May Market Commentary | AI leads, while inflation and rates push back

Nicola Wealth Market View

Markets in May were caught in the middle of a push and pull between enthusiasm for artificial intelligence, grounded in strong earnings, and stubborn inflation, which has begun to pressure valuations and create near-term challenges for fixed income investors. Those gains have been delivered primarily by a narrow group of companies, and many investors buying "the market" today are, knowingly or not, putting more than half the portfolio behind one theme.

Importantly, it is not the broader economy driving returns; the engine has been corporate earnings, and the numbers are hard to argue with. The market is not betting on a strong economy. It is betting that companies can keep delivering profits even if the economy doesn't. The risk is that valuations in parts of the market leave little room for disappointment.

If AI is the force pulling markets up, interest rates are the force pushing back. Inflation has proven sticky, rate expectations have flipped from cuts to potential hikes, and rising bond yields are raising the cost of capital and making lofty valuations harder to justify. Meanwhile, renewed conflict involving Iran has kept oil markets on edge, and a disruption to the Strait of Hormuz would feed directly into inflation, reinforcing the "push" side of the market's tug-of-war.

In an environment where so much depends on so few and macro forces are pulling in opposite directions, we believe a disciplined and diversified approach remains the most effective way to navigate evolving risks and opportunities.

Key takeaways

• Markets are caught in the middle between AI enthusiasm and stubborn inflation
• When the market leans on a handful of names, narrow leadership concentrates risk
• The market is increasingly an AI bet, with related companies making up over half the index
• Profits are doing the heavy lifting, not the broader economy
• Interest rates and geopolitical risk remain the key wild cards

Below is Chief Economist Rob Edel's Market Commentary, offering a more in-depth look at the forces shaping markets in May.

Markets caught in the middle

Markets in May reflected a push and pull between enthusiasm for artificial intelligence, supported by strong earnings, and stubborn inflation, which has begun to pressure valuations and create near-term challenges for fixed income investors. North American equity markets saw strong returns, with the S&P 500 up 5.3% (total return, US$) in May and the S&P/TSX adding +2.5% (total return, C$). In contrast, US bond investors faced rising yields across the curve as inflation remained persistent.

We view this push-and-pull as the most useful lens for understanding today's market. The optimism around AI, and the infrastructure spending racing to support it, appears to be grounded in genuinely strong earnings. However, those gains have been delivered primarily by a narrow group of companies, and valuations in parts of the market leave little room for disappointment. The buildout itself cuts both ways too, contributing to supply constraints and adding incremental price pressures to an economy already absorbing higher oil prices. When combined with geopolitical tensions, inflation risks have begun to re-emerge more broadly.   

When so much depends on so few

A defining feature of the current market is its narrow leadership. Over the past two months, the headline S&P 500, which weighs companies by their size, rose roughly 16.3% (total return, US$), one of its strongest two-month periods in recent years. The average stock, measured by an equal-weighted version of the same index, gained just 8.8%. Technology remains the primary driver, up 36.3% over April and May.

Narrow leadership is not inherently negative, but it does concentrate risk. With the index leaning so heavily on a handful of names, a stumble by one or two large companies can have an outsized effect on returns, and on portfolios that simply track it. This is one reason we continue to emphasize true diversification across asset classes and strategies. 

The market is increasingly an AI bet now

Looking through the sector labels, the S&P 500 is increasingly concentrated in a single theme. Companies in Bloomberg’s Intelligence’s AI theme basket now account for 45% of the index’s total weight. Add in firms building the compute and power infrastructure behind it and the figure rises to roughly 53%. In other words, many investors buying “the market” today are, knowingly or not, putting more than half the portfolio behind one theme. The month offered a fitting illustration: Micron, a memory-chip maker, saw its valuation rise significantly crossing a trillion dollars in market value on the strength of AI-driven demand.

This concentration sits at the heart of an ongoing debate. The optimistic case is that AI represents a meaningful productivity revolution, one that could raise output, lower costs and ultimately justify today's valuations. The cautious case is about price. By long-run measures such as the cyclically adjusted price-to-earnings ratio, which compares prices to a decade of inflation-adjusted earnings to smooth out short-term swings, U.S. equities are trading at historically elevated levels.

High valuations do not predict the timing of a pullback, but they tend to reduce expected long-term returns and leave less margin for error if the AI productivity narrative takes longer to materialize than currently assumed.

