The U.S. and Iran finally reached an agreement, opening the door to an end to hostilities. It is only a memorandum of understanding that leaves many sticky elements for subsequent negotiation and could possibly be derailed on several counts. Its 60-day settlement target is ambitious given the importance of the issues that have kept the countries at loggerheads for half a century, but it will likely be extended by mutual consent.
While discussing the deal, President Trump expressed his hope that the war would soon be in the rearview mirror. The White House has little appetite for re-initiating full-on conflict in the run-up to the midterm elections, so our best guess is that the ceasefire will hold even if negotiators fail to reach a binding agreement within 60 days. Both sides will claim to have won this conflict, but that is immaterial to financial markets.
Pockets of resistance will likely emerge from Israel and the Iranian Revolutionary Guard Corps or other Iran-backed militant groups. But the behavior of the key actors this year reveals that the U.S. can generally restrain Israel, while the new Iranian leadership, such as it is, can control the intensity of attacks.
This deal is positive for global economic and market sentiment. But it should be seen as an extension of the April 8 ceasefire plus a “memorandum of understanding” on Hormuz and the nuclear program. It should not be seen as a complete and durable peace deal. The deal has pushed oil prices back to pre-war levels. A final deal will probably be positive for equities, despite the fact that the end of the war was already anticipated by equity markets.
- Recent Market Volatility
- Fundamentals Remain Firm Despite the Pullback
- AI Investments Growing to Meet Demand
- Investment Implications
- The ECB Tightens Into Weakness
- The Yen Remains Underpriced
- Bond Yields
- Strong Credit Fundamentals
- What About Gold?
- Lower Oil Prices
- Long-Term Outlook Better for Metals Than Oil
- Our Portfolio Positioning
Recent Market Volatility
The recent market volatility over the past month looks more like a sector rotation and rebalancing of segments that ran up too fast, rather than the start of a broader market correction. Economic growth, earnings revisions, and AI-driven capex demand remain firm, but rising Treasury yields, inflation concerns, Fed policy uncertainty, and a monster IPO wave are likely to constrain further multiple expansion.
However, the U.S. economy has remained resilient this year despite slowdown fears tied to geopolitical tensions. U.S. economic data have surprised positively since the start of the year.
The Iran war has weighed on business and consumer confidence, but has had little impact on the hard economic data. Real consumer spending weakened briefly but now shows signs of re-acceleration. Capital expenditure (Capex) has also remained strong during this period, driven by AI investment.
Having said that, we are now in the summer months, which always tend to be a bit more volatile due to less financial news and lower trading volumes in markets. So, we would not be surprised if markets trade in a range over the next two months. Yet, we remain constructive on equity markets for the second half of the year.
The economy has shifted from slowdown into expansion; earnings growth is broader and stronger than we expected. Heading into the second half of the year, our constructive equity view rests on earnings, not valuation. The economy has shifted from slowdown to expansion, the investment side of the economy continues to accelerate, and earnings growth is broader and stronger than expected at the start of the year, supporting our positive view on the equity markets.
However, higher rates, lingering inflation, and a coming IPO wave are likely to limit further multiple expansion, making earnings, not valuation, the primary driver of returns in 2H26.
Fundamentals Remain Firm Despite the Pullback
The U.S. economy has been expanding for three consecutive months, earnings revisions remain positive, and capex demand has not slowed down, suggesting the market drawdown reflects valuation and positioning pressures rather than deteriorating fundamentals.
The market has shifted from an earnings story to a rates and valuation story. Sector returns have become increasingly untethered from earnings growth as investors focus on rising yields, stubborn inflation, and an uncertain Fed transition.
AI-related capex remains the clearest impulse. Outside a narrow group of AI hyperscalers, elevated capex spending has not materially impaired free cash flow, and leverage has generally declined, reinforcing the durability of the investment cycle.
Upside remains, but multiple expansion faces headwinds. Inflation risk, rising yields, and a potentially record-setting IPO calendar are likely to weigh on valuations, even as earnings strength supports a constructive outlook.
AI Investments Growing to Meet Demand
Four concerns dominate: capex is excessive, capex investments will not be recouped, capex is draining free cash flow, and capex is creating a leverage problem. The bear case is straightforward: AI-related spending ultimately resembles prior episodes of overinvestment, generating excess capacity, weaker cash conversion, and rising leverage. We do not yet see signs that any of this is happening.
The ultimate ability of companies to monetize the massive AI buildout will be determined jointly by demand and eventual industry structure, which could be anything from highly competitive and commoditized to monopolistic or duopolistic. For now, demand is strong, capacity does not appear excessive, cash flows are mostly robust, and corporate leverage is falling, not rising.
For now, the AI capex cycle looks more like an earnings-supported investment boom than a cash-flow or balance-sheet accident waiting to happen. The key risks remain demand durability, rising depreciation expense, and higher financing costs. Those risks are real, but they have yet to overwhelm the powerful earnings and revenue tailwinds currently supporting the investment cycle.
