Stock Market Outlook Hinges On AI Earnings And Fed Rate Risks

Market Reaction

As would be expected in a tech-focused sell-off, the Magnificent 7 underperformed last week. The Magnificent 7 includes Microsoft (MSFT), Apple (AAPL), NVIDIA (NVDA), Tesla (TSLA), Alphabet (GOOGL), Meta Platforms (META), and Amazon (AMZN). The 1.6% gain in the average stock price shows that the stock swoon was not very broad; it was centered on tech and AI-related companies.

The profit-taking in the tech and AI-related sectors should be kept in proper perspective; the iShares Future AI and Tech ETF (ARTY) remains over 50% higher year-to-date, even after declining 10.4% from its peak. Despite robust earnings accompanied by an improved outlook from Micron Technology (MU), the semiconductor sector was a primary target of the sell-off. Given its torrid rise, the semiconductor sector is still up over 37.8% year-to-date, even after last week’s decline. Thanks to its improved earnings guidance, Micron Technology (MU) only declined fractionally last week and is up over 296% year-to-date. Notably, the software sector, which is down over 21% year-to-date due to fears of AI’s negative impact, held up quite well during the tech wreck last week.

Other Assets

Some other assets that some claim are non-correlated with stocks offered no shelter from the storm. Gold (-3.4%), silver (-10.5%), and Bitcoin (-5%) all declined more than stocks last week. It has been a challenging year for all 3 assets after a stellar 2025 for silver and gold. Year-to-date, the 3 are all lower: gold (-5.6%), silver (-17.3%), and Bitcoin (-31.8%).

Let’s consider the primary good, bad, and unknown that should impact the market in the second half of the year.

The Good

The primary good news for stocks is the combination of robust expected earnings growth and the resilient US economy.

Earnings

According to FactSet data, the technology sector should continue to post robust earnings growth. The second-quarter technology earnings growth is estimated at 63.2% year over year, while full-year earnings growth is forecast at 47.5% year over year.

While stock prices may not follow earnings over the short term, earnings growth is the fuel for rising prices over the long run.

Economy

The US economy has remained shockingly resilient in the face of the higher oil prices caused by the conflict with Iran. Second quarter GDP growth is expected to be around 2.5%. With oil prices beginning to decline at the start of May, the economic headwind from higher energy costs has been receding, which should aid economic growth in the second half of 2026.

The betting odds of a US recession fell to 1-in-10 last week, reflecting an improving outlook for US economic growth.

The Bad

The primary headwinds for stocks are likely the combination of elevated inflation and expectations of Federal Reserve rate hikes in 2026.

Inflation

While energy prices have now declined, the surge in energy prices left an elevated inflation rate in its wake. The Cleveland Fed estimates that the year-over-year pace of consumer inflation is running at close to 4%. While the inflation rate has likely peaked, assuming the Iran conflict’s impact on oil supply is nearing its end, it will take some time for it to return to a level closer to the 2% target.

The Fed

The elevated inflation rate and resilient US economy have caused the Federal Reserve (Fed) to be more likely to raise short-term interest rates than lower them this year. If the Fed must concentrate on fighting inflation rather than supporting economic growth, this would likely be a headwind for risk assets, including stocks.

The Unknown

Two of the crucial unknowns for stocks are the status of the Iran conflict, the artificial intelligence (AI) cycle, and valuation.

The Iran Conflict

Markets have largely priced in the end of the US’s armed conflict with Iran. Oil has retreated to below $70 per barrel after reaching above $110.

Betting odds, courtesy of Kalshi, suggest a roughly 50-50 chance that the US and Iran will reach a new nuclear deal. A nuclear deal isn’t necessary for oil to continue flowing, but it would certainly mark the effective end of any serious tensions with Iran. The conflict with Iran continues to flare up, so it remains an unknown, though markets are typically good at sniffing out a likely peaceful outcome.

The Artificial Intelligence (AI) Cycle

As noted previously, the estimated forward earnings growth for the market, particularly in technology, looks very attractive, but much of that earnings rests on the continuation of the virtuous AI spending cycle. Corporate adoption of AI continues to climb, but the massive spending required to build the necessary AI infrastructure leaves investors wondering whether the return on investment will be attractive enough.

Stock Valuation

At 21.4 times estimated 2026 earnings and 18.5 times 2027 estimates, stocks are not cheap. All other things being equal, higher valuations are a headwind for further stock gains. However, continued above-average earnings growth can offset higher valuations. Furthermore, if the returns on capital, as measured by return on equity (ROE), continue to climb as the consensus expects, higher valuations can be justified. Much of the past earnings growth and ROE improvement was driven by technology and AI-related companies, so much of the forward outlook hinges on whether that positive trend continues.

What To Watch This Week

The July 4th holiday-shortened trading week still featured some notable data releases. The most crucial economic release will be the June monthly job data. A stable labor market remains crucial to the US economy’s positive outlook. Nonfarm payroll jobs are expected to grow by 118,000, while the unemployment rate should remain steady at 4.3%.

While no technology companies are scheduled to report earnings this week, Nike (NKE) and Constellation Brands (STZ) are scheduled for Tuesday after the market close. The second-quarter earnings season begins in earnest in a couple of weeks, and all eyes will be on technology and AI-related companies for clues about the outlook for AI growth and spending.