Historically, investors have required an equity risk premium where earning yields exceed bond yields. This premium is currently compressed, suggesting future stock returns will likely be more modest over the next 10 years. 

Profits are doing the heavy lifting

It is important to distinguish what is currently driving returns. It is not the broader economy, which has been mixed with uneven growth and some areas clearly softer than others. The engine has been corporate earnings, and the numbers are hard to argue with. According to Bloomberg Intelligence, Q1 2026 S&P 500 earnings increased over 29% year over year, the fastest pace since 2021 and well above estimates of 12.4% growth. Goldman Sachs sees earnings rising 24% in 2026 before easing to a still solid 13% in 2027. In other words, the market is not betting on a strong economy. It is betting that companies can keep delivering profits even if the economy doesn’t. 

This distinction matters.  A market supported by rising profits rests on firmer ground than one supported by valuation expansion alone. As long as earnings continue to grow, they provide a fundamental anchor for valuations, even elevated ones. The risk, of course, is that so much of the expected earnings growth is concentrated in the same handful of AI-related companies that already dominate the index, which brings us back to the theme of concentration. For the current rally to be sustainable, we think earnings growth needs to broaden across sectors.

Interest rates re-emerge as the key risk

If AI is the force pulling markets up, interest rates are the force pushing back. Inflation has proven sticky, and the Fed appears unlikely to cut rates as quickly as markets had hoped earlier in the year. Policy may need to stay restrictive for longer, with the possibility of further tightening if inflation surprises to the upside. The repricing has been dramatic. Earlier in the year, financial markets were discounting 50 basis points of cuts in 2026; the swaps curve is now pricing in 25 basis points of hikes by December.

In past public remarks, incoming Fed Chairman Kevin Warsh has argued that AI’s deflationary potential could allow the Fed to keep rates lower than historical models would dictate. He tends to favor inflation measures like the trimmed mean CPI, which are currently giving a tamer reading of inflation. Regardless, Warsh will come under pressure from both the market and his Federal Reserve colleagues to raise rates if the Fed appears to be falling further behind the curve on inflation.  

While we monitor the 2-year U.S. Treasury yield as an indicator of expected policy direction, we watch the U.S. 10-year Treasury bond just as closely. It is effectively the benchmark interest rate for the global economy, influencing mortgage rates, corporate borrowing costs and, crucially, the valuations investors are willing to pay for stocks. When this yield rises, it raises the cost of capital and makes the lofty valuations of fast-growing companies harder to justify. With 10-year yields reaching 19-year highs in May before retreating late in the month, markets have started to take notice. 

The story is global, as developed world bond yields have been trending higher since hitting historic lows during the pandemic. What matters most, however, is why yields are rising. If yields are climbing because economic growth is stronger, markets are generally less concerned. The current picture is more complicated. Apollo sees upward pressure across the entire U.S. yield curve, with a different culprit at each point: inflation at the short end, heavy bond issuance to fund AI-related capital expenditure in the bully of the curve, and fiscal concerns at the long end. In other words, none of the three is a good kind of yield pressure.

Geopolitical risk remains the key wild card

Finally, events in the Middle East remain a significant source of uncertainty we cannot model. Renewed conflict involving Iran has kept oil markets on edge, and the central concern is the Strait of Hormuz, the narrow shipping lane through which a large share of the world's seaborne oil passes. A serious disruption could push energy prices sharply higher.

This matters well beyond the energy sector. A spike in oil prices would feed directly into inflation, complicating the interest rate picture described above and reinforcing the "push" side of the market's tug-of-war. While both sides are under tremendous pressure to reopen the Strait, the key sticking points in reaching a deal appear, well, sticky, and we fear a resolution may take longer than markets are currently discounting. Pricing at present suggests investors expect a relatively contained outcome. We are monitoring the situation closely, while recognizing that geopolitical outcomes are inherently unpredictable and not something to position a long-term portfolio around with high conviction.

Build to withstand, not to predict

Taken together, May's market reflects genuine innovation in AI, alongside real concerns about concentration, valuation, and the cost of money. Neither force is likely to resolve quickly, and we see little value in predicting which side wins in the short term.  In our view, the appropriate response is to build portfolios that can withstand a range of outcomes: staying diversified across asset classes, maintaining exposure to the long-term growth AI may deliver without depending on it, and holding the income-producing and defensive assets that provide ballast when conditions change.

This push and pull is likely to persist. Our focus remains where it has always been, on the durable, long-term drivers of wealth rather than short-term noise.