After the successful SpaceX IPO, the next few months appear to bring a significant increase in IPO activity, one that could challenge the peaks reached in 2021 and 2000. That wave may dampen forward market returns, limit further multiple expansion, and interrupt sector trends.
That said, even very large IPOs have rarely coincided with sustained market peaks, with only about 20% of mega IPOs aligning with such turning points. The more important risk is rotation within AI. New listings could dilute the scarcity premium embedded in current winners, especially AI hyperscalers and other AI beneficiaries with direct earnings or valuation exposure to private AI leaders. Once investors can buy those companies directly, they may trim positions in other stocks they own to fund that exposure.
The historical record is cautionary, not bearish. Forward S&P 500 returns tend to be weaker, and the probability of negative forward returns is highest when IPO activity is highest. But mega-IPOs are not unambiguous markers of a market top. Mega-IPOs are more common near market peaks, but most do not coincide with sustained market downturns, making them perhaps a caution flag rather than a sell signal.
While the supply-demand balance seems favorable for the market to absorb the new shares, the bigger risk is within the tech sector, where new AI listings could pull capital away from other tech companies.
Investment Implications
However, as the large AI companies become more aggressive in monetizing their tokens, we believe that the dynamic will begin to shift. While the picks and shovels of the AI system (i.e. the chips and the memory providers) will likely continue to benefit, more value should begin to accrue to the upper layers of the AI ecosystem.
The question for investors is how much value can be created in these layers, and who will be the winners. While AI spend is still less than 2% of corporate spend, it has grown by a factor of 13 since January 2025, according to data by RampAI. Even after normalizing for usage, paid prices per token have doubled since the start of the year, a sign that companies are paying for more advanced, expensive models.
This means that the return on investment (ROI) for the companies that invested heavily in the AI infrastructure is already beginning to show up in some parts of the corporate sector. Soon, the market will pay a premium not only for companies building out the infrastructure necessary for AI but also for those that can turn AI into more dollars for their core businesses.
A potential winner is the software sector. Software has been severely punished over the last few months as investors have priced in the likelihood that this industry will be disrupted by AI. What has not been priced is that it is also the industry that is adopting AI, and agents in particular, most aggressively. We think that there is a possibility of re-rating, as the theme transitions from software as an AI loser to software as an AI winner.
Another interesting sector could be the consumer sector, which has underperformed the past year because of tariffs, the Strait of Hormuz, and a soft labor market. However, all of those pressures are easing. The effective tariff rate has declined by 4.8 percentage points since its 2025 peak; the labor market is now in a better place, and the opening of the Strait of Hormuz should relieve pressure. We believe that as markets rotate away from bottleneck trades, these quality sectors will increasingly prove to benefit.
A broadening of the AI trade beyond infrastructure stocks, as well as an easing in oil prices as negotiations around the Strait of Hormuz continue, should be positive for risk assets over the next six months. Moreover, the macro backdrop in the U.S. is upbeat as economy-wide corporate profit growth has once again begun accelerating.
The ECB Tightens Into Weakness
Last month, the European Central Bank (ECB) hiked as expected, but further tightening would be a mistake as the economy is not that strong. The policy rate was raised by 25 bps to 2.25%, as expected. The ECB also revised its inflation forecasts higher and its growth forecasts lower. It sees greater upside risks to inflation than downside risks, with the outlook hinging on crude prices.
One hike will not meaningfully tighten financial conditions. Yet, signals of further tightening will emerge, and it looks premature. While price pressures have increased, there is still no sign of second-round effects from the energy shock in the Eurozone. Wage growth is muted, and market-based inflation expectations remain anchored.
A second hike would be a mistake for an economy that is quickly losing pace. A hawkish ECB in the face of weakening growth and contained inflation would weigh on European assets and ultimately support European bonds, especially relative to U.S. Treasuries.
The Yen Remains Underpriced
The Bank of Japan (BoJ) raised rates to their highest since 1995, but market pricing still understates the tightening path. The BoJ hiked 25 bps to 1%, as expected. This marks another step in Japan’s exit from its structurally deflationary regime. Despite the hike, and despite rates reaching their highest level in decades, the BoJ still sees financial conditions as accommodative.
Our Japanese growth diffusion index points to growth continuing at a decent pace, with only slight headwinds from the energy crisis. A Hormuz resolution is also positive for Japan, after it weathered the crisis relatively well given its large energy reserves. Importantly, market-based inflation expectations remain within the range the BoJ tolerates, but they have risen quickly.
Given decent growth momentum and the rise in long-dated inflation expectations, market pricing still looks too dovish. The JPY presents an increasingly asymmetric setup. A hawkish BoJ surprise, another FX intervention, or a global risk-off shock could trigger a major rally. Until then, the yen is likely to continue trading sideways and is unlikely to meaningfully depreciate further.
