July 2026 Market Review: Proof of Return

AI spending needs to show up in sales

Alphabet reported impressive second-quarter revenue of US$119.8bn, up 24% and ahead of forecasts. But its shares fell as it lifted full-year capital-expenditure guidance from US$180-190bn to US$195-205bn. Focus has shifted to the amounts of cash set to leave the business compared with the revenue it is likely to generate. Meta faced the same test, and with net income falling as AI spending rises its shares fell after the announcement.

In contrast, Microsoft saw its Azure cloud business deliver 43% revenue growth and Amazon saw its AWS division grow 37%, its fastest rate since late 2021. Both companies are spending at a similar scale, but both also showed customers paying for cloud services now. Consequently, their shares rose.

This represents a clear change in the market's judgement of the AI theme. For the last couple of years, announcing more AI investment often pushed share prices up. In July, the concern shifted to who would pay for the servers, electricity and chips through the AI build-out phase – an ever growing question given market forecasts that put hyperscaler capital expenditure at around US$800bn in 2026 and US$1.2trn in 2027.

Added to the mix, China’s technological progress has made the argument that this investment will pay off much harder for leading AI names. Moonshot, a prominent Beijing-based artificial intelligence startup, claimed its Kimi K3 model yielded results close to leading Western models on several benchmarks. DeepSeek also released a powerful yet cheap to run model utilising Huawei hardware rather than Nvidia chips. ASML, the Dutch maker of the lithography machines on which almost all advanced chips are produced, fell about 6% after reports that a Chinese consortium had begun producing its own immersion DUV lithography tools.

While none of these developments proves China has fully caught up with the best American models, or that ASML has lost its position, they do show the pressure is mounting. Should capable models continue to become cheaper with hardware made locally, the moats surrounding the big US AI names might evaporate and the largest returns from the theme may shift towards the companies selling power, cooling and buildings, the services customers actually use and the businesses that implement the technology to lift earnings.

That is why the T. Bailey funds of funds have exposure to semiconductors, data-centre infrastructure as well as regulated industrial and healthcare businesses - businesses that can benefit even if the economics move away from the model providers and hyperscalers.

Geopolitics and oil

Unfortunately, but rather predictably, the agreement signed in June to settle the conflict between the US and Iran did not survive July. Attacks on ships near the Strait of Hormuz resumed and the US retaliated. The Houthis attacked Saudi tankers and Aramco facilities. Brent rose from the high US$70s to above US$100 on 23 July, before easing back near US$90 after American strikes paused.

This matters more than just the price of oil itself. One fifth of the world's oil passes through the Strait of Hormuz, so any threat to shipping there feeds straight into fuel costs, transport costs and inflation. With America's Strategic Petroleum Reserve close to its lowest level in forty years, there is less of a shock absorber available. That passes the problem to central banks, which face a deteriorating choice: tolerate higher inflation, or raise rates into a weaker growth outlook.

For now, however, the data has been kind. June's US inflation report was better than expected, with headline inflation slowing to 3.5% from 4.2%, core inflation falling to 2.6% and producer prices also soft. Energy prices have started to ease back from the highs reached earlier in the year following the Iran conflict, and if that trend holds, headline inflation could continue to moderate over the coming months. But this is unlikely to bring much relief for households for whom the weekly shop will still remain more expensive. In addition, fertiliser disruption during the spring planting season, and weather pressure from El Niño, are likely to feed into food prices later in the year.

Central banks held their ground

The Federal Reserve left rates at 3.50%-3.75% on 29 July albeit three of its twelve voters wanted an immediate quarter-point increase. The Bank of England similarly held at 3.75% the next day, by six votes to three.

Kevin Warsh, the recently appointed Fed Chair, had spent much of July trying to tighten financial conditions without lifting rates, informing Congress that the Fed had no tolerance for inflation remaining above target. Softer US inflation numbers provided some breathing space to repeat that message without having to act. However, his end-of-month press conference gave markets less clarity and short-dated Treasury yields fell after the decision while longer-dated yields rose. Investors took the combination to mean less chance of a near-term rate rise, but more concern about inflation and borrowing costs further out.

