AI and Big Tech Drive U.S. Equities to Record Highs

In fixed income, the expected rate cuts pushed yields lower across most of the Treasury curve. The 2-year yield fell 0.35% to 3.57%, while the 10-year declined 0.14% to 4.23%. The 30-year Treasury was essentially unchanged at 4.9%. Core bonds (Bloomberg U.S. Aggregate Bond Index) benefited from lower rates and gained 1.2% in August. High-yield bonds (ICE BofA U.S. High Yield Index) performed similarly, gaining 1.2%, reflecting continued investor confidence in the economic outlook. Year-to-date, high yield has outperformed investment-grade bonds.

The month started with a sign that the job market is losing momentum. The July jobs report, released August 1st, showed nonfarm payrolls rising just 73,000, which was below expectations. Furthermore, the prior two months were revised lower by more than 250,000. Concurrently, the unemployment rate ticked up from 4.1% to 4.2%, which is still a historically low level. For investors, this data led to a reduction in economic growth expectations and optimism that the Federal Reserve may resume rate cuts after one of the longest pauses in a rate cut regime.

Inflation data complicated the market’s rate-cut narrative. In mid-August, the Consumer Price Index came in largely as expected, with core inflation up 3.1% year-over-year. While not alarming, the figure underscored that price pressures remain meaningfully above the Fed’s 2% target. Only two days later, the Producer Price Index surprised on the upside with its largest monthly increase in three years, reinforcing the thinking that inflation’s path back to target will not be linear and might still be a way off. On the last trading day of the August, the Personal Consumption Expenditures index, the Fed’s preferred inflation gauge, showed year-over-year inflation is running at 2.9%.

Markets also had to digest another source of volatility: politics. President Trump increased his public criticism of the Fed for not lowering interest rates, and late in the month moved to fire a sitting Fed Governor. Legal challenges are expected, but this underscored the political risks surrounding monetary policy. Fed Chair Jerome Powell, speaking at the Jackson Hole conference on August 22nd, struck his usual pragmatic tone, acknowledging softer growth data while keeping optionality on the table. His remarks were interpreted as opening the door to a September rate cut, and markets reacted positively with equities rallying while shorter-term Treasury yields moved lower.

Corporate earnings offered a steadier backdrop. At the end August, second-quarter reporting was essentially complete, and S&P 500 earnings growth was 11.9%, compared to 4.8% projected at the end of June (according to FactSet data). This was the third straight quarter of double-digit growth. Results were strongest in the technology and communications sectors, where the artificial intelligence theme continues to dominate. At the same time, investors remained highly attuned to single stock catalysts, with much of the sentiment tethered to NVIDIA’s earnings. The result was a market that looks strong at the headline level, but with leadership increasingly narrow and valuations (23x forward earnings), remaining elevated.

Stocks reflected this balance between optimism and caution. The S&P 500 and Nasdaq notched fresh highs, but day-to-day swings were driven by Fed expectations and AI headlines. Beneath the surface, market breadth softened, with a smaller group of mega-cap stocks accounting for the lion’s share of performance. This narrowing of leadership is an important watch point as we enter the historically more volatile September and October stretch.

In August we saw U.S. stocks lag developed foreign equities. The U.S. dollar was a key driver. The chart below shows the DXY Index, a measure of the U.S. dollar relative to a basket of six major world currencies, from July 31 through August 26.

The weaker dollar this year has clearly benefited foreign assets. The question going forward is if the dollar’s trend continues. The current Administration clearly wants lower interest rates. While Trump’s confrontations with the Fed are raising concerns about the Fed’s independence, we have to believe that part of the administration’s motivation is fiscal sustainability, as it has also been vocal about wanting to ease the increasing interest-payment burden of the U.S. Treasury. Interest rate levels relative to other countries have an important impact on the value of U.S. dollar. So, to the extent that U.S. rates are relatively less attractive, it would likely push the dollar lower.

We also consider economic growth, which impacts interest rates. Current immigration policies, according to sources such as the Yale Budget Lab, are projected to lower GDP by approximately 0.5% going forward. Slower growth could necessitate lower rates, and therefore a weaker dollar.

On the flip side, the market is telling us that it is currently constructive on the economy. Not only is the S&P near all-time highs, but yields in the credit market are trading at historical tights (relative to Treasuries). Consumption may be slowing; however, economic growth is being lifted by significant tech sector capital expenditures and continued government spending. Credit markets often detect trouble before the equity market, and it’s common to see spreads rise in advance of a recession. That’s not the case now. One metric we observe is the yield on the lowest-quality bonds compared to Treasuries, which in theory should be one of the earliest warnings signs. Today that metric is tightening and is at levels that suggest optimism.

August reinforced reasons for both optimism and caution. Earnings remain supportive, providing a solid fundamental anchor, but equity valuations are stretched, and leadership remains narrow, leaving markets more vulnerable to shifts in sentiment. In fixed income, bonds continue to present attractive yield opportunities, particularly in non-traditional and diversified segments, offering investors both income and a measure of resilience.

Looking ahead, we continue to expect a slowdown, accompanied by periods of volatility as markets react to shifting labor market data, inflation data, and ongoing communications from the Fed. These challenges are compounded by an unusually politicized policy backdrop (e.g., the legality of the tariffs), which could inject additional uncertainty into monetary and fiscal expectations.

In this environment we are closely monitoring developments and will continue to look for opportunities that balance growth potential with prudent risk management. We remain diversified across geographies and asset classes, and we continue to take advantage of select income opportunities in fixed-income.