U.S. equity markets finished the week mixed, with the tech-heavy S&P 500 declining 1.94 percent, even as U.S. Small- and Mid-Cap equities advanced. Beneath the surface, the story was notably more constructive: 322 stocks rose on the week, lifting the equal-weighted S&P 500—which removes the impact of index concentration at the security level—by nearly 1.6 percent. This continues a trend we have been highlighting in which the S&P 500 has lagged broader U.S. indices. Its 8.05 percent year-to-date gain has been overshadowed by 16.2 percent and 23.4 percent advances in Mid- and Small-Cap stocks, while the equal-weighted S&P 500 has risen 12 percent. The headline index remains weighed down by its significant exposure to the so-called “Magnificent Seven”—Nvidia, Apple, Microsoft, Meta, Amazon, Google, and Tesla—which together make up more than 30 percent of the index. After leading the market higher over the past several years, this group has pulled back on an equal-weighted basis by more than -5 percent this year.
In our view, this divergence continues to reflect how the buildout of artificial intelligence (AI) is influencing both the economy and markets as it progresses across the value chain, even as the associated costs continue to climb. That dynamic was evident this week as Micron Technology, a more recent AI beneficiary, reported strong earnings driven by robust memory-chip demand from AI data centers and offered a favorable outlook. What began as a concentrated story centered on chips and hyperscalers has evolved into one increasingly defined by data-center infrastructure and memory. While memory is a key profit driver for companies like Micron, it represents a rising cost for other parts of the AI ecosystem—including some of the Magnificent Seven. This highlights an important point: Value is not being created uniformly across AI but is rather redistributed across different parts of the ecosystem.
The same forces boosting Micron’s results are also contributing to higher costs for other companies and, by extension, the broader economy. Consistent with this theme, Apple announced price increases this week on products such as Macs and iPads, while Microsoft implemented its third Xbox price increase in the past 13 months—both citing higher memory and storage costs. Notably, shares of both companies declined last week, suggesting investors are increasingly focused on the potential demand implications of these rising costs.
This discussion feeds directly into the broader macroeconomic backdrop, particularly the path of inflation. Inflation has moved higher in recent months and remains well above the Federal Reserve’s 2 percent target, yet market expectations appear increasingly anchored to the idea that falling energy prices will alleviate price pressures. Despite violations of the terms of the ceasefire on Thursday, oil prices declined, with West Texas crude closing at $69, nearly back to the $67 level seen prior to the conflict’s start on February 28. Correspondingly, both two- and five-year breakeven inflation rates fell to near their lowest levels of the year, with markets pricing in only one Fed rate hike over the next year.
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We believe this is a risk that may be underappreciated. Recent economic data suggests inflation is not solely driven by energy but is increasingly embedded within the services sector. Moreover, while AI may ultimately prove disinflationary over the long term, in the nearer term it is likely contributing to inflationary pressures. The buildout of AI infrastructure is driving strong demand for key inputs—particularly memory—pushing prices higher and creating additional cost pressures that are working their way through the economy.
These pressures were evident in the May Personal Consumption Expenditure (PCE) inflation report. Headline inflation rose 0.5 percent, bringing the year-over-year figure to 4.1 percent. Core PCE, the Federal Reserve’s preferred measure excluding food and energy, increased 0.32 percent, pushing the year-over-year rate to 3.4 percent, up from 3.3 percent and the highest level since October 2023. The three-month annualized rate rose to 3.5 percent, while the six-month pace reached 4.14 percent. Although goods inflation increased 0.44 percent, reflecting energy dynamics, services inflation rose 0.45 percent and remains elevated at 3.8 percent year over year. Notably, supercore services ex shelter—a measure closely watched by the Fed—rose 0.5 percent and is now above 4 percent across the three-, six-, and nine-month annualized measures. Taken together, this data indicates that inflationary pressures were present prior to the conflict and are not confined to goods but have broadened into services.
Importantly, these pressures appear to have persisted into June, even as oil prices declined. The S&P Global U.S. Purchasing Managers’ Index (PMI) report showed continued elevated input prices across both manufacturing—where firms continue to build inventories amid concerns about potential supply chain disruptions—and services, where input costs rose to a six-month high. Companies are passing these costs through to customers, with average selling prices increasing at the fastest rate since July 2025. Most notably, service-sector selling-price inflation accelerated to an 11-month high.
There are also signs that higher prices are beginning to affect consumer behavior. The third and final estimate of Q1 GDP was revised higher from 1.6 percent to 2 percent, but this masked a notable deterioration in consumer spending, which was revised down from 1.4 percent to just 0.5 percent quarter over quarter—the weakest reading since the two negative quarters during the COVID-impacted period in Q1 and Q2 of 2022 and, prior to that, Q1 2011. While May spending data showed a modest increase, real disposable income (after taxes and inflation) improved only slightly following three consecutive declines—driven largely by higher transfer payments—and remains flat on a year-over-year basis. The savings rate was revised up to 3 percent but remains historically low.
