As we continue to provide on an occasional basis for our Napier Financial newsletter readers, we’re sharing some brief perspectives from our investment team’s vantage point on what’s recently taken place in markets and the economy, and also convey some thoughts about our investment outlook going forward.
Since our last update, the stock market pulled back for several weeks in April before continuing its trajectory higher and has rewarded investors with a series of ongoing record high prices, particularly for the S&P 500 large-cap index[1]. This move has been driven by several factors: ongoing enthusiasm for artificial intelligence (AI) and it’s potential to drive economic efficiency down the road; significant progress on consumer inflation; widespread expectations that the Fed will begin gradually lowering interest rates commencing at their September meeting; and accelerating corporate earnings growth.
This all sounds like nirvana, but as often is the case, when looking under the hood, there can be more that meets the eye. Since last October, much of the S&P 500’s rise has been increasingly driven by a narrow group of stocks from just a few economic sectors, largely fueled by the hype in AI[2]. These stocks now represent an outsized percentage of the S&P 500 and while they are justifiably strong performers and have contributed significantly to earnings growth, they also have become priced for perfection, in our opinion. As illustrated last week, if any of these select names should hit a speed bump, such as what happened to Alphabet and Tesla after their earnings reports, volatility can be a byproduct that can drag down an entire index, such as the S&P 500[3].
We believe there are more opportunities in markets than the “Magnificent 7,” particularly because corporate earnings are now broadening and accelerating to other sectors and stocks that are more attractively valued. Ultimately this should be a positive over the longer term. Also if the Fed begins lowering rates, we’d also expect the unloved and under-owned smaller-cap companies to be outsized beneficiaries, as they tend to be much more sensitive to interest rate cycles than their large-cap counterparts. However, if a rotation away from mega-cap tech occurs, as we briefly experienced last week, we’d still expect volatility to rise, potentially leading to lower index prices. This is because these sectors now represent such a large percentage of the major equity indexes and it may take time for markets to regain their equilibrium while assets rotate.
Before concluding, we also wanted to highlight that the presidential election is right around the corner. Markets tend to get jittery with uncertainty and with the two major candidates polling closely but having significantly different economic agendas, we may see more fluctuation in asset prices as the election nears. Longer term we still remain positive on markets based on earnings momentum, ongoing consumer spending, disinflation, and an economy that has become much balanced since the depths of the pandemic.
If you have any additional questions or wish to discuss our investment outlook further, please contact my colleague Nick Berlen to schedule a meeting with a member of Napier Financial Team. His contact information: nberlen@napierfinancial.com; (781) 884-2355.
[1] Market data provided by YCharts.com
[2] Market data provided by YCharts.com
[3] Market data provided by YCharts.com
