Google’s first-ever negative cash flow quarter

Alphabet reported second-quarter revenue of $119.8 billion, up 24% year-over-year, while operating income increased 30% to $40.8 billion. Google Cloud revenue rose 82% to $24.8 billion, and its backlog reached $514 billion. The company generated $39.1 billion of operating cash flow but spent $44.9 billion on capital expenditures, resulting in negative free cash flow of $5.9 billion, its first negative quarter in company history. Trailing 12-month free cash flow remained positive at $53.3 billion, although Alphabet raised its 2026 capital-spending forecast to $195–$205 billion from $180–$190 billion. Reported earnings also benefited from $98 billion of other income, primarily unrealized gains on equity investments. Alphabet shares fell approximately 7% following the report.

• Google’s core businesses remain very strong
• However, capex was higher than operating cash flow
• This was Google’s first quarter of negative free cash flow
• $98 billion of unrealized gains also inflated reported earnings
• AI spending is beginning to affect earnings quality and cash flow for companies that were historically cash flow machines
• If LLMs become commoditized, the returns may not justify the spending
• This is something to watch across the rest of the MAG7

Yields rise to prior “TACO” levels

Treasury yields moved sharply higher this week, with the 2-year reaching 4.37%, the 10-year touching 4.71% and the 30-year approaching 5.20%. The 30-year real yield, which excludes expected inflation, rose to 2.98%, its highest level since 2008. Markets now expect the federal-funds rate to peak near 4.23% next June, compared with the current target range of 3.50%–3.75%. The implied probability of a rate hike at next week’s Fed meeting increased to 38% from 12% one week earlier. The move followed renewed fighting in the Middle East and a brief rise in Brent crude above $102.

• Long-term rates are approaching levels not seen since the financial crisis
• The market is now pricing rate hikes after expecting cuts earlier this year
• Higher rates increase mortgage and corporate borrowing costs
• They are particularly problematic for real estate and over-levered companies
• Higher real yields also put pressure on technology valuations
• Oil prices and tariffs make it more difficult for the Fed to lower rates
• The last time the 10-year rose to these levels, Trump announced that we were making progress with Iran
• Last time, however, stocks had sold off sharply; this time stocks are only slightly below all-time-highs

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