The Water’s Fine—Just Know What’s Swimming Beneath You

Markets are near record highs and earnings remain strong, but two important accounting sharks are lurking beneath an otherwise healthy bull-market story.

KEY TAKEAWAYS

• S&P 500 earnings growth remains exceptionally strong. Even after removing some of the biggest contributors and unusual gains, underlying corporate profit growth is still impressive and broad-based.

• The earnings story extends well beyond AI. AI-related companies are growing quickly, but non-AI companies are also delivering healthy double-digit earnings growth across the economy.

• Tariff refunds are temporarily boosting corporate profits. Billions of dollars are flowing back to companies, improving earnings and cash balances, but these payments are one-time benefits rather than recurring revenue.

• Private-company investment gains are materially inflating headline earnings. Large technology companies have recorded enormous mark-to-market gains on stakes in companies such as Anthropic and SpaceX, creating reported profits without corresponding operating cash flow.

• AI capital spending remains a major structural tailwind. Hyperscaler spending is spreading through semiconductors, power, cooling, networking, construction, and increasingly international infrastructure projects.

MY HOT TAKES

• The bull market has legitimate fundamental support. The strongest argument for staying constructive is not simply AI enthusiasm—it is the breadth of actual earnings growth underneath it.

• Headline earnings numbers deserve skepticism without requiring bearishness. Stripping away one-time refunds and noncash investment gains produces a less spectacular number, but still leaves an extraordinarily strong earnings environment.

• Investors should distinguish earnings quality from earnings quantity. A dollar created by selling more products is fundamentally different from a dollar produced by revaluing a private investment.

• Tariff refunds reveal something important about corporate margins. The size of the reimbursements suggests companies absorbed more tariff costs than many investors may have realized instead of simply passing everything through to consumers.

• The AI investment cycle still appears early rather than exhausted. The expansion of spending beyond hyperscalers and into governments, sovereign investors, infrastructure, and the broader supply chain argues for a longer runway.

• You can quote me: “There are sharks in the water, but we are still swimming!”

Swimming with sharks. My longtime followers know that I have a problem. And that problem is that I am simply unwilling to just follow the current without question. If you browse mainstream media trending articles you will find a generally positive narrative. Earnings are going great, markets are near or at all-time highs, AI is-REMAINS huge, data centers in space, to the Moon…er Mars–all is good but for a few nuances. The fineprint–or as I sometimes like to refer to them–the sharks.

I have used this analogy before but this morning while you drank your morning coffee and cast a wicked stare at the last night’s dirty dishes in the sink, I had the privilege of sitting on a news desk next to one of my favorite anchors and a few industry colleagues whom I deeply respect. It was not just national TV–it was international. I know this because I have had folks in Europe ping me when I have been there in the past (it's lunchtime over there 😉). We had ten minutes to cover the most important financial news topics of the morning–and we did it. We covered them all from inflation, to SpaceX, to tariffs, to taxes, to AI–the works. And we did it critically. It was fun and informative. The anchor ended with the block referring to a discussion we had started in the green room prior to the show. There are sharks in the water, but we are still swimming!

Some of you know about this favorite analogy of mine. I spend an awful lot of time making sure I know about all manner of predatory sea creatures lurking beneath the calming, shiny, blue surface before I get in for a swim. But I still swim! I just like to know.

This week has so far thrown us a cool CPI and we are expecting a moderating PPI later this morning. Probabilities for Fed hikes are pulling back–BUT STILL LIKELY by year end. Bond yields have eased a bit and earnings continue to astound in the positive. Stocks are near all time highs and the stock everyone hated last week (fill in your favorite) seems to have turned around. Time for a swim. Let's dive in.

Let's start with the good news, because there is quite a bit of it and it deserves more airtime than it gets. Second quarter earnings for the S&P 500 are coming in at a blended growth rate of 50% year-over-year–and even after you strip out Alphabet and Amazon, the two names doing the heaviest lifting, growth still lands at 32.0%. That is not a typo and it is not a rounding trick. This marks the seventh straight quarter of double-digit earnings growth for the index, and ten of eleven sectors are showing year-over-year gains, eight of them in double digits. Revenue is playing along too, tracking near its best pace since late 2021, with all eleven sectors chipping in.

Here is the part that matters for the "it's just AI" crowd. The median AI-related stock posted 28% earnings growth last quarter. Fine, expected–AI is still the growth engine. But the median NON-AI stock in the index still grew earnings by 12%. TWELVE PERCENT. That is a real economy still doing real things–selling airplane parts, running hospitals, financing cars, stocking shelves–and growing profits while doing it. That breadth is why you probably saw that JPMorgan bumped its year-end S&P 500 target from 7,800 to 8,000 this week, joining a growing list of strategists quietly raising targets over the summer. When the story is broader than one sector, targets tend to follow.

So the surface is calm, blue, inviting. Time to swim. But I promised you I'd check for fins first, and I found two.

