A Loss of Situational Awareness
By Crest Capital Advisors on August 3, 2026
Dow: 1.04% to 52,485.03
S&P 500: 1.05% to 7,489.72
Nasdaq: 1.59% to 25,373.85
Russell 2000: 0.05% to 2,933.17
Bitcoin: 63,160
10 Year Yield: 4.71%
Outperformers: Consumer Discretionary 8.31%, Communication Services 5.37%
Underperformers: Utilities (4.23%), Real Estate (2.22%), Materials (1.72%)
US stock markets were modestly higher this week, with the S&P 500 and Nasdaq both up for a second-straight week. The AI capex/ROI/monetization narrative was the key focus to this week amid Big Tech earnings. Microsoft Azure growth and guidance were bright spots. Amazon AWS growth was stronger than expected; both stocks saw substantial gains on the week. However, Meta was hit by its latest AI capex ROI concerns as it has yet to demonstrate a path towards monetization, and Apple (which was previously a beneficiary of the AI spending concerns) fell after results with disappointing guidance, cost pressures, and supply shortages.
The Fed concluded its July meeting with no rate change, as expected, though it did feature three dissents in favor of a 25 bp hike. The day after the Fed meeting concluded, the Fed’s favored measure of inflation (Personal Consumption Expenditure (PCE)) posted a very benign 0.12% price increase for the month, allowing markets to calm down from the mounting fear of a rate hike at one of the next few Fed meetings.
US-Iran hostilities remained this week, but markets have largely ignored it, other than perhaps a modest back-up in the price of oil. This remains an ongoing overhang but is less and less critical as markets focus on earnings, AI and momentum.
Speaking of momentum, this week’s big story was the elevated momentum volatility. Semiconductors, memory, and AI infrastructure names sold off sharply at the beginning of the week, but a late-week rebound was tabbed to factors including oversold conditions and largely exhausted hedge fund positioning. The main culprit behind the selling pressure was the forced unwind of AI-focused hedge fund Situational Awareness, which was forced to sell its public equities portfolio to Citadel after suffering heavy losses. This served as the inspiration for our title this week (tongue in cheek, of course) as well as our meme of the week.
The AI Paradox Evolves
For the better part of two years, Wall Street has treated artificial intelligence as a one-way trade. Companies that announced larger AI investments were rewarded, while companies perceived to be falling behind were punished. The assumption was simple: spend now, monetize later.
This earnings season suggests the market has entered a new phase. The question is no longer who is investing in AI. The question is who is proving those investments are actually generating returns.
Just last week, we highlighted what we called The AI Paradox. Google delivered an outstanding quarter (strong Cloud growth, expanding margins, and another increase in AI capital expenditures) only to see the stock sell off as investors questioned whether the spending would ever generate an acceptable return. At the same time, ServiceNow reported another excellent quarter, raised full-year guidance, and continued demonstrating resilient enterprise demand, yet the stock barely responded before finishing the week lower.
The market was simultaneously expressing two seemingly contradictory beliefs:
- AI infrastructure spending has become excessive.
- AI is about to permanently impair software economics.
Those views were difficult to reconcile.
This week, however, investors began drawing an important distinction. Microsoft reported another exceptional quarter. Azure accelerated meaningfully, management pointed directly to AI services as a driver of growth, and cloud demand once again exceeded available capacity. Investors had little trouble accepting another massive increase in capital spending because the revenue was already beginning to validate the investment thesis.
Amazon received a similar reception. While management continued to signal elevated infrastructure spending, AWS growth and improving operating leverage gave investors confidence that those dollars are producing tangible economic returns.
Meta, by contrast, reminded investors that spending alone is no longer enough. The company continues to invest aggressively in AI infrastructure, but questions surrounding the pace of monetization and the pressure on free cash flow left investors considerably less enthusiastic.
The message from the market has become remarkably consistent. CapEx is no longer the story. Return on CapEx is. That represents an important shift in investor psychology.
For nearly two years, the market largely rewarded ambition. Announcing larger GPU deployments, larger data centers, and larger AI budgets was often enough to justify higher valuations. Today, investors are becoming far less interested in the size of the investment than in the timeline for earning an economic return.
In many respects, this is exactly what healthy markets are supposed to do. Every technological revolution begins with extraordinary infrastructure spending. Railroads, electricity, the internet, cloud computing…each required years of capital investment before the eventual winners emerged. Eventually, however, investors stop asking who is building and start asking who is earning. Artificial intelligence appears to have reached that transition point. The irony is that this may actually be bullish for the sector.
Markets are moving beyond hype and beginning to differentiate execution from aspiration. Companies capable of converting AI investment into accelerating revenue, expanding margins, and improving productivity are likely to command premium valuations. Those that cannot may discover that simply saying “AI” is no longer enough.
The AI trade isn’t ending. It’s growing up.
The Market Still Doesn’t Get It
As expected, the Federal Reserve left interest rates unchanged at Chairman Kevin Warsh’s second FOMC meeting. The statement itself changed very little, but the press conference provided a clearer picture of how the new Chair is thinking about the economy.
Warsh described an economy with solid growth, healthy capital investment, improving productivity, and a labor market that remains on firm footing. Inflation, while still above the Fed’s long-term target, was characterized as a more nuanced problem than the market appears willing to acknowledge. His message was clear: the Fed remains committed to price stability, but interest rates are not the only tool available to achieve it.
Markets, however, continue to tell a very different story.
Fed funds futures entered the meeting assigning nearly a 100% probability of another rate hike by September. Even after the meeting, investors continue to price meaningful odds of additional tightening before year-end. We believe that remains far too aggressive.
