rising at a 1.4% annualized pace from an upwardly revised 0.8% in Q1. Unit labor costs, what businesses pay employees per unit of output, increased by 1.3%.
Strong productivity growth may reflect companies’ reluctance to increase employment in an uncertain but resilient environment. Typically, strong productivity growth would be accompanied by stronger wage growth. But the labor market remains cool.
Another explanation would be that AI is indeed increasing company productivity. Official productivity data may not reflect AI’s effects for several years, limiting its usefulness for timing the AI trade. Still, return on investment in AI infrastructure is already appearing in reported corporate results, with return on incremental invested capital for hyperscalers near 30% on capital spending totalling hundreds of billions of dollars. We therefore remain positive on U.S. equities, as earnings remain supported by decent U.S. nominal growth. Slowing labor-force growth means U.S. economic growth increasingly depends on productivity, which is supported by AI capex infrastructure spending
The Iran Conflict
The level of hostility between the U.S., Iran, and Israel remains governed by crude oil prices, within a $70-$100/bbl range. At the lower end, tensions tend to rise, but as prices approach the upper end, escalation gives way to de-escalation.
The U.S. is also running low on Patriot and THAAD interceptors and has adjusted its tactics to conserve ammunition. Combined with depleted oil inventories, this limits Washington’s capacity to expand the war, particularly ahead of the midterm elections. Replenishing military inventories could take up to two years. Iran, meanwhile, wants the benefits of a ceasefire without allowing oil prices to collapse. Lower prices would reduce its revenues and ease pressure on President Trump.
If this apparent ceasefire continues, the next step will be a resumption of traffic through Hormuz. Though crossings remain extremely depressed currently, we continue to believe the most likely destination is de-escalation, even if the path remains volatile. Recent signals from both sides indicating a willingness to explore de-escalatory steps reinforce this view.
Therefore, we do not expect geopolitics to derail the current economic cycle. President Trump has stepped back from further escalation with Iran, while the incentives on both sides increasingly favor de-escalation. As such, neither geopolitics nor monetary policy should derail the bull market. Only a desperate Putin or an overconfident Iran can upset the current economic cycle.
The Fed will Stay on Hold
At the July FOMC meeting the Fed held rates at 3.5%-3.75%. The decision drew three dissents from regional presidents Hammack, Kashkari, and Logan who were in favor of a 25-bps hike. The FOMC statement was roughly unchanged from the previous meeting, acknowledging solid activity alongside strong productivity and investment growth. It also reiterated the Committee’s intent to deliver price stability, confirming that the FOMC remains focused on inflation risks while employment stays close to equilibrium measures.
The Fed chair press conference offered little additional insight or guidance on the direction of policy. The bond market responded with higher 10-year and 30-year yields, indicating that the bond market believes the Fed might be underestimating future inflation. We believe that the Fed was right not to hike in July. The economy remains resilient, but both labor and inflation releases have begun to miss expectations.
Dissents and volatility around FOMC meetings will become the new normal. Still, the new Chairman’s communication style is an outlier within the FOMC, and other members will continue to provide guidance and signals on the Fed’s reaction function. The goals of monetary policy will remain unchanged regardless of who leads the Committee. We expect softer U.S. data to keep the Fed on hold.
There is a risk of a one 0.25% hike in September if inflation data stays high in August. But we think that such a hike would be mostly to establish its inflation- fighting credibility rather than the start of a rate-hiking cycle. However, if it happens, we will probably see short-term volatility in bond and equity markets.
The problem is that half of the U.S. economy could use a rate hike, while the other half could use a rate cut. However, inflation is still too high to expect a rate cut any time soon.
What’s Next for Europe?
The Euro Area’s July ZEW survey pointed to a sharp improvement in sentiment alongside a lagging economy. However, current conditions indices remain depressed for the Euro Area, underscoring that investors keep anticipating a recovery that has yet to materialize.
Improving sentiment reflected easing Middle East tensions and energy prices, but recent re-escalation bears watching. Due to optimism over looming German fiscal deployment, Europe has been caught in a cycle where any sign of re-acceleration tightens financial conditions through higher yields and a stronger Euro. Tighter financial conditions leave the economy dependent on timely public spending to sustain the recovery that investors are already discounting. So far, Europe has the costs, but not yet the benefits of looser fiscal spending.
Determining what’s next for Europe thus hinges on the timing of Germany’s fiscal package. Swift deployment would help translate improving sentiment into stronger domestic demand and validate the optimism already reflected in markets.
China’s AI Momentum
China’s latest semiconductor and AI developments strengthen the case for Chinese tech stocks. Last month, China reportedly began producing domestic immersion DUV lithography machines, the country’s most upstream AI breakthrough to date. While production capacity is low and the machines remain behind ASML’s most advanced systems, their deployment reduces a critical foreign dependency.
These developments will likely pose a risk to the pricing power of Korean chipmakers. Competition is also intensifying among LLMs. Moonshot AI’s Kimi K3 outperformed some of the latest models from Anthropic and OpenAI on certain coding benchmarks, while their tokens are cheaper than their U.S. counterparts. As a result, Chinese-model token consumption is now rising faster than U.S. usage, increasing downward pressure on U.S. token prices. China’s progress across both AI models and hardware is unlikely to be fully priced in yet.
Fixed Income Starts to Look Attractive Again
A softer labor market and lower oil prices should help to lower inflation expectations going forward. This is a key reason why we think the Fed will stay on hold. This year, U.S. Treasury yields have risen, and fixed income has not performed well thus far. If we look 12 months forward, we think returns on fixed income are starting to look much more attractive. A globally diversified fixed income portfolio of U.S. Treasuries, mortgage-backed securities, and global corporate bonds is currently yielding about 5%. If U.S. Treasury yields were to fall back to around 4-4.25%, you can expect to gain 2-4% on top of the interest income. Meaning we could expect to see a 7-9% return on fixed income over the next 12 months.
Time to Buy Gold
Gold has experienced a sharp reversal in performance since its January 29 all-time high. Its price has slumped by 26% over this period after having been among the top performers in 2025. It failed to provide protection during the inflationary shock from the Iran war. Does gold’s reversal mark a temporary pullback or the end of the bull run? And what would mark an attractive opportunity to get long?
Our sense is that the sell-off is at or near the end. Gold’s short-term headwinds are fading. Real rates and the U.S. dollar are once again the primary drivers of gold’s price. While gold’s ability to act as an inflation hedge is overstated. Real rates, rather than inflation, determine gold’s performance. The worst of the real rates headwind to gold is likely behind us. This also means that the U.S. dollar is likely to weaken, which is another tailwind for gold.
Geopolitical uncertainty will continue to support gold structurally. Global central banks will keep diversifying their reserves away from the U.S. dollar toward larger gold holdings.
This would probably mean that other precious metals like silver could also see higher prices, as these have corrected even more than gold.
Our Portfolio Positioning
The continued volatility in markets showed the value of portfolio diversification again. Despite the recent market turbulence, our portfolios continued to perform well. In this environment, we believe investors should stay diversified and fully invested.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Tax services provided are separate from the Securities or Advisory services offered through Leo Wealth Americas. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
The Nasdaq 100 is an index composed of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange. This index includes companies from a broad range of industries with the exception of those that operate in the financial industry, such as banks and investment companies.
The S&P 500 Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
