Halfway There

Halfway through the year: How Corporate America Bulled Through the Fog

Think back to late February and March of this year. It was only a few short months ago, but I can remember how people were feeling from my conversations. Most weren't too optimistic, and many feared the market was broken. The Strait of Hormuz was functionally paralyzed, oil was spiking past $115 a barrel, and the mainstream media were practically screaming that the sky was falling. Pretty scary stuff for sure, but then again, the stock market is always facing something scary. I remember pretty much all of the articles I read, TV channels, and newspapers presented the doom and gloom story. Was the world somewhat upside down? Sure was, and even though it was incredibly real, panic is never a profitable investment strategy. Haven't seen it done correctly even a single time, although I've had some clients give it a try.

If you opened your first quarter statements a few months ago, you probably wanted to slam them closed just as fast and pretend they didn't exist. But if you stayed disciplined, ignored the emotional noise, and stuck to your financial playbook (like 99% of our clients did), you were heavily rewarded over the last 90 days. So much for sell in May and go away. Maybe all the hedge fund managers who went on vacation missed out. Doesn't matter to me or my clients; we stayed at work and stayed invested!

Here we are at the close of the second quarter and halfway through the year. The market outlook has flipped entirely. The S&P 500 just capped off a stellar second quarter with a massive 14%+ return — its best three-month performance since the pandemic rebound in the second quarter of 2020.

But what is actually driving this market, and what is happening beneath the surface? Let’s break down