Market Rotation Takes Hold as Labor Data Cools

July 6, 2026

Executive Summary

Markets finished the week higher, supported by positive breadth and continued investor appetite for equities. However, the start of the third quarter brought renewed focus on market rotation, as many of the strongest second-quarter momentum stocks, particularly semiconductors and memory-related companies, came under pressure. This shift appears less like broad risk aversion and more like investors reassessing areas where expectations and valuations had risen quickly.

The coming earnings season will be especially important in determining whether elevated valuations are justified by continued profit growth. Expectations for second-quarter S&P 500 earnings growth remain strong, but much of that strength is concentrated in AI-related companies. Meanwhile, labor market data softened, reinforcing the view that hiring momentum is slowing even as layoffs remain contained. Policy developments also remain important, particularly following the Supreme Court’s decision allowing Federal Reserve Governor Lisa Cook to remain in her position while litigation over her removal proceeds.

Key Takeaways:

• Equity markets advanced for the week, with positive breadth suggesting that investor sentiment remains constructive despite notable rotation beneath the surface.
• Momentum stocks, particularly semiconductors and memory-related companies, weakened after an exceptional second-quarter rally, reflecting profit-taking and heightened sensitivity to elevated expectations.
• The second-quarter earnings season begins next week and will be a critical test of market valuations, especially as more than 60% of expected S&P 500 earnings growth is concentrated in AI-related companies.
• Labor market data cooled, with June nonfarm payrolls rising just 57,000 and prior months revised lower, though the unemployment rate declined to 4.2%.
• Federal Reserve expectations shifted modestly more dovish following the softer payroll report, with markets now assigning a higher probability that the Fed holds rates steady in July.
• The Supreme Court’s decision in Trump v. Cook provided an important, though not final, signal in support of Federal Reserve independence.

Financial Markets

Equity markets finished the week higher, with positive breadth suggesting that investor appetite remained constructive despite another notable shift in leadership. Market rotation was again the central theme, as the strongest recent momentum stocks gave way to laggards at the start of the third quarter. This change was most visible in memory and semiconductor-related companies, many of which came under pressure after an extraordinary second-quarter rally. Semiconductors had advanced approximately 88% during the quarter, while memory chip leaders such as Micron and SanDisk rose roughly 250%, leaving the group vulnerable to profit-taking as investors reassessed near-term expectations for an industry that has been quite cyclical with boom-bust patterns. Given the AI boom, investors must reassess the duration of the demand and pricing upswing.

This rotation does not necessarily indicate a deterioration in risk sentiment. Rather, it reflects a market that is becoming more selective after a powerful advance in AI- and semiconductor-linked shares. When leadership becomes concentrated and valuations rise quickly, even strong companies can become sensitive to modest shifts in positioning, earnings expectations, or investor confidence.

Corporate earnings season begins next week and will be an important test of whether fundamentals support elevated valuations. Consensus expectations call for S&P 500 earnings to grow 23% in the second quarter of 2026 compared with the same period last year. However, more than 60% of that growth is expected to come from AI-related companies, while the median S&P 500 company is projected to grow earnings at a more moderate 9% rate. This gap highlights both the strength and the risk of the current market backdrop: earnings momentum remains impressive, but much of the market’s optimism depends on a relatively narrow group of companies continuing to deliver exceptional growth.

In fixed income, the Treasury yield curve steepened during the week. Longer-term yields, including the 10-year Treasury, moved higher, while shorter-term yields, such as the 2-year Treasury, rose only modestly. A steeper curve can reflect several forces, including expectations for stronger longer-term growth, concerns about inflation persistence, or increased sensitivity to fiscal and supply-related pressures. For equity investors, higher long-term yields bear watching because they can pressure valuations, particularly in growth-oriented areas where much of the expected cash flow lies further in the future.

Economics

Labor market data were the main focus of the week and generally pointed to continued cooling. June nonfarm payrolls increased by 57,000, well below consensus expectations for a 110,000 gain and the softest headline payroll print since February. The prior two months were revised lower by a combined 74,000 jobs, reinforcing the view that hiring momentum has slowed more meaningfully than earlier reports suggested.

The unemployment rate offered a more constructive signal, declining to 4.2% from 4.3% in May and coming in slightly below the 4.3% consensus estimate. However, the drop in unemployment was accompanied by a decline in labor force participation, which fell to 61.5% from 61.8% in May. Lower participation can reflect several factors, including an aging workforce, reduced foreign labor supply, and workers leaving the labor force. As a result, the lower unemployment rate should be interpreted with some caution.

The composition of job growth was mixed. Healthcare and social assistance added 47,000 jobs, continuing a familiar pattern of strength in less cyclical areas of the economy. Professional and business services added 36,000 jobs, a notable bright spot given its sensitivity to corporate activity. In contrast, leisure and hospitality lost 61,000 jobs, suggesting some softening in consumer-facing service sectors.

Other labor indicators painted a similarly nuanced picture. Initial jobless claims came in at 215,000, slightly below consensus expectations of 220,000 and little changed from the prior week’s revised 216,000. Continuing claims were 1.814 million, roughly in line with expectations and near the prior week’s revised level. These data remain consistent with a low-hiring, low-firing labor market: companies are not laying off workers aggressively, but they are also becoming more cautious about adding new employees.

Private payroll data also softened. ADP reported that private payrolls increased by 98,000 in June, below consensus expectations for a 113,000 gain. Hiring was concentrated in service-providing industries, which added 96,000 jobs. Small businesses again accounted for more than half of the headline increase, with much of the hiring coming from firms with 1 to 19 employees.

