As a new quarter opens, the NASDAQ 100 has just delivered its strongest quarter in six years. The gains are not accidental or one-dimensional; they rest on three distinct pillars that together explain both the market's direction and the sharp rotations happening beneath the surface.
The Three Pillars Supporting the Market
First and most important: fundamentals, meaning the AI trade. In the long run, what drives market performance is strong earnings, and the AI story is currently the dominant force shaping earnings and the valuation premiums investors are willing to assign. This pillar carries the most weight of the three, and it is where the most interesting sector-level divergence is playing out.
Second: the US–Iran conflict. This factor is receding into the background as a market driver. Following the memorandum of understanding signed on June 18th, the market is reacting far less to the tweets and messaging surrounding the conflict. The fading of this geopolitical noise is a welcome development for markets.
Third: macroeconomic data. This includes the lingering impact of the war on oil prices, inflation, and the arrival of a new Fed chair. The macro picture always complicates the outlook, but at the end of the day everything comes back to fundamentals — earnings — because that is what ultimately drives performance over time.
Is the AI Bull Market in Its Early Innings, or Are Investors Overpaying?
A central question is whether investors are paying too much for growth or whether we remain in the early innings of the AI trade. The answer is that it is not really about overpaying for growth — it is about rotation and a sharpened focus on who is actually making money in AI.
The AI trade has matured. In the very early phase, everybody doing anything in AI was rewarded. That has shifted decisively to a "show me the money, show me the results" mentality. Strong performance has increasingly flowed to the recipients of the massive AI capex spending program — the chipmakers, the semiconductor companies, and the memory companies such as Micron, alongside Nvidia and AMD. These names have done extremely well, and the semiconductor index is up about 63% within the NASDAQ 100.
By contrast, the market is taking a more skeptical view of the hyperscalers — the Microsofts, Metas, and similar firms — that are doing the spending. Estimates point to roughly $700 billion of AI capex spending for 2026. The market has grown cautious on the spending side while rewarding those on the receiving side, not only for the earnings they have already booked (order flow for these companies has been phenomenal) but also for their strong forward-looking forecasts.
Making Sense of the Rapid Rotations
Beneath the surface, the market is churning. Money is rotating out of the long-crowded trades and into the hated, unloved, underweighted parts of the market — and even within technology itself, the rotations between hardware and semiconductors have been so rapid they resemble an Olympic ping-pong match.
The market is still trying to get a handle on this. The earnings for these companies are clearly there; the real question is what valuation is appropriate. A selloff in some of the best performers on the first day of a new quarter is not surprising. Part of it may be window dressing — fund managers wanting quarter-end and month-end statements that show they owned all the biggest winners (Micron, AMD, Nvidia, Intel), then lightening up on a short-term basis once the quarter closed. But the fundamentals remain very strong: Micron just reported earnings that blew away estimates and raised forward guidance. So while some of the movement reflects short-term positioning, the longer-term trade remains very much intact.
The Startling Gap Between Semiconductors and Software
One of the most striking data points is the enormous performance gap between semiconductors and software. There has been a "SaaS apocalypse" in which essentially all the software names got caught up.
Breaking down the NASDAQ 100's roughly 20% gain for the quarter makes the divergence vivid:
- Bucketing all the semiconductor and hardware companies together, they added about 23 percentage points to performance.
- Bucketing the software companies together, they detracted about 3 percentage points.
- Net-net, that leaves the index up about 20% for the quarter.
That is an extraordinary performance differential — numbers so extreme it is hard to recall the last time they appeared. The explanation is that software companies are currently the spenders, and the market is being more skeptical of spenders. This skepticism is actually healthy: rather than rewarding everyone involved in AI, the market is asking who is winning right now, and the answer is those receiving the AI capex and building out the infrastructure.
When Will Software Capture More of the AI Value?
The natural follow-up is when software companies will begin capturing more of the AI value now flowing to semiconductors. There is no exact timing, but the turn will come as return on investment becomes visible. Reports indicate that about 25% of S&P 500 companies are starting to report meaningful contributions from AI. As those contributions take hold and investors can genuinely evaluate the benefits of AI, software should begin to pick up again. For now, though, the market is simply rewarding those booking more tangible orders.
Dispersion and the "Neural 9"
There is growing attention to dispersion among the market's biggest names. One notable framing is the "neural 9" — the Magnificent 7 plus Broadcom and Micron — used to highlight how much these leaders are diverging from one another.
For a long time the narrative was "MAG7 versus everybody else," but that is not what the last quarter, or even the year, has shown. The Magnificent 7 have generally underperformed the rest of the NASDAQ 100. There are pockets of strength — Nvidia has done very well — but several of the others have lagged. The real story has been software versus semiconductors rather than MAG7 versus the other 93.
Evidence of this broadening is clear in the equal-weighted index. The NASDAQ equal-weighted index is keeping pace remarkably well with the NASDAQ 100, up close to 20% for the quarter and also about 20% year-to-date. The strength has spread to other semiconductor names, making this more of a thematic trade than a MAG7 concentration trade — a meaningful shift from what was seen last year.
Valuations Are Contracting Despite Rising Prices
A final and counterintuitive point concerns valuation. Over the last 18 months — from the end of December 2024 through the end of June — the NASDAQ 100 is up roughly 40 to 44% on a cumulative basis. Yet over that same stretch, the forward price-to-earnings ratio is actually down about 8%.
In other words, PEs have been contracting despite very strong price performance. This is because earnings have been growing so fast, and forecasted earnings continue to get ratcheted upward, that they have outrun the rise in prices. Rising prices atop even faster-rising earnings estimates produce a market that is, on this measure, cheaper than it was — an observation echoed by strategists highlighting the same dynamic in mid-year outlooks.