The first shark looks harmless at a glance– and in fairness, it mostly is. You'll recall that the Supreme Court invalidated a batch of IEEPA tariffs back in February, which set off a refund process that has, as of last week, pushed more than $100 billion back out of Treasury's hands and into corporate coffers, against roughly $166 billion still owed. Per the Wall Street Journal's reporting this week, Apple alone has collected $2.19 billion, which added eleven cents to its per-share earnings, which is about 5% of the quarter's total EPS. Nike picked up $986 million. FedEx got roughly $800 million and says it will start passing some of that along to shippers and customers this month. Amazon booked $600 million. Ford is expecting $1.3 billion tied specifically to the IEEPA ruling, part of a broader $3 billion in total tariff reimbursements it anticipates. GM is looking at $500 million, and Costco is in line for something in the neighborhood of $2 billion, which it has pledged to pass back to members.

On its face, this is about as good as corporate news gets–revenue with no offsetting cost, straight to the bottom line, no factory to build, no product to sell. And notice what the size of these checks tells you: companies ATE a real amount of tariff cost earlier in this cycle rather than passing it through at the register. That's not nothing. Margins held up better than they otherwise would have, and the cash is now coming home to roost. More cash on the balance sheet is, all else equal, always a good thing.

Here's my "but." This is a one-time goose, not a new revenue stream. Once the refund checks clear, they're gone. Next quarter's comp doesn't get another $2.19 billion drop-in from Cupertino. If you're modeling forward earnings off a base quarter padded with tariff refunds, you're modeling off a number that will not repeat, and I'd rather you know that going in than get surprised by it in October.

The second shark swims a little deeper and is, frankly, the more interesting one. A chunk of the eye-popping headline growth this quarter isn't operating profit at all–it's paper. Alphabet, Amazon, and Microsoft all hold equity stakes in AI companies like Anthropic, along with positions in SpaceX and, in some cases, Intel, and accounting rules require them to mark those stakes to market each quarter. When private valuations jump, so does "other income" on the income statement, even though not a single share changed hands. Alphabet's stake gains, mostly tied to Anthropic and SpaceX, added roughly $98 billion in other income last quarter, pushing net income up 298% to $112.1 billion. Strip that out and growth was still solid, but a far more human 23%. Amazon booked a $53.4 billion gain, mostly from Anthropic, inflating EPS growth to 242%; excluding it, growth runs closer to 17%. Microsoft picked up roughly ten points of earnings growth the same way. Zoom out to the whole index and the data shows headline S&P 500 earnings growth above 48% for the quarter, but backing out these investment gains brings that down to roughly 29%.

Now, 29% is still an outstanding number. I want to be clear about that. But the DIFFERENCE between 48% and 29% is not revenue, it's not margin, and it's not even cash, it's an accounting entry tied to the private valuation of a handful of companies that don't trade on an exchange. Anthropic's valuation reportedly nearly tripled in a single quarter. SpaceX went public in June at $1.77 trillion, up from a $400 billion private mark a year earlier. Those are extraordinary moves, and they're real in the sense that the mark is defensible under the accounting rules. But they are not cash flow, they are not a repeatable business line, and unlike the tariff refunds, they can swing the OTHER direction just as fast if private valuations cool. Combined, these two sharks are why I'd rather you look at the 29% and the 32% ex-mega-cap number than the flashiest headline print–the underlying story is still very good, it's just not quite as good as the top-line number wants you to believe.

And that underlying story really is good. Hyperscaler capital spending is not slowing down. AI-related spending, mostly from the big cloud players, is expected to be roughly $900 billion by year-end, out of about $1.5 trillion in total S&P 500 capex. That spending doesn't stay inside four companies. It flows down through the entire AI ecosystem–chipmakers, power and cooling infrastructure, networking, construction–and it isn't just a domestic story anymore. Sovereign wealth funds and foreign governments are now funding data center buildouts of their own, which tells me this cycle has legs well beyond the usual suspects. Every piece of evidence I look at says we are still in the early innings here, not the late ones.

So yes, there are sharks. There's a one-time tariff check that won't repeat, and there's a chunk of "earnings" that lives on a balance sheet as somebody's best guess at what a private company is worth this week instead of last week. I see both fins clearly, and I'm not going to pretend they're not there just because the surface looks calm. But I also know the difference between a real threat and one I can swim around, and I've got my escape plan mapped out well before I need it. The water's still good. I'm still in it.

YESTERDAY’S MARKETS

The S&P 500 rose 0.26%, the Nasdaq Composite gained 0.54%, and the Dow Jones Industrial Average slipped 0.04% to 53,770. Indexes caught a tailwind from a benign CPI print and reduced Fed tightening possibility.The 10-year Treasury yield held at 4.69%. WTI crude settled at $83.27 per barrel, up 7 cents on the day. Super Micro Computer and CoreWeave each surged 19% following stronger-than-expected quarterly results.

NEXT UP

• Initial Jobless Claims (August 8th) is expected to come in at 202k, slightly higher than last week’s 199k claims.

• Producer Price Index / PPI (July) probably eased to 4.9% from 5.5%.

• Fed speakers today include Hammack and Harkin.

• Important earnings today: YETI Holdings, Tapestry, X-energy, Demi, Ondas, Intuitive Machines, Applied Materials, and York Space Systems.