This combination of persistent inflation and a pressured consumer presents the Federal Reserve with difficult choices. While additional rate hikes could help contain inflation, they also risk further weighing on consumption and overall economic activity—particularly in an economy that has increasingly relied on the AI buildout, which itself depends on access to both debt and equity capital. Historically, higher rates tighten financial conditions and increase the cost of capital.
As a result, the economy remains in a delicate balance with a wide range of potential outcomes. Investors must recognize that risks exist on both sides of the mandate: Inflation could remain elevated, even as growth shows signs of slowing due to consumer strain. This underscores a broader point: Inflation is not merely a data point—it is a force that can materially influence returns and portfolio outcomes. Periods of sustained and unpredictable inflation have historically favored assets that can either benefit from rising prices or provide protection against the erosion of purchasing power.
This is why, in our view, a well-diversified portfolio should include exposure to real assets such as real estate and commodities. These asset classes have historically behaved differently than traditional stocks and bonds in inflationary environments, offering a potential hedge when inflation proves more persistent or less predictable than expected. In our recent Asset Allocation work, we have highlighted the role of real assets—including increased exposure to Real Estate Investment Trusts (REITs)—as part of a broader effort to enhance portfolio resilience across varying economic scenarios, as outlined in our latest edition of Asset Allocation Focus.
Importantly, this is not about attempting to time the market or making a short-term call on inflation. Rather, it reflects an acknowledgment that the current environment—marked by structural investment in AI, ongoing supply constraints, and persistent services inflation—may produce a wider range of outcomes than investors have experienced in recent years. In that context, diversification across asset classes becomes even more critical.
Wall Street wrap
PCE inflation accelerates in May amid increasing consumer strain
The May PCE report from the U.S. Bureau of Economic Analysis (BEA) last week reinforced that inflation pressures remain both elevated and broad-based rather than confined to recent geopolitical developments. Headline PCE rose 0.45 percent in May, pushing the year-over-year rate to 4.1 percent. More importantly, core PCE increased 0.32 percent, lifting the year-over-year reading to 3.4 percent. This leaves the three-month annualized pace at 3.5 percent and the six-month pace at a more elevated 4.14 percent, underscoring that inflation is not simply conflict-driven but more deeply embedded across the economy. The breadth of the increase supports this view, with goods prices rising 0.45 percent and services also advancing 0.45 percent. Within services, the Fed’s closely watched supercore services ex shelter category rose 0.5 percent and is now running at 4.03 percent on a three-month annualized basis and 4.33 percent over six months, highlighting persistent underlying pressures.
Additional data points to rising strain on the consumer. The final estimate of Q1 GDP was revised up to 2.1 percent from 1.6 percent in the second estimate and 2 percent initially, but the composition was notably weaker. Consumer spending—the largest component of PCE—was revised down sharply to 0.5 percent quarter over quarter, from 1.6 percent in the first estimate and 1.4 percent in the second, marking the weakest pace since the COVID-impacted quarters of Q1 and Q2 2020 and, prior to that, Q2 2011, which was 0.4 percent. Real wages remain negative as inflation has moved higher, further pressuring household purchasing power.
At the same time, the data underscores the continued influence of AI-related investment on growth. Intellectual property products (+0.74 percent) and information processing equipment (+0.77 percent) together contributed 1.51 percent to the 2 percent growth figure. This highlights the extent to which the current expansion remains tied to ongoing investment in AI infrastructure, even as inflation pressures tied to that buildout continue to broaden across the economy.
PMI hits five-month high as manufacturing strength masks ongoing weakness in services
The headline Manufacturing PMI showed that overall business activity improved, with the headline index rising to 52.2 from 51.5 last month, marking a five-month high. While that points to a better growth trajectory following March’s two-and-a-half-year low, the pace of expansion remains modest compared with the start of the year, before the outbreak of the war in the Middle East.
The strength once again came primarily from manufacturing, where the index rose to 55.7 from 55.1, the highest level since May 2022. New orders were especially strong, increasing at the fastest pace since April 2022. However, some of that demand appears to reflect precautionary inventory building as companies try to get ahead of increasingly widespread supply issues rather than a broad-based acceleration in end demand.
The report also highlighted an increasingly uneven economy. Demand for manufactured goods remains historically strong, while the services side of the economy continues to grow only modestly. Services rose to 51.3 from 50.7, likely helped in part by activity tied to the soccer World Cup. Still, the broader consumer backdrop continues to weigh on the sector. Service providers reported only modest gains in both output and new orders, with many citing elevated prices, higher interest rates, and low confidence among business and consumer customers as ongoing headwinds.
