A handful of Artificial Intelligence related stocks, referred to as the “Magnificent 7”, propelled the S&P 500 to new all-time highs with lofty valuations[01]. The S&P 500 is concentrated in a handful of stocks, with the Top 10 stocks representing nearly 40% of the S&P 500[02]. Market breadth appears to finally be broadening[03] to include both Growth and Value oriented stocks. However, a strong Dollar may negatively impact Mega-Cap multinational stocks[04] because of their reliance on exports. Small Cap stocks are more reasonably priced and should be less affected by tariffs[05] but historically have been more volatile. Also, Small Cap stocks would benefit from lower interest rates because of their dependence on borrowing for operational expenses.
This has certainly been an extremely challenging decade for investors thus far. It seems like we’ve had many decades worth of events crammed into the past five years. Markets have availed us to scenarios NOT seen for an exceptionally long time, such as a pandemic, the highest inflation in forty years, along with one of the FED’s most aggressive rate hiking cycles[06], which caused precipitous drops in both the stock and bond markets in 2022. We can now backtest portfolios against these additional scenarios.
Because of the continued low unemployment rate, companies have had to compete through higher wages in the hiring process, especially in the service sector[07]. The resilient labor market has caused inflation to be sticky, which is forcing the FED to hold short-term interest rates higher. After the longest yield curve inversion in history, longer dated Treasuries are finally yielding more than short duration Treasuries[08]. Global rate-cutting cycles in conjunction with improving real gross domestic product, and accelerating earnings usually reduce market concentration as investors find attractive ideas across style and the capitalization spectrum[09].
With election uncertainties behind us, uncertainty over the new administration’s changes with respect to policy and regulatory changes are a new concern, especially around increased tariffs that could be inflationary. The triple whammy of tariffs, deportation along with limits on immigration in a tight labor market, and tax cuts may very well be inflationary and force the FED NOT to lower rates as much or possibly even increase rates somewhat. The new administration’s policy and regulatory changes will need to be monitored with respect to the effects on inflation, the economy, and the investment environment.
Tariffs could be a negotiating ploy to get concessions[10], but the initial round of tariffs could lead to a one-time bump in inflation[11]. However, escalating retaliatory tariffs could spark a tariff-based trade war and possibly a global recession, which could negatively impact world-wide equity markets. A note of importance is that some of what would have been 2025 purchases were brought forward into 2024 by companies and consumers for products that might be subjected to tariffs in 2025 making year-over-year corporate earnings comparisons challenging.
The announcement of DeepSeek’s Artificial Intelligence Model sent high-flying Tech stocks reeling[12], which demonstrates the vulnerability of companies with lofty valuations to unexpected developments. As companies report earnings, investors are coming to the realization that the Artificial Intelligence mania has been more of an expense and less of a revenue generator[13], which may take the froth out of those stocks. As the Artificial Intelligence mania widens from “creators” to “adaptors”[14], the winners will be companies that can unleash productivity enhancements and lower costs by using the technology.
Commercial Real Estate, as tracked by the NCREIF index, continues to struggle from the effects of the pandemic[15], especially office and retail space. Said index may finally be bottoming out after declining for two consecutive years as the NCREIF index eked out a small gain last quarter[16]. However, housing affordability[17] continues to struggle from high mortgage rates and lack of inventory that has kept home prices high. Even with significant appreciation of existing homes, families with low-rate mortgages are reluctant to move[18] because of the high mortgage rates to finance a new home.
Higher interest rates enable bond funds to provide a viable income stream with possible appreciation when rates recede. Therefore, there’s a less compelling reason to add equity risk within an overall portfolio, which aids in risk management and reduced volatility. Also, in a higher for longer interest rate environment, bonds should provide better portfolio diversification. The higher interest rate environment allows longer duration bond funds to replace more of the lower yielding bonds held in such funds, making them more attractive as an income source. However, an increase in interest rates may cause the price of bonds and bond mutual funds to decline.
As Louis Pasteur so eloquently said, “Chance favors the prepared mind ”. Consumer confidence declines as credit card delinquencies rise[19]! Given heightened geopolitical tensions and lofty market valuations[20], Caution is the Watchword!The best defense in volatile markets like this is a highly diversified portfolio used in conjunction with a well-articulated management strategy. If you’re concerned about market valuations, a member of the Iron Belt Partners Team will gladly discuss any concerns you have with you. We can be contacted via phone at (724) 493-9473 or via Email at:
Lindsay M. Turchetta LTurchetta@lpl.com
John D. Martin JDMartin@lpl.com
Working as a team to better serve our clients!
This communication is meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. You should consult your tax, legal, and/or financial advisor prior to making any financial decisions. The views expressed here are those of the authors, John Martin & Lindsay Turchetta, and not necessarily those of LPL Financial. Information is based on data gathered from what are believed to be reliable sources. The opinions and other information contained in this article are subject to change continually and without notice of any kind. Forward-looking statements are subject to assumptions, risks, and uncertainties, which change over time and may not happen. Past performance does not guarantee future results.
Investments are not guaranteed and are subject to investment risk including the possible loss of principal.
Past performance does not guarantee future results.
The index references herein are unmanaged and cannot be directly invested in.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio, and diversification does not protect against market risk.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Investing in mutual funds involves risk, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.
Bonds are subject to credit, market, and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Duration is a measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates. It is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices. The bigger the duration number, the greater the interest-rate risk or reward for bond prices
Securities and investment products and services offered through LPL Financial, member FINRA/SIPC.
Iron Belt Partners is a name used by independent advisors associated with LPL Financial.
[01] Source: “'Magnificent 7' Widens Gap With Rest Of S&P 500” on businessinsider.com By Benzinga
[02] Source: “Get ready for a broader US equity market” on Franklin Templeton Institute
[03] Source: “Market breadth will broaden through mid-2025” on msn.com By Wells Fargo
[04] Source: “Why a Strong Dollar Is Bad for the Stock Market” on Investopedia By Adam Hayes
[05] Source: “Why small caps domestic focus mitigates tariff risk” on Voya.com
[06] Source: “The Most Aggressive Tightening Cycle in Decades” on Statista.com By Felix Richter
[07] Source: “Forecasts for April CPI Report Show Continued Sticky Inflation” on Morningstar.com
[08] Source: “Inverted yield curves finally end” on dws.com
[09] Source: “Get ready for a broader US equity market” on Franklin Templeton Institute
[10] Source: “Are Trump’s Tariffs a Negotiation Strategy” on everythingsupplchain.com
[11] Source: “Federal Hiring Freeze Could Appease Markets” on LPL Research 20250123 By Jeffrey Roach
[12] Source: “Investors see DeepSeek as a serious threat to Big Tech stocks” on finance.yahoo.com
[13] Source: “Stocks tumble as AI jitters rattle Wall Street” on Bloomberg.com By Rita Nazareth
[14] Source: “The A.I. Boom could shift from Creators to Adaptors” on msn.com By Kevin Gordon
[15] Source: “How COVID Impacted Commercial Real Estate” on wealthmanagement.com By Thomas Foley
[16] Source: “Latest NCREIF Property Index returns” on NCREIF.org
[17] Source: “US Housing Market Grapples with Record-Low Affordability” on msn.com By Emmanuel Abara Benson
[18] Source: “How Do Rate Cuts Affect Housing Affordability?” on Richmond Federal Reserve Bank By John O’Trakoun
[19] Source: “Delinquencies are up as credit-card debt hits a record $1.08 trillion” on msn.com By Zoe Han
[20] Source: “Is the Stock Market on a Collision Course With History?” on msn.com By Sean Williams