Bond Yields
Treasury yields have settled into a higher trading range since March’s oil price spike caused investors to reconsider the outlook for Fed policy. The bond market is now priced for 0.3% of Fed tightening during the next 12 months, compared to 0.75% of easing prior to the Iran war.
The oil price was the catalyst for the shift higher in Treasury yields, but it is no longer the dominant driver of bond market fluctuations. The correlation between changes in Treasury yields and the oil price has fallen as inflationary worries have broadened beyond the energy shock. Investors are now looking at a tight labor market, solid economic growth and core inflation that has been above the Fed’s target for more than five years and concluding there is effectively no case for Fed easing, even if the oil shock dissipates quickly.
Interestingly, rising bond yields continue to weigh on the stock market. The correlation between daily changes in Treasury yields and the S&P 500 remains negative. This negative correlation between bond yields and the stock market limits the potential upside in Treasury yields since any bond selloff could trigger a stock market correction, which would lower economic expectations, which in turn would lead to lower bond yields.
Fixed income is the worst-performing asset class this year. We think that a combination of the higher yields and potentially lower inflation expectations going forward, fixed income will perform better in the second half of this year.
Strong Credit Fundamentals
Credit markets are sending a surprisingly optimistic signal. Credit spreads did not wait for a de-escalation in the Middle East, the gradual reopening of the Strait of Hormuz, or a stabilization in global growth prospects to reverse most of the March widening. Today, both U.S. and European credit spreads sit near the lower end of their historical ranges, despite tighter financial conditions, elevated bond yields, and an energy shock that is still weighing on economic activity, especially in Europe.
The resilience of credit markets is not entirely without foundation. Stronger corporate balance sheets, abundant liquidity, and a shrinking public credit universe have helped support valuations in recent years. However, credit spreads are tight, and the additional return investors receive for the credit risk is low. So, we only like selective opportunities in private credit, mortgage-backed securities (MBS), and emerging-market bonds now.
What About Gold?
The gold price has corrected by more than 30% since hitting its all-time high in January, even if the longer-term bull case remains intact. After rising alongside stocks for most of the past two years, gold has sharply underperformed since the start of the Iran war, falling 20% as global equities rallied 7%.
Gold’s slump has been driven by a mix of U.S. dollar strength, rising real rates, profit-taking, and tactical central bank selling aimed at mitigating the fallout from the geopolitical conflict. Historically, gold has been characterized by explosive rallies followed by lengthy periods of consolidation or decline. Only time will tell whether January 29 marked a short- or long-term peak, but in the very near term, the rebound should continue. Over longer horizons, we think that gold is in a structural bull market and is worth buying on major dips.
Despite the run-up in prices over the past few years, gold only accounts for 3.8% of global household wealth, significantly below the peak of 22% in 1980. The fiscal outlook in many countries is worrying. Perhaps most importantly, sovereign demand should remain strong as central banks seek to shift more of their reserves into hard assets.
Lower Oil Prices
After rising to as high as $144 per barrel, the price of Brent crude has retreated to $73/bbl. At this point, further downside for oil is limited. For one thing, transit through the Strait of Hormuz remains far below pre-war levels. The truce between the US and Iran is fragile, with many contentious issues still to be worked out before an official ceasefire can be signed. It is not impossible that the ceasefire will fall apart after the U.S. midterm elections in November, when President Trump might have different priorities. Moreover, the conflict led to a depletion of global oil inventories. Most countries will want to rebuild those reserves in the months ahead, probably in excess of pre-war levels, given the risk that the Strait could be blocked again at some point in the future.
Long-Term Outlook Better for Metals Than Oil
While the downside for crude oil is limited, so too is the upside. The 5-year futures price for WTI crude tracks the breakeven cost for shale producers very closely. Higher prices incentivize new production, which eventually brings prices back down. There is no shale equivalent for most metals. According to S&P Global, it takes around 18 years for a mine to become operational. The number of large copper deposits discovered has been trending lower over the past few decades, as has the quality of the ore. An AI capex bust would pose near-term challenges for metals. However, prices would likely rebound once AI becomes more firmly embedded in the physical world. After all, if Elon Musk’s vision of 10 billion Tesla Optimus humanoid robots becomes a reality, this will generate huge demand for metals, not just to manufacture the robots but, more importantly, to produce all the goods that those robots will be able to create. So, we continue to favor an allocation to base metals in a diversified portfolio.
Our Portfolio Positioning
The past month was volatile as we saw a strong sector rotation in markets. Our core portfolios are overweight in global small caps and in health care. Two market segments that performed well. At the same time, our exposure to emerging markets continues to outperform, partly driven by Taiwanese and Korean chip and memory stocks, which have a large weight in the emerging markets universe.
The recent market rotation shows again that being diversified in your portfolio is the best strategy.
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. 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.
