The AI Rally Just Hit Its First Real Test

👋 ICYMI

This was a week of crosscurrents — and the undertow won. The S&P 500 fell 1.5% to close at 7,458. The Nasdaq dropped 3% to 25,520. The Dow slid 1% to 52,146. The Philadelphia Semiconductor Index (SOX) is now approaching a 20% decline from its highs — correction territory for the sector that has led the market all year.

The week began on a promising note. Tuesday's June CPI report showed headline inflation at 3.5% annually — below the expected 3.8% — as falling energy prices began filtering through to consumer prices. Bank earnings were strong: Goldman Sachs $GS ( ▼ 2.76% ) surged 9% after a blowout quarter, JPMorgan $JPM ( ▼ 0.6% ) rose over 2%, and Bank of America $BAC ( ▼ 0.36% )  beat on both the top and bottom lines. The S&P 500 ticked higher. For a moment, the narrative looked clean.

Then IBM $IBM ( ▼ 2.91% ) cratered 18% on Tuesday after CEO Arvind Krishna warned that Q2 results would miss expectations. Krishna said clients had shifted their quarterly capex spending toward servers, storage, and memory purchases to secure supply-constrained infrastructure — a direct consequence of the AI hardware gold rush cannibalising software demand. It was IBM's worst single-day decline in nearly four decades.

By Thursday, the U.S. had intensified strikes on Iran after Trump told Fox News from the NATO summit that if a diplomatic breakthrough wasn't achieved, American forces would target key Iranian infrastructure "next week". Iran responded by warning it would "crush" key regional targets. Oil surged back above $80. The U.S. had revoked the waiver that permitted Iranian oil sales after four tankers were attacked in the Strait of Hormuz in a single day.

Friday capped the week with a global tech sell-off. Netflix $NFLX ( ▼ 7.26% ) dropped 8% after issuing weaker-than-expected Q3 guidance despite meeting Q2 estimates. $TSM ( ▼ 2.78% ) fell 3.6% in Taiwan a day after announcing a $100 billion additional investment in U.S. fabrication plants. SoftBank plunged 9.2%. The semiconductor ETF (SMH) was down over 6% for the week.

In a potential bombshell, PayPal $PYPL ( ▼ 0.3% ) surged after reports that Stripe and Advent International had made a $53 billion takeover approach.

🔁 Market Movers

• 📉 Semiconductor Index Approaches Bear Market Territory

  The SOX index is now nearing a 20% decline from its recent highs — the textbook definition of a bear market. Samsung's Q2 results (a 19-fold profit increase that still missed the most optimistic estimates) triggered a cascade across Asia and into the U.S. South Korea's KOSPI fell nearly 5% on Tuesday. Taiwan dropped 6.5% on Friday. SoftBank, Tokyo Electron, and Advantest each fell roughly 9% in a single session. The question that haunted the sector all week: are expectations so elevated that even record results can't satisfy them?

• 💻 IBM Crashes 18% — Worst Day in ~40 Years

  IBM warned Q2 adjusted EPS would come in at $2.93 on $17.2 billion revenue, below the $3.01 and $17.86 billion estimates. CEO Krishna blamed clients shifting capex toward hardware: "In the last few weeks of June, we saw clients shift their quarterly capex spend toward servers, storage, and memory purchases to secure supply-constrained infrastructure". This is the flip side of the AI hardware boom — what's good for Micron and Dell is bad for enterprise software.

• 📊 June CPI: 3.5% vs 3.8% Expected — Inflation Is Cooling

  June headline CPI came in at 3.5% annually — lower than the 3.8% consensus — as energy prices pulled back. This is the most constructive inflation data point since the war began and supports the case that the energy-driven price spike is transitory. If the trend continues, rate hike odds — currently around 67% by December — could fade meaningfully by September.

• 🏦 Banks Beat Across the Board — Goldman Leads

  Goldman Sachs surged 9% after beating estimates. JPMorgan rose over 2%. Bank of America posted EPS of $1.21 versus $1.13 expected on revenue of $31.7 billion. Wells Fargo beat with $2 EPS versus $1.72 expected. Capital markets activity, trading revenue, and consumer credit quality all came in stronger than feared. Financials remain one of the best-performing sectors of the Q2 earnings season.