The May JOLTS report provided a counterbalance to the softer payroll readings. Job openings rose to 7.594 million, above consensus expectations of 7.300 million and slightly above April’s 7.585 million. This was the highest reading since May 2024, indicating that labor demand has not collapsed. Still, job openings are a measure of demand rather than actual hiring, and the broader data continue to suggest that employers are becoming more selective.

Market expectations for Federal Reserve policy shifted modestly toward more dovish territory following the payroll report. According to the CME FedWatch Tool, investors now assign a 77% probability that the Fed will hold rates steady at its July meeting and a 23% probability of a rate hike. Before the release, those probabilities stood at 68% and 32%, respectively. In other words, softer labor data reduced expectations that the Fed would need to tighten policy further, though markets are still not pricing a near-term rate cut.

Policy

Policy developments centered on the Supreme Court’s decision in Trump v. Cook that denied the Government’s stay application and allowed Federal Reserve Governor Lisa Cook to remain in her position while litigation over her attempted removal proceeds through the lower courts. In a 5-4 decision, Chief Justice Roberts joined Justices Sotomayor, Kagan, Kavanaugh, and Jackson in the majority, while Justices Thomas, Alito, Gorsuch, and Barrett dissented.

The majority opinion rejected the government’s argument that the president’s determination of for-cause removal should be effectively unreviewable. The Court argued that such an interpretation would make the position functionally equivalent to at-will employment, which would be inconsistent with the Federal Reserve Act and the long-standing tradition of independent central banking in the United States. Chief Justice Roberts also noted that the method of removal, which occurred through a social media post, was procedurally unsatisfactory.

The dissents took a different view. Justice Thomas argued that the allegations against Governor Cook, including apparent mortgage fraud, constituted sufficient cause for removal, and federal courts lacked authority to provide the relief upheld by the majority. Justice Alito separately argued that the lower courts had incorrectly resolved several issues, and Justice Barrett emphasized that preventing the president from removing a subordinate could satisfy the standard for irreparable harm.

For markets, the decision was important less for the specific facts surrounding Governor Cook and more for what it signaled about Federal Reserve independence. Investors had been closely watching to see whether the Court would reinforce the principle that Federal Reserve governors cannot be removed solely because of political disagreement. The majority opinion supported that principle, though the case itself is not yet concluded. The broader issue remains highly relevant: confidence in the Fed’s independence is central to the credibility of monetary policy, inflation expectations, and long-term financial stability.

Conclusion

The past week reinforced a familiar but important market dynamic: fundamentals remain supportive, but investor tolerance for disappointment is narrowing. Equities finished higher, breadth was positive, and rotation suggests that investors are not abandoning risk assets. However, the pullback in recent momentum leaders, particularly in semiconductors and memory stocks, shows that markets are becoming more discerning after a powerful AI-driven rally.

The upcoming earnings season will be critical. The stocks of AI-related companies have been supported by exceptional earnings growth and significant corporate spending on infrastructure, data centers, semiconductors, and related technologies. That growth has justified much of the enthusiasm behind the group, but expectations are now elevated. When valuations and earnings forecasts are both high, investors tend to react quickly to any sign that growth rates are slowing or that capital spending may not translate into durable profits.

The labor market, meanwhile, continues to cool without showing clear signs of broad deterioration. Payroll growth has slowed, participation has declined, and private hiring has softened, but layoffs remain contained, and job openings remain elevated. This combination should keep the Federal Reserve cautious and data-dependent.

For long-term investors, the message remains one of balance. Market leadership is shifting, earnings expectations are high, and policy uncertainty persists, particularly around the Federal Reserve’s independence. A disciplined, diversified approach remains appropriate as investors evaluate whether corporate fundamentals can sustain elevated valuations in the second half of the year.

I. Front End Disclosure

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of 1919 Investment Counsel, LLC (“1919”). This material contains statements of opinion and belief. Any views expressed herein are those of 1919 as of the date indicated, are based on information available to 1919 as of such date, and are subject to change, without notice, based on market and other conditions. There is no guarantee that the trends discussed herein will continue, or that forward-looking statements and forecasts will materialize.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all clients and each client should consider their ability to invest for the long term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.

All investments carry a degree of risk and there is no guarantee that investment objectives will be achieved. Information provided herein should not be relied upon as investment advice or a recommendation of any particular security.

This material has not been reviewed or endorsed by regulatory agencies. Third party information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

There is no guarantee that employees named herein will remain employed by 1919 for the duration of any investment advisory services arrangement.

1919 Investment Counsel, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission. 1919 Investment Counsel, LLC, a subsidiary of Stifel Financial Corp., is a trademark in the United States. 1919 Investment Counsel, LLC, One South Street, Suite 2500, Baltimore, MD 21202. ©2026, 1919 Investment Counsel, LLC. MM-00002530

II. Investment Analysis

The information shown herein is for illustrative purposes. 1919 may consider additional factors not listed here or consider some, but not all, of the factors listed here as appropriate for the strategy’s objectives.

There is no guarantee that desired objectives will be achieved. 1919 has a reasonable belief that any third party information used for investment analyses purposes is reliable but does not represent to the complete accuracy of such information by any third party.

III. Portfolio Composition

For illustrative purposes. There is no guarantee that the portfolio composition for the strategy discussed herein will be comparable to the portfolio shown here.