Inflation pressures also remained elevated. Average input prices rose sharply, and while the pace of inflation eased from May, it was still the third-highest reading since the start of 2023. Manufacturing input-cost inflation moderated from May’s recent peak but remained the second highest in nearly four years. Meanwhile, services input-cost inflation edged up to a six-month high, reinforcing the view that price pressures remain broad and are not limited to goods.
Companies continued to pass these higher costs through to customers. Average prices charged for goods and services rose at the same pace as in May, which had been the fastest rate since July 2025. Goods price inflation cooled but remained elevated, while service-sector selling-price inflation increased to an 11-month high. This is particularly important given the Fed’s focus on services inflation and suggests that underlying inflation pressures remain sticky even as some goods-related pressures moderate.
The labor market details were also weak. Employment fell for a second consecutive month in June and for the third time in the past four months as companies continued to focus on cost reduction amid high input prices and concerns about the outlook. Services employment declined only modestly, but manufacturing headcounts fell at the fastest pace since the COVID-19 lockdowns of early 2020, with manufacturing employment slumping to its lowest level since May 2020.
Importantly, the survey period ran from June 11 to June 22, meaning the results likely reflect some optimism tied to the U.S.-Iran deal. Even with that potential support, the survey suggests that current output levels are consistent with an economy struggling to grow much faster than a 1 percent annualized rate in the second quarter. Taken together, the report points to an economy that is still expanding but unevenly: Manufacturing remains supported by inventory building and demand for goods, while services continue to face pressure from high prices, higher rates, and weaker confidence.
Housing demand slows as affordability pressures rise, but pricing holds firm as the market absorbs inflation shocks
The May 2026 New Residential Sales report from the U.S. Census Bureau and U.S. Department of Housing and Development suggests that the housing market is adjusting to a more restrictive environment, with demand softening in response to higher borrowing costs while pricing remains relatively resilient. The supply of new homes on the market rose to a 10.3-month supply, up from 9.3 months in April and 9.7 months a year ago, underscoring the uptick in new inventory as sales fell 7.3 percent month over month and 6.8 percent year over year. While elevated mortgage rates and affordability challenges continue to weigh on buyer demand, home prices have remained relatively resilient, with the median price holding at near year-ago levels of $424,900.
Consumer spending remains resilient, but inflation continues to weigh on purchasing power
The May 2026 Personal Income and Outlays report from the BEA showed a modest rebound in both income and spending, but the underlying dynamics point to continued strain on consumers. Personal income rose 0.7 percent in May after no growth in the prior month, with wages and salaries increasing 0.4 percent. However, income growth remains distorted by volatile transfer payments tied to programs such as the Farmers Bridge assistance program and the American Relief Act. Excluding these payments, personal income was down 0.4 percent year over year, highlighting underlying weakness.
Personal spending also rose 0.7 percent in May. After accounting for inflation—PCE rose 0.4 percent—both real personal income and real spending increased 0.3 percent. Notably, real disposable personal income (DPI) rose 0.3 percent, marking the first increase after three consecutive declines. However, on a year-over-year basis, real DPI remains flat, underscoring the ongoing constraints on consumer spending power.
The savings rate came in at 3 percent, with the prior month revised up to 3 percent from 2.6 percent. While this represents a modest improvement from initial estimates, savings remain historically low.
The Week Ahead
Note to readers: In observance of the Fourth of July holiday, we will be taking a brief pause in our Weekly Market Commentary schedule and will return on Monday, July 13. You can expect the following data to be released throughout the week:
Tuesday: The Conference Board is releasing its Consumer Confidence Index for June 2026 at 10:00 a.m. ET. While May data was weighed down heavily by oil and gas price shocks stemming from the Middle East conflict, we will be looking to June data to see if easing energy costs and early-stage peace negotiations are beginning to lift consumer sentiment.
Wednesday: The Challenger, Gray & Christmas June job cut report will be released at 5:30 a.m. ET. Last month’s data revealed an accelerating wave of corporate restructuring. U.S. employers announced 97,006 job cuts in May, the highest May total since the 2020 pandemic.
Separately, the Institute for Supply Management will release its monthly Manufacturing PMI report for June at 10:00 a.m. ET. Consensus estimates project that the headline June index will ease slightly after reaching a four-year high in May, as business demand remained resilient despite sticky inflation.
Thursday: The U.S. Bureau of Labor Statistics will publish its next Employment Situation report at 8:30 a.m. ET. Consensus estimates point to a slowdown in job creation, with 113,000 job gains expected.
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
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