A Market Defined by Extreme Rotation
The equity market has been extraordinarily volatile over the past several weeks, with leadership rotating almost day by day. The swings move constantly between three categories of AI-related names: the winners, the enablers, and the spenders. There is a high degree of volatility even within the narrow universe of AI-focused technology stocks.
Two indicators help track this churn. The first is comparing growth indexes against value indexes, where very wide disparities have appeared in recent weeks. The second is comparing the standard S&P 500 against the equal-weighted S&P 500, which has also shown huge daily disparities. On the day in question, growth was outperforming value by a couple hundred basis points within the US large-cap universe, and the market-cap-weighted S&P 500 was outperforming its equal-weight counterpart by over 100 basis points.
The precise cause of this volatility is hard to pin down. However, when a market is led by momentum to the extreme degree seen today — arguably one of the all-time great momentum markets — high daily stock-price volatility is essentially inevitable. This shows up not only in the most extreme momentum names but across a broad range. Micron is prominent in investors' minds after an incredible earnings report the prior week. It is also visible in the big capex spenders, several of which are investing so aggressively in new data centers that they have effectively wiped out their own free cash flow. As a result, Amazon, Alphabet, Meta, and Microsoft have all been fairly weak over the last couple of weeks — though notably they were leading the market on the day discussed. These names sit at the center of the key debates investors are currently wrestling with.
The Monetization Debate and Current Returns
There is real, persistent skepticism about whether data center spending will continue to generate strong returns. The scale of the spending is not in question — it is unambiguously rampant — but there remains genuine back-and-forth over the ability to monetize this massive capital expenditure.
What may be getting overlooked is how high the returns are today. The big capex spenders are investing aggressively precisely because they see great opportunity: they believe they are building a very durable, consumption-based, highly profitable business in their cloud computing units. This applies to Amazon, Google, and Microsoft alike.
The evidence that returns on data center spending are currently high is close to unequivocal. Just the prior week, Amazon raised the price for many of its Nvidia GPU instances by 20% — clear proof of pricing power. All of these companies report that they have more demand for compute than they have available installed supply in their data centers, which is exactly why they are rushing to invest more and open additional facilities to serve customers. On that basis, ROIs for the hyperscalers are high today.
The genuine debate is whether those returns will still be high a couple of years from now, once supply catches up with demand. That can only be resolved by watching the evidence accumulate quarter by quarter. So far, each quarter the companies report that the supply shortage continues, that they are investing aggressively, and that earnings are strong. Estimate revisions for future years — 2026 and 2027 — are being revised upward more or less continuously.
The conviction, therefore, is that ROI on AI data center spending is high, and that the four large companies doing roughly 70% of the data center building in the country — Meta, Microsoft, Google, and Amazon — are going to do very well.
A Hawkish Fed and the Inflation Picture
The interest-rate backdrop has shifted toward higher-for-longer, reinforced after Warsh's comments and updates on what the new Fed leadership could look like. The tone struck by the Fed was a notable departure from what markets had grown accustomed to in years past, and the question is how this recalibration in leadership will affect equities going forward.
The new tone was decidedly tough on inflation, and inflation is indeed higher than both policymakers and consumers would like. The picture can be broken down into a baseline plus three additive pressures. The tight baseline inflation rate sits at roughly 2.5%. On top of that:
1. Tariff flow-through — the delayed pass-through of last year's tariffs.
2. Higher oil prices — quite hefty recently, though hopefully fading as the year moves into its second half.
3. The spillover effect of AI data center capex — this is showing up directly in consumer pricing. Examples include Microsoft Xbox price increases and Apple's announced iPad and Mac price increases. Higher memory costs are filtering through to the consumer, and this particular impact is getting worse, not better.
Because inflation is too high and Chairman Warsh spoke in fairly harsh tones about the importance of bringing it down soon, the expectation is that the Fed will remain on hold through the end of the year. This is simply not an environment conducive to rate cuts, given the central bank's intense focus on inflation.
Exuberant Capital Markets and the IPO Pipeline
The pickup in IPOs and large-scale M&A activity points to a high level of risk appetite and a healthy overall state of the capital markets. Investor enthusiasm is genuinely high, and equity markets have been strong for an extended stretch — this is year four of a massive bull market in US equities, with large caps performing particularly well.
AI is a very capital-hungry technology, and the massive data center spending it requires is producing a flood of both credit issuance and equity issuance. SpaceX's IPO is the most recent evidence of this dynamic. Looking ahead, Anthropic is expected to go public before year-end, with OpenAI probably following shortly thereafter, and other IPOs after that. The door to capital markets has creaked open considerably, and Anthropic is likely to push it further open. Credit spreads are fine, signaling no problem there.
In sum, capital markets are exuberant, healthy, and optimistic — conditions conducive to an active IPO market over the next year. It is a busy and headline-rich environment, with much to be excited about and a great deal to watch as these developments continue to unfold.