That may have been a deliberate strategy - a credible central bank can get part of the effect of a rate rise by making investors fear one. But a simpler explanation is that a new chair gave markets too little detail about what would make him act. Without a reference framework, investors were left to work out the path for themselves.

The T. Bailey multi-asset funds remain tilted towards bonds that mature sooner rather than later. The iShares $ Treasury Bond 7-10yr UCITS ETF holding fell 1.7% in July; the shorter-dated gilt holding fell 0.2%. Longer-dated bonds may offer more income, but they lose more when inflation or government borrowing pushes yields higher.

The UK economy is not the UK market

Andy Burnham became UK Prime Minister on 20 July, inheriting weak economic growth, rising household energy bills, and an inflation outlook that leaves the Bank of England little room to cut rates.

UK shares told a different story, with a strong performance in aggregate for the month. Among UK holdings in the T. Bailey UK Responsibly Invested Equity Fund, Keller upgraded its full-year guidance on North American infrastructure and data-centre work. Computacenter said it expected first-half profit to be around double last year's figure, on demand from US data-centre operators. SThree's US net fees grew on work in energy infrastructure, data-centre construction and AI-related hiring. Man Group reported record client assets of US$253.6bn and performance fees more than three times higher than a year earlier.

None of these companies needs a stronger British consumer to grow. They are listed in London, but their customers are elsewhere in the world.

Corporate buyers have been reaching a similar view of late. ABB agreed to buy Rotork for just over 500p per share in cash, valuing the Bath-based maker of electric actuators at around £4.1bn (more than 60% above the previous close).

We would rather the UK equity market recognised good businesses without taking them private or selling them to overseas buyers. Every takeover leaves one fewer company in London for investors to own.

How the portfolios fared

July was slightly negative for all three T. Bailey funds of funds. The falls were small compared with the moves inside the portfolios.

The Polar Capital Artificial Intelligence Fund fell 14.5% and was the largest detractor within each portfolio. Nonetheless, it has still returned 53.7% over twelve months. We had reduced the holding within the T. Bailey Global Thematic Equity and Multi-Asset Growth funds in Q2, which helped at the margin, but it did not mean we called the last week of the sell-off.

The Baillie Gifford Pacific Fund fell 9.6%. Samsung, TSMC, SK Hynix and MediaTek make up around a third of the fund, so the falls in Korea and Taiwan came straight through. The HSBC MSCI Emerging Markets ETF fell 7.4% for the same reason.

Other holdings did what they were there to do. Ranmore Global Equity returned 7.2% and was the largest contributor to all three portfolios. WS Havelock Global Select returned 5.7%. Polar Capital Global Insurance gained 2.3%. VT Gravis UK Infrastructure Income gained 3.5%. WisdomTree Copper gained 2.3%.

Merlin Fidelis Emerging Markets gained 4.6%, while the average emerging-market fund fell 4.7%. The manager owns less of the Asian chipmakers that dominate the benchmark which hurt in June, when those shares rose, but helped in July, when they fell.

Japan showed a similar pattern: the JK Japan Fund, which has a bias towards growth and technology companies, fell 4.4%, while WS Zennor Japan Equity Income rose 1.1%. Holding both in the T. Bailey portfolios is deliberate - they will not lead in the same market.

Where we stand

Despite the volatility we have seen this month, AI is still a major investment theme for us. However, the sizing of that exposure is what matters most.

We hold a dedicated AI fund at a size that can add to returns without deciding the outcome for a whole portfolio. Elsewhere, we own businesses where future revenues and earnings are easier to see through being based on steady cash flows from insurance premiums, water volumes, infrastructure income, etc.

We remain cautious on longer-dated bonds, because oil, food and public borrowing can all push inflation and yields higher. We hold gold and absolute-return strategies for periods when shares and bonds do not provide the usual offset. We retain emerging-market exposure without needing benchmark-sized weights in Asian chipmakers. UK holdings are chosen for the cash they generate from global customers, not for the direction of British politics.