Second Quarter 2
U.S. stocks have had a tumultuous year so far, driven by concerns over tariffs leading to slower growth, higher inflation, and greater accumulation of national debt. Peak to trough (February 19th to April 8th), the market dropped nearly 20%. Despite these issues remaining unresolved, and the addition of a rise in Middle East tensions, the market rallied 24% from its lows on April 8th and is now up 5.5% on the year. In our estimation, this is a fairly classic example of stocks climbing a “wall of worry,” which is to say that investors trade positive news updates that help to rule out a worst-case-scenario. This dynamic can take place even when the road gets a little bumpy and questions about earnings growth arise. The momentum factor, along with the fear of missing out, and strong returns from mega-cap stocks can be powerful drivers of the overall market, even in the face of increased macro uncertainty.
1. Tech and Communication Services (includes META and GOOGL) drove the 2Q recovery by a wide margin
2. Leadership changes quarter-to-quarter can be stark. Energy went from first-to-worst and Tech went from second-to-last to first (a 33.3% change)
In short order, the S&P 500 is at a new all-time high and the resurgence of tech stocks, specifically AI names, was the overwhelming theme that helps to explain the market’s comeback. Tech was among the worst performing sectors of the first quarter, driven largely by concerns about AI competition out of China and a general risk-off sentiment. The valuation of Nvidia’s stock, for example, lost 30% ytd through April 8th, which left plenty of room for shares to run before they looked expensive again. With growth stories that were still largely intact and signs of an even brighter future, tech stocks staged a stunning rally, up 23.5% in the second quarter, leading all sectors. Nvidia’s shares are now at a new all-time high, despite earnings expectations for this year having declined, driven by a rapid reflation of its multiple.
1. Tech’s weight in the S&P 500 is a whisker away from its peak in 2000, and practically is already the highest on record if we consider META and GOOGL
At 33%, Tech’s weight in the S&P 500 is now the highest since the dot com bubble in 2000. With this massive contribution, a rally like we saw in 2Q drives the broader market and improves overall sentiment and risk appetite. You can also see that Communication Services, which includes Facebook and Google – part of the Magnificent 7 – tracks Tech very closely, adding to its momentum. The main takeaway is that Tech was a coiled spring that was able to drive the market through the second quarter. The S&P 500 now is trading at 23.5x, compared to a 25-year average of 18x – so a little more expensive than where we started the quarter. However, we are still finding names that fit our investment criteria and offer good potential for stable returns over the long term.
Earnings, particularly across other sectors, will likely have to do more of the heavy lifting to power stock returns in the back half of the year. We expect to see expectations for rate cuts challenged by the impact of tariffs, and potentially inflation, which will start to be felt more as the year progresses. Anchored by a focus on quality growth and paying reasonable prices, we were not whipsawed by reversals in sector performance from the first to second quarter and our current portfolio remains well positioned to navigate macro uncertainty in the second half.
