News & Insights

Key Takeaways

• Despite a headline GDP number of just 1.5% in the second quarter, underlying measures of U.S. domestic demand may reveal a much stronger economy with real final sales of private domestic purchases growing 4.2%, business investment broadening and consumer spending rebounding.
• Hyperscaler capital expenditures are expected to exceed $1 trillion next year, a figure we believe is increasingly justified by increased revenue growth, backlogs and returns on invested capital.
• Though individual stock volatility will remain high in the sector, hyperscalers appear well-positioned with cloud revenues growing 48% year over year and returns on capital, exceeding their costs of capital.

Domestic Demand Accelerates as Business and Consumer Spending Strengthen

Gross domestic product data from the second quarter painted a more nuanced picture of the U.S. economy than the headline 1.5% figure suggests. While inventory drawdowns and import changes weighed down the headline number, real final sales of private domestic purchases grew 4.2%. This metric strips away the noise and illustrates the actual spending decisions of businesses and consumers.

Capital expenditures posted a strong quarter, with capital goods new orders from manufacturers (excluding defense and aircraft) showing growth. This signals that businesses are expanding their productive capacity and support greater growth going forward. AI-related spending, while still large, represented a smaller proportion of total business investment than in the previous quarter. This shift indicates genuine broadening in business investment beyond the technology sector. While non-tech business investment remains tepid, the direction is encouraging.

Consumer spending showed a turnaround in the second quarter after weakness in the first quarter, demonstrating that households remain willing to spend despite financial pressures. Even if that’s mostly due to tax refunds, the underlying trend remains positive. With continued strength in the economy, a build in inventories could provide even greater growth to GDP in the coming quarters.

Nominal GDP growth has been particularly strong, running well above typical levels. While nominal figures include inflation and do not directly measure economic growth, strong nominal GDP typically translates into increased corporate revenue growth because companies pass inflation through to consumers. In fact, corporate revenues track closely with changes in nominal GDP, making this elevated growth supportive for the top line and earnings, particularly for companies able to maintain pricing power.

U.S. GDP Contributions Q1 2024-Q2 2026

Source: Oxford Economics

Hyperscaler Capital Spending Justified by Accelerating Demand and Strong Returns

Bull and bear investors are very divided, each holding strong opinions on the outlook for returns from the trillions of dollars being invested in AI infrastructure by the hyperscalers. CapEx spending has been revised upward repeatedly among these firms, and projections now call for over $1 trillion in combined spending next year, up from a $630 billion forecast at the beginning of the year. These companies have historically been cash-generating machines requiring minimal asset investment, regularly returning money to investors through share repurchases and buybacks. The shift from free cash flow generation to newly indebted companies has been jarring to many. Rapidly growing demand for AI compute power suggests that this spending is not only justified but still lags demand.

Nearly 50% of S&P 500 earnings growth in the second quarter came from hyperscalers, driven substantially by cloud revenue, rising 48% year over year. Individual hyperscalers reflect similar patterns: Amazon, Google, and Microsoft all reported increased cloud revenue expansion.

Behind these accelerating revenue gains is genuine end-user demand. Hyperscaler service backlogs, which are orders and contractual commitments that have yet to be fulfilled, have continued to increase. This backlog explains why capex spending is so aggressive: Companies are racing to build data center capacity and other infrastructure to meet organic demand.

As capex spending has increased, one of the most pressing concerns for the hyperscalers remains free cash flow, which has decreased. This represents a departure from their profile of prior years, but consensus analyst forecasts are projecting free cash flow to rise once the capex investment cycle matures near the end of the decade.

Industry bears point out that throughout history, the top decile of capex-intensive companies have significantly underperformed the market, but we believe these were largely capital-intensive manufacturing and industrial businesses with lower returns on capital. As opposed to traditional capital-intensive sectors, hyperscalers operate within an industry with historically high growth, margins, and cash flows. Meta, Google, and Microsoft, in particular, have returns on invested capital exceeding their financing costs, helping explain why these companies continue to invest heavily in infrastructure and capacity. Despite the returns on capital, we believe these businesses trade at a discount to the rest of the tech sector, reflecting investors’ skepticism of their ability to sustain performance. Illustrating the sustainability of these returns, GPU rental prices are rising despite concerns about chip obsolescence, suggesting that the useful life of this infrastructure is extending beyond bear case assumptions, materially improving capex payback.

Individual stock volatility will likely remain elevated, especially in AI related areas. Certain segments, such as memory chip pricing, may experience corrections as new fab capacity comes online and frontier model economics remain uncertain. Nonetheless, as a group, we believe hyperscalers appear well-positioned because their capex spending is justified by demand, returns on capital, and the fundamental shift in computing infrastructure requirements. With our bullish outlook for AI and its long-term positive effect on the economy, we want to remain invested in the sector while acknowledging it is difficult to be certain of the ultimate winners in this rapidly evolving technology. Therefore, we continue to recommend a broadly diversified portfolio.

Projected 2027 Hyperscaler Capex Estimates

Source: FactSet, Goldman Sachs

Combined Hyperscaler Backlog

Source: Exponential View report, “The State of the AI Economy”

Hyperscaler Cloud Revenue Growth YOY% (AMZN, GOOGL, MSFT)

Source: Goldman Sachs Investment Research

Important Information

The following securities mentioned above are held in the Frost Growth Equity Fund. Weights provided are as of close of market August 31, 2026:

Amazon (4.26%), Google (8.47%), Meta (3.50%), Oracle (0.44%), Microsoft (7.69%).

This commentary is as of Sept. 2, 2026, for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.

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