iCapital Market Pulse: Will AI Capex Vigilantes Emerge?

Key Takeaways:

• Growth remains broad-based, with synchronized expansion across consumers, business investment, and profits—pushing key indicators to multi‑year highs despite geopolitical disruptions.
• Inflation is proving sticky, keeping rates higher for longer, with the 10-year Treasury now expected to remain in a 4.0%-4.8% range, creating a more challenging macro backdrop.
• Three key risks are emerging: (1) “AI capex vigilantes” as investors demand returns on heavy AI spending, (2) fading cyclical tailwinds (liquidity, fiscal support, consumer boosts), and (3) persistent upward pressure on interest rates.
• Investment stance: stay invested but more selective and risk-aware—maintain equity exposure with hedging, favor real assets in private markets for inflation resilience, and avoid extreme duration positioning in fixed income.

The U.S. macroeconomic backdrop remains notably stronger than anticipated, even in the face of one of the biggest oil supply disruptions on record. What is particularly striking is not just the level of growth, which is generally breaking out to four-year highs, but that it is also broad-based, spanning retail spending, business investment and corporate profits.

At the same time, this strength is creating a more complicated macro regime. Rather than normalizing toward the Fed’s 2% inflation target, inflation has been elevated since 2024, even before the military conflict in Iran. This is likely to keep interest rates higher for longer, particularly at the long end of the curve, where we are raising our 10-year Treasury yield expected range to 4.0%-4.8% from 3.8%-4.5%.

A broad-based breakout

Following the 2021-2022 post-pandemic boom, the U.S. economy didn’t face a singular crash. Instead, it navigated a sequence of rolling downturns as it digested the “triple threat” of high inflation, restrictive interest rates, and the withdrawal of fiscal stimulus that hit technology, then consumer goods and manufacturing.

For a time, this underlying friction was masked. A remarkably resilient consumer base—albeit with increasing signs of weakness among lower income consumers—and a tech sector that successfully passed the baton from pandemic-era growth to an AI-driven capital expenditure cycle kept the broader economy stable.

The Great Synchronization

We are shifting from fragmented resilience to a synchronized rebound. Boosted by improved liquidity and a fresh wave of investment, multiple segments of the economy are finally pulling in the same direction. This in part has been evidenced through robust corporate profits that have been largely broad-based, with small cap companies beginning to experience an earnings rebound and the S&P SmallCap 600 Index beginning to see EPS rise back to late 2024 levels. Several key indicators are currently breaking out to levels we haven’t seen in years:

• Manufacturing Purchasing Manager Indices: The US ISM Manufacturing Index surged into expansionary territory this year and sits at a four-year high, echoed in the Global Manufacturing PMI [Exhibit 1].
• Retail Sales: The Johnson Redbook weekly retail same-store sales growth is running at 7.8%, also the highest level since the end of 2022 [Exhibit 2].
• Labor Market: Even with demographic and immigration headwinds, the employment diffusion measure of labor market breadth just hit a two-year high.

What would start to worry us

While fundamentals are undeniably strong and supportive of the bull market, the margin for error is narrowing given valuations and liquidity have surged past pre-war levels. As we move into the second half of the year, we have identified three key risks to growth and liquidity that could shift our outlook to a more cautious stance:

1. The potential for AI capex vigilantes

Through April, tech companies have raised record amounts in the bond, private credit and equity markets to finance a historic capex cycle. We recently wrote about this dynamic in our market pulse, “AI’s Price Tag is Rising,” noting that sustained capex spend will be contingent on clear evidence of operating leverage. While we believe capital will continue to be abundant, we are cognizant that investors will pull back in pockets of the industry if they believe funds are being deployed without clear, sustained returns.

In an indication of the shifting nature of liquidity, investors are now more discerning when it comes to rewarding the surging capex in AI-driven capital expenditures, particularly as it weighs heavily on free cash flow – a metric that is forecast to plummet at the largest hyperscalers [Exhibit 3].

On the back of recent earnings, we saw the market reward companies that are posting greater cloud adoption and token usage. This has led to divergent performance of the hyperscalers, with Alphabet and Amazon demonstrating the clearest benefit to their cloud growth, while Meta’s stock declined 9% on the back of raised capex guidance and unclear revenue payoff [Exhibit 4]. Importantly, we see the performance of the Philadelphia Semiconductor Index, which has risen more than 65% this year through the first week of May, as a signal that investors are still seeking to stay close to the AI infrastructure play, while displaying caution about how such infrastructure would start to benefit enterprise clients.¹

Weakness in the conversion of capex into revenue and changes to the competitive landscape can reshape which companies are perceived as AI winners and losers, which can in turn change how much and where capital is allocated:

