AI Rally Broadens to Small Caps as Inflation Rises

Global equities hit fresh record highs on Tuesday as an AI-driven rally extended beyond large technology firms into smaller industrial, energy and infrastructure companies. Major indexes including the S&P 500 and several MSCI benchmarks closed at new peaks amid calm fixed-income and currency trading and no major new geopolitical events.

Investors shifted toward companies that supply physical infrastructure for AI expansion, including chip component makers, power and cooling equipment manufacturers, and energy and logistics providers. The rotation followed announcements of large capital spending plans by major technology firms to scale data centers and AI compute capacity.

Alphabet unveiled an $80 billion equity financing program to help fund roughly $200 billion of AI-related capital expenditure this year. The company reported about $126 billion in cash at the end of the first quarter and issued roughly $85 billion of debt over the past year. Berkshire Hathaway committed a $10 billion block to the offering. The size of the financing and the wider capex push drew investor attention to smaller suppliers that may benefit from corporate investment.

Macro data reinforced expectations of tighter monetary policy. Eurozone headline consumer inflation rose above 3% year-over-year in May for the first time since September 2023, while core inflation increased to 2.5% from 2.2% in April. Markets priced in a 25 basis point European Central Bank rate increase at next week’s meeting and additional tightening through the rest of the year. In the United States, April’s JOLTS report showed job openings at a two-year high, concentrated in professional and business services, supporting higher odds of further Federal Reserve tightening under incoming leadership of Kevin Warsh.

Market moves were uneven across asset classes. Small-cap and non-tech cyclical stocks outperformed, and seven of 11 S&P 500 sectors advanced, led by utilities, materials and industrials. Global sovereign bonds experienced a brief relief bid: the long end of the U.S. Treasury curve rallied modestly and Japan’s 10-year JGB yield fell sharply after a strong auction. The U.S. dollar traded in a narrow range while USD/JPY inched toward the 160.00 level. Bitcoin dropped about 6% during Asian trading.

Regionally, the MSCI Asia ex-Japan index reached an all-time high. South Korea posted strong gains and China A-shares rose as domestic service activity expanded; Hong Kong equities showed intraday weakness while mainland markets outperformed. Data indicated China drew down onshore crude stockpiles as imports declined to a decade low.

Market participants will monitor remarks from Bank of Japan Governor Kazuo Ueda, the ADP private payrolls report and the ISM services PMI for potential short-term moves in currencies, bond yields and equity sentiment.

“The AI build-out is becoming more capital intensive, and that pushes spending down the supply chain — smaller industrial and energy companies are capturing more direct revenue from that spending.” — Kelvin Wong, senior market analyst at OANDA.