• 📺 Netflix Drops 8% on Weak Guidance

  Netflix reported Q2 EPS of $0.80 on revenue of $12.56 billion — roughly in line with expectations — but guided Q3 revenue below forecasts and announced it would reduce how often it publishes its "What We Watched" engagement reports. The in-line results with below-consensus guidance triggered an 8% decline, underscoring the market's punishing reaction to any company failing to exceed already-elevated expectations.

• 🛢 U.S. Resumes Iran Strikes — Oil Back Above $80

  The U.S. intensified military operations against Iran on Thursday after Trump warned of further action from the NATO summit. The Treasury Department revoked the waiver allowing Iranian oil sales after four tanker attacks in the Strait in a single day. Oil rebounded above $80, up over 4% on the week. The peace deal signed in June appears to be unravelling.

👀 Signals I'm Watching

• 📈 Yardeni Sees S&P 500 at 8,250 by Year-End

  Ed Yardeni of Yardeni Research told CNBC this week that the S&P 500 could climb another 10% from current levels to 8,250 by December. His key point: "This has not been a PE-led bull market. It's been an earnings-led market. And I think it continues to be an earnings-led market". BMO Capital Markets echoed this — nearly all of the S&P 500's year-to-date returns are tied to earnings growth, not multiple expansion. If that holds, the market can keep climbing even if yields stay elevated.

• 🤖 The AI Trade Is Splitting Into Winners and Casualties

  IBM's 18% crash and Micron's $MU ( ▼ 0.5% ) record quarter in the same earnings cycle tell the complete story. AI is creating enormous value — but it's redistributing it, not creating it uniformly. Hardware companies (Micron, Dell, Intel) are gaining the clients and revenue that software companies (IBM, Salesforce) are losing. Investors who treat "AI stocks" as a single trade will underperform those who understand this bifurcation.

• 🛢 The Peace Deal Is Fraying — Again

  Four tanker attacks in a single day, the U.S. revoking Iran's oil waiver, Trump threatening further strikes from NATO — the June peace deal that sent oil below $70 is under severe stress. If the Strait of Hormuz closes again, the inflation outlook reverses and the CPI progress from this week's report could prove fleeting. The next few weeks are critical for determining whether the ceasefire survives or collapses.

• 💰 PayPal's $53B Takeover Report Could Reshape Fintech

  Reports that Stripe and Advent International made a $53 billion takeover approach for PayPal would represent one of the largest fintech deals in history. PayPal's CFO bought $255K in shares last month on the day the Iran peace deal was announced. Whether this deal materializes or not, it puts a floor under PayPal's valuation and signals that sophisticated buyers see the stock as deeply undervalued.

⚠️ Red Flag to Note

The Semiconductor Correction Isn't Just About Chips

When the SOX index falls 20% from its highs while the companies within it are reporting record earnings, something deeper is happening. Samsung's profit increased 19-fold and the stock fell. Micron reported $41.46 billion in revenue and the stock dropped. TSMC announced $100 billion in new U.S. investment and Taiwan's market fell 6.5%. The issue isn't fundamentals — it's that expectations had outrun reality. As Vital Knowledge warned last week, "The bar is quite elevated" and the S&P 500 is roughly 1,000 points higher than where Q1 earnings began. A chip correction doesn't mean the AI trade is over — it means it's being repriced. The distinction matters.

🔍 Insider Transactions I’m Watching

📬 Closing Note

This was a week that tested the rally's foundations — and found some cracks. Not in earnings. Banks beat. Inflation cooled. And the economy is still growing. The cracks are in positioning, expectations, and geopolitics.

Semiconductors — the sector that powered the entire first half — are nearing bear market territory. IBM's 18% crash showed what happens when the AI hardware boom cannibalises software spending. Netflix disappointed a market that now punishes anything short of perfection. And the peace deal with Iran, which seemed to be holding just three weeks ago, is unravelling as the U.S. resumes strikes and oil pushes back above $80.

Yet through the noise, the signal remains. CPI at 3.5% — below expectations — confirms that the energy-driven inflation surge is fading. Bank earnings are strong. Consumer credit quality is stable. And Ed Yardeni — one of Wall Street's most respected strategists — sees the S&P 500 at 8,250 by December, driven by an earnings-led market that doesn't need lower rates to keep climbing.

The second half of 2026 was always going to be harder than the first. The easy gains from buying the war bottom are behind us. What's ahead is a market that rewards selectivity over momentum, and discipline over conviction.

Stay patient. Stay selective. And let the data guide the story.

Until next Sunday —

George ☕