The market split: Five AI leaders drive 84% of returns as the rest of the S&P 500 decorrelates

The Federal Reserve kept the benchmark short-term interest rate in the range of 3.50% to 3.75%, at its June Federal Open Market Committee (FOMC) meeting. This was the first FOMC meeting under the leadership of Chairman Kevin Warsh, who took the reins at an uncertain time for the central bank, as inflation accelerated this spring, exacerbated by higher oil prices. Value Line predicts that the Fed will pause interest-rate changes through the summer and early fall months to better assess inflation.

Inflation might slow down going forward. The primary reason is news that the United States and Iran have agreed to the framework of a deal to end the military fighting and reopen the Strait of Hormuz. An extended ceasefire would, in time, put downward pressure on oil prices and provide some needed help for the Fed. Both the May Consumer and Producer Price Index reports showed notable increases in the pace of price growth.

In the meantime, the high cost of borrowing money is hurting parts of the U.S. economy. True, both manufacturing and non-manufacturing (services) activity is expanding, and the labor market is holding up well. However, some of the interest-rate-sensitive sectors are struggling, with both residential and, to a lesser extent, non-residential construction activity still running below historical averages. Higher mortgage rates and affordability concerns are pushing would-be buyers out of the housing market according to Value Line. On point, housing starts (down 8.2% year over year) fell well short of expectations last month, and the nation’s largest homebuilders have a pessimistic near-term outlook.

On the positive note, artificial intelligence (AI) spending is the primary engine for the U.S. economy right now. As Professor Siegel puts it:

“…The other major theme this week was AI and productivity. Massive investments in data centers, semiconductors, energy infrastructure and reshoring are creating significant demand for labor even as AI improves efficiency. Rather than producing a labor apocalypse, AI appears more likely to augment workers and raise output per employee. The lesson from history is that technology often changes jobs more than it eliminates them. This productivity story is particularly important for investors because it supports a more optimistic long-term outlook for earnings growth. While there will undoubtedly be winners and losers as AI reshapes industries, the broader economic impact is positive. Higher productivity allows stronger growth without generating the inflationary pressures that traditionally accompany economic expansions. That is precisely the type of environment that can support both rising corporate profits and more favorable monetary policy.”