A Rally Built on Resolve: July Markets Recap & What Lies Ahead

July delivered fireworks of its own this year, closing out a month of record-setting momentum across U.S. equity markets. After a stretch of geopolitical tension and rate uncertainty, investors embraced a wave of optimism—pushing both the S&P 500 and Nasdaq to six consecutive record closes late in the month. But beneath the surface of this rally lies a complex balancing act. Here’s a closer look at what powered July’s bullishness, what’s fueling investor sentiment, and the risks that still warrant attention as we head into the second half of Q3.

What Drove the July Rally?
The initial spark came from the global stage. New trade agreements with Japan and the European Union helped ease tensions, injecting a welcome dose of clarity into an environment still grappling with the fallout of tariff policy uncertainty. That development gave investors confidence, particularly in sectors sensitive to global growth. Tech once again took the lead, especially the market-defining “MAG-7” mega-cap names. But this time, the rally extended beyond just the giants. For the first time in months, small-cap stocks and equal-weighted indexes participated meaningfully, suggesting a broadening of market breadth that some analysts see as a bullish confirmation signal. A major undercurrent of this strength has been capital investment in artificial intelligence. AI-driven spending continues to bolster U.S. GDP growth—adding an estimated half a percentage point over the past year. While markets have rewarded these investments with higher valuations, there’s still open debate about whether the promised long-term productivity gains will materialize at the scale investors are pricing in.

Rates, Yields, and the Fed's Patience
Monetary policy remains a pivotal part of the market narrative. The Federal Reserve held rates steady in July, choosing to wait for more clarity on inflation’s trajectory before making any moves. Earlier in the month, futures markets priced in a roughly 70% chance of a September rate cut. But by month-end, that probability dropped below 40%, signaling a shift in expectations as inflation data remained mixed. Bond markets reacted swiftly. Short-term yields moved higher across the curve, reflecting both reduced confidence in a near-term pivot and modestly stronger economic data. Interestingly, fixed income volatility—measured across both government and corporate debt—has fallen to its lowest level since early 2022, a sign that markets are at least temporarily comfortable with the Fed’s “wait and see” approach.

A Tale of Two Investors: Sentiment Splits
Despite strong headline performance, sentiment remains divided. Retail investors have been steadily increasing risk exposure, drawn in by AI enthusiasm and strong recent returns. Institutional investors, however, are more cautious—lightening up positions and rotating into defensive strategies. This divergence has created what some strategists call a “pain trade” setup: a scenario where strong economic data could force institutional investors to chase the market higher, extending the rally in the face of already-stretched valuations. And stretched they are. The S&P 500 now trades at approximately 22 times forward earnings, well above the long-term average of around 16-17x. While Q2 earnings season is beating expectations, earnings growth has decelerated, and much of the market’s performance is now predicated on continued AI-fueled investment and long-term productivity gains that remain more potential than proven.

Economic Data: Resilient, But Slowing
Underneath market strength, the economic story is more nuanced. Core GDP growth is showing signs of gradual cooling. Indicators of the broader U.S. business cycle remain in contraction territory, even as headline employment and output data continue to signal modest resilience. Consumer spending—the engine of two-thirds of GDP—has softened. Manufacturing activity remains narrowly concentrated in a few key sectors, and housing continues to lag as higher mortgage rates weigh on affordability and buyer sentiment. Meanwhile, early signs of tariff-driven inflation are beginning to creep into pricing data, further complicating the Fed’s task of threading the needle between economic support and inflation control.

A Market Walking the Tightrope
All of this leaves investors walking a tightrope. Bulls point to trade progress, strong Q2 earnings beats, and the transformational potential of AI as reasons to stay long. Bears, on the other hand, highlight the risks of elevated valuations, slowing macro indicators, and renewed inflation pressures—particularly if tariffs re-escalate or energy prices surprise to the upside. For now, the market is choosing optimism. The prevailing narrative is a Goldilocks scenario: not too hot to force aggressive Fed action, not too cold to signal recession. But to sustain current levels—and especially to justify further upside—investors will need confirmation. That means earnings must hold up, productivity gains must start to show up in the data, and the Fed must ultimately deliver on its dovish leanings.

Our Take at UX Wealth
At UX Wealth, we continue to monitor market dynamics closely, particularly the intersection of policy, innovation, and investor psychology. While recent gains have been impressive, they’ve also been narrow and sentiment-driven. We believe selectivity, discipline, and a focus on fundamentals are essential in this environment. Yes, AI-driven innovation is real—and it will continue to reshape the investment landscape. But as always, timing, diversification, and rigorous risk management remain the cornerstones of long-term success. We’ll continue to provide insight and perspective as the macro picture evolves. In the meantime, thank you for your trust, and we look forward to helping you navigate what comes next.