2. Fading tailwinds

As we enter the second half of the year, some of the first half tailwinds could become headwinds as their impact fades. To the extent that the market has extrapolated the strong momentum in growth, with the biggest upgrade to annual S&P 500 EPS forecasts since the end of the pandemic [Exhibit 1], the greater the risk that growth could fall short of expectations.² Here are some of the tailwinds that may begin to fade as the year progresses:

• Fed balance sheet: After reducing its balance sheet by 27% during the latest round of quantitative tightening, the Fed began expanding its balance sheet in December through reserve management purchases (RMPs), which involve supporting banking liquidity through purchases of Treasury bills.³ However, these purchases have only resulted in a 3% boost to the balance sheet so far, and the pace of purchases has moderated a bit in recent weeks.⁴
• Fiscal mortgage market support: In January, President Trump directed Fannie Mae and Freddie Mac to purchase up to $200bn (roughly 2% of the market) of agency mortgage-backed securities (MBS), in order to lower mortgage rates.⁵ However, in recent months, the trend has partially reversed, with MBS interest rates rising both on an absolute basis and relative to Treasury yields.
• World Cup: With the US hosting the FIFA World Cup for the first time in 32 years, related spending could provide a short-term boost to growth, but that boost would be short-lived after the event wraps up in late July.
• Energy prices: At the end of 2025, falling average gasoline prices fell below $3.00/gallon for the first time since the pandemic, providing a further boost to households and corporate margins.⁶ However, in the wake of the Iran war, gasoline prices have surged past $4.50/gallon and fast approaching the $5.02/gallon record levels hit in 2022.⁷ While households are not as sensitive to energy prices as they used to be, further increases will likely begin to eat into demand for other areas of spending, many of which are experiencing their own inflationary pressures.
• Tax refunds: The record tax refund season is winding down. As of May 1st, the average refund of $3,273 was up 11% vs the prior year, providing a nice offset to higher gasoline prices.⁸ However, with most of those refunds having been distributed, this tailwind is likely to be short-lived.

3. Higher for longer interest rates

Interest rates remain a key risk to liquidity and growth, largely driven by the stickiness of high inflation and the dual threats of Iran and the potential continuation of the strong growth momentum discussed earlier:

Supply-driven inflation: If the Strait of Hormuz remains significantly disrupted for much longer, the impact on commodity prices and inflation may accelerate, as a lack of physical supply in certain markets wreaks havoc on prices and pushes interest rates higher. The longer this lasts, the stickier future inflation is likely to be.

Demand-driven inflation: Alternatively, if growth were to continue to come in above expectations, this could exacerbate inflationary pressures, regardless of what happens in the Middle East.

No matter how things play out, we think that the higher for longer inflationary backdrop has put a floor on how low interest rates can go this year. We think it unlikely that the 10-year Treasury yield will fall below 4% unless growth slows to the point where the market starts to price in a significant risk of recession. But if we see further supply- or demand-driven pressure on inflation, we think 10-year yields could approach 4.8%, a level we think would begin to weigh on markets and cause volatility to rise. We have raised our 10-year Treasury yield range from 3.8-4.5% to 4.0-4.8%.

Investment implications

Public markets: Maintain equity exposure, but consider hedging

The healthy earnings backdrop provides strong fundamental support for public equities, but the risks to liquidity and growth, particularly the binary nature of the military conflict in Iran, suggest that the potential for further gains is accompanied by elevated tail risks. As such, we recommend that clients maintain broad exposure to public equities, but those with shorter time horizons or lower risk tolerance should consider hedging their downside. Structured investments provide a way to protect against downside risk while capturing income.

Private markets

In private markets, higher inflationary pressures could reinforce the benefits of holding real assets, many of which are linked to inflation. Real assets have historically performed favorably in a variety of inflationary environments—in periods of high inflation over the past 20-plus years, real assets outperformed both public equity and public fixed income—but have especially excelled when the prices of goods and services have risen rapidly.⁹

Value-add and opportunistic investing remains our top idea in real estate. Net operating income (NOI) for such strategies has increased significantly faster than inflation over the last 10 years, which should enable total return strategies to outperform as real estate values stabilize.¹⁰

Interest rates: Own duration but not too much

With the 10-year Treasury yield near the middle of our new expected range of 4.0-4.8%, we see reason to be tempered in duration positioning. That said, we think risks skew to the upside given the inflationary dynamics discussed earlier. While a range of borrowers may be strained from higher-for-longer interest rates, equally lenders may be able to capture meaningful yields in private markets should investors stay high up in capital structure with sufficient protections. This could make parts of the 2026 vintage attractive for private credit.