The recent inflation pressures have been driven disproportionately by energy and other supply-side factors rather than a broad-based acceleration in underlying inflation. At the same time, money supply growth has remained subdued, productivity is improving, and AI-driven efficiency gains are only beginning to work their way through the economy. Those are not conditions that typically require additional monetary tightening.
Warsh also made a subtle but important point. The Federal Reserve has other ways to tighten financial conditions, including continued balance sheet reduction, without resorting to higher policy rates. That flexibility gives policymakers room to remain patient while monitoring incoming data.
Markets appear convinced that another hike is coming. We believe they are pricing the wrong risk.
Absent a meaningful reacceleration in underlying inflation, our base case remains unchanged: the Fed stays on hold for the balance of the year. If anything, the next move in rates is more likely to be down than up.
The Flow Show
Bullish sentiment among individual investors in AAII’s weekly survey hit its lowest level of the year earlier this week, dropping 15.3 percentage points down to just 29.6% for the biggest weekly drop since 9/16/21. Between 1990 and 2010, bullish sentiment topped 60% in 44 different weeks, but it hasn’t been above 60% since 12/23/2010!
It doesn’t take much to make the bulls scatter these days, and the market’s weakness so far in July in the stocks that were big winners in the first half of the year looks to have scared a lot of investors.
Weak bullish sentiment is exactly what contrarian investors like to see when looking for short-term entry points.
Earnings in Full Swing
Earnings season is in full swing, and expectations for profit growth continue to move higher. Consensus earnings growth for the quarter has risen to 38.8%, up from 24.4% on July 1st, with virtually all of that increase driven by Alphabet. Revenue growth has also exceeded expectations, improving to 12.6% from 11.7% at the start of the reporting season. Next 12 Months Earnings-Per-Share (EPS) growth is now at its third-highest level on record, with previous peaks typically occurring during recoveries following recessions.
While it has been difficult to challenge the profit outlook given its sustained strength, the combination of parabolic margin expansion and rising input costs warrants closer attention.
2026 Full-year earnings growth expectations now sit roughly at 27.7%, with 2027 forecasted to come in at 14.5%.
The Next 12-Months Earnings-Per-Share growth is now the 3rd highest on record, with the prior 2 periods occurring directly after significant recessions.
S&P 500 index operating margins continue to move parabolic, driven by the mega caps.
Sometimes Congress Gets it Right
Few ideas in finance have been as successful as the 401(k), which has helped some 70 million American workers plan for their later years and sock away $10 trillion in the process. The average total savings rate, including employee and employer contributions, reached a record 12.1% in 2025, with about 45% of participants increasing their savings rate last year, and a record 62% of plans automatically enrolling participants at 4% of pay or higher.
Economic Funnies
Crazy Stat of the Week
- Blowout earnings from Microsoft released Wednesday afternoon helped energize the tech sector on Thursday. Microsoft stock rose 15.5% for the day, recording its largest single-day increase since 2008, and its largest post-earnings bump on record, according to Dow Jones Market Data. The company gained $449.7 billion in market cap, notching the largest one-day market cap gain for any U.S. company on record!
Quote of the Week
“AI will reinvent every customer experience, and there will be a slew of new experiences only possible because of AI. I’ve followed the public debate on whether this technology is overhyped, whether we’re in ‘a bubble,’ and if the margins and ROIC will be appealing. My strong conviction, at least for Amazon, is that the answers are no, no, and yes.”
– Andy Jassy, Amazon CEO (earnings call quote from 7/30/2026)
Calendar of Events to Watch for the Week of August 3rd
Another peak week of earnings remains on deck as the market transitions from mega-caps to merely large caps and some of the top tier mid-cap names. Earnings season continues to post strong numbers, therefore underpinning the stock market as a whole.
In Central Banking, the July FOMC meeting ended with no change, as expected (though uncertainty was elevated into the rate decision). There were no changes to the policy statement, though the meeting featured three dissents (Hammack, Kashkari, Logan) in favor of a 25 bp hike. Chair Warsh said the committee remains resolute to delivering price stability, though continued to decline to comment on the Fed’s reaction function or forward guidance. Warsh also said that markets have already done quite a bit of tightening.
In US economic data next week, we get readings on Manufacturing and Services PMIs, but the main event will be Friday’s Non-Farm Payrolls report.
Monday 8/3 – The July ISM Manufacturing is expected to move further into expansionary territory at 54.5, up from 53.3 last month. June Construction Spending is expected to show a 0.3% increase.
Tuesday 8/4 – The JOLTS Job Openings report is expected to come in at 7.2m, down from ~7.6m last month. June Factory Orders are expected to contract by -0.4%, whereas Durable Goods Orders for the month of June are expected to come in at 0.3%.
Wednesday 8/5 – The July ISM Services report is expected to be 54.4, up a few ticks from 54.0 last month. Services continue to lead the economy higher overall. The ADP Private Payrolls report is forecast to show 75k net new jobs, down from 98k in the prior month.
Thursday 8/6 – Q2 Productivity is expected to post a robust 3.0% rate, well up from 0.3% in the prior quarter. Unit Labor Costs are expected to cool to a 0.5% pace, down from 1.8% in Q1. The Weekly Jobless Claims data will continue to be watched carefully for any signs of deterioration.
Friday 8/7 – The main event of the week will be the Non-Farm Payrolls report for July, which is expected to come in at 87.5k net new jobs, up from last month’s 57k pace. The Unemployment rate is expected to tick up modestly to 4.3%, from 4.2%, still very, very low. Hourly Earnings are expected to post a 0.3% increase.
Source: MarketWatch / FactSet (July 31, 2026)
