From Tailwinds to Headwinds
The bull market that began in 2022 was carried by two powerful currents. The first was a steady disinflationary trend: the rate of inflation cooled consistently over that period. The second followed directly from it, as falling inflation opened the door for interest rates to come down. Together, these forces provided a sustained tailwind that lifted equities and underpinned investor confidence.
That dynamic is now reversing. Both inflation and interest rates have begun moving higher, and the concern is not merely that they have turned, but that they have risen far enough and fast enough to become a genuine headwind rather than a passing inconvenience. Inflation has been simmering on the back burner of market attention even as it has grown hotter, and it deserves more scrutiny now than it did just a few months ago.
A Near-Term Concern, Not a Structural Break
The crucial distinction for investors is the difference between a choppy correction and a true bear market. The evidence so far points to the former. The most dangerous scenario—stickier, entrenched inflation that forces the Federal Reserve into rate hikes—has not yet materialized. The so-called second-order effects are absent: inflation is not feeding through into the labor market in a way that would make it self-sustaining. Wage gains, in particular, are not as strong as one would expect if inflation were becoming structurally embedded.
From a longer-term perspective, this is reassuring. The near term, however, is a different matter. Rising inflation and higher yields are likely to produce more volatility through the summer, with the realistic expectation being five-to-ten-percent choppy corrections rather than a sustained decline that would justify repositioning an entire portfolio. The case for staying invested rests on fundamentals, which have been notably strong. The most recent earnings season was robust, and the strength was broad rather than narrow: ten of eleven sectors reported positive earnings growth, with many sectors expanding their profit margins. This is a healthy backdrop once the inflation scare is set aside, and it is the primary reason a bear market does not appear to be in the cards.
Volatility Cuts Both Ways
Some of this turbulence is simply seasonal and political in nature. Midterm election years tend to be choppy for one reason or another, and this cycle the friction is coming primarily from the inflation and interest rate story. Markets also have a habit of testing new Federal Reserve chairs, probing how a fresh leader will respond under pressure. The reasonable expectation is therefore continued volatility—but volatility works in both directions. The same conditions that produce difficult stretches also generate strong rallies, and investors should anticipate both as the summer unfolds.
The Path for Monetary Policy
On the policy front, the most likely outcome is a long holding pattern. A rate cut is off the table in the near term, but the picture could change if the energy-driven component of inflation passes through without spreading into the broader economy. Should that containment hold, inflation figures could begin rolling over later this year, and by early next year a case for a cut might return to the table. A hike, by contrast, remains a distant prospect. It would require clear evidence of those second-order effects taking hold, and that evidence is not present. The reluctance to use the word "transitory" is telling—that term has earned its retirement—but the substantive view is still that inflation is not a long-term problem, even as it pressures markets in the short run.
Decomposing Inflation
Understanding where inflation is heading requires breaking it into its components rather than treating it as a single number. Shelter carries an enormous weight in the inflation calculations, and here the signals are encouraging: real-time rent data and indices such as Zillow's point in the right direction. Core goods are currently a positive contributor, largely because of tariff pass-through, but this pressure should ease over time and drift back toward a roughly zero inflation rate. Services are the area to watch, as they tend to pick up alongside energy prices—airlines, for instance, sit in the services bucket and are highly sensitive to the cost of fuel. The lingering geopolitical uncertainty around the US and Iran, where a ceasefire has held for over a month but its durability remains unclear, keeps energy prices and therefore services inflation in focus, a reality felt directly at the gas pump. Decomposed this way, inflation looks manageable over the long term while still drifting higher and acting as a headwind in the near term.
From AI Enablers to AI Users
Beneath the macro story lies a structural shift in how the equity market's leadership may evolve. The momentum has been concentrated overwhelmingly in the technology sector, and there is genuine substance behind that: these are enormous cash generators performing exceptionally well on a fundamental basis. The error would be to assume the market's strength is only about a handful of AI names—it is not, given how broad the earnings growth has been—but the weighting of momentum has undeniably sat with tech.
The more interesting opportunity lies in where that momentum goes next. The companies that have built and supplied the AI infrastructure—the "AI enablers"—have been bid up to rich valuations. Semiconductors, for example, have traded fifty to sixty percent above their 200-day moving average, a stretched condition that is difficult to sustain indefinitely. The natural progression is for the economy, and investor attention, to transition toward the "AI users": the much wider universe of companies across virtually every sector that can adopt AI to improve profit margins and overall profitability. These businesses carry lower starting valuations, which creates an attractive setup.
The implication for investors is not to abandon the dominant growth companies—that growth is real and worth holding—but to diversify deliberately. Skating to where the puck is going means broadening exposure beyond the enablers and toward the far larger set of potential beneficiaries of AI adoption. Combined with strong, broad-based fundamentals and a Federal Reserve likely to remain on hold, this rotation offers a constructive way to navigate a market whose tailwinds have, for now, become headwinds.