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Mind on the Market Chart of the Week S&P 500 Sectors % Change in Margins over 1 Year 10.00 Operating Margin (%) FCF Margin (%)

Source: FactSet, S&P. Change in margin (%) calculated as the difference between the current margin (%) as of 7/29/2026 and the margin (%) one year ago, expressed in percentage points.

Are businesses still profitable in a higher-cost, higher-rate world? Earnings season suggests that they are, but investors may need to look beyond EPS beats. While operating margins, which reflect the profitability of a company's core business, have remained broadly resilient, free cash flow margins are beginning to diverge across sectors. Since free cash flow (FCF) ultimately reflects the cash available to repay debt, return capital to shareholders, or reinvest in the business, it may provide a more complete picture of financial health. As AI-related capital spending accelerates, FCF margins could become an increasingly important measure of whether strong earnings growth is translating into sustainable shareholder value, especially in an environment marked by persistent inflation and higher capital costs.

Contact Christine Norton, CFA Dane Smith Investment Strategist Head of Investment Strategy & Research – North America

Month-to-Date Total Return 10Y US Treasury Yield S&P 500 Banks Industry of S&P 500 IT Q2 YoY Earnings Growth

-7.76% 4.67% +33.81% Source: FactSet, as of July 29, 2026. Source: FactSet, as of July 29, Source: FactSet, as of July 29, Total returns in USD. 2026. 2026.

Rising Rates, Higher Standards

Rising rates, inflation, and geopolitical uncertainty would normally challenge equities, but the market has remained resilient through rotation rather than broad weakness. Leadership has broadened beyond AI- linked and semiconductor names, with more cyclical sectors such as Energy and Financials assuming a greater share of market leadership. Higher yields may be contributing to this shift by pressuring long- duration growth assets whose valuations rely heavily on future cash flows.

In an earlier edition, we noted that strong earnings growth had largely allowed technology companies to look through a higher-rate environment. Today, that relationship appears to be shifting. Earnings expectations remain robust, but investors are placing greater weight on tighter financial conditions and whether future growth can justify demanding valuations, particularly as free cash flow comes under pressure and the return on today's investments remains largely prospective.

Interestingly, fixed income markets appear to be sending a similar message. Spreads have remained relatively contained at the broad index level, suggesting credit markets are not pricing in a meaningful deterioration in economic or corporate fundamentals. However, spreads on hyperscaler debt have drifted wider as investors absorb record levels of issuance. That theme is also showing up in credit default swap markets, where CDS spreads for hyperscalers such as Alphabet, Amazon, and Meta have recently reached record levels.

Investors demand more than just earning’s growth. The chart below illustrates how FCF margins have evolved across hyperscalers over the past decade. While the trend has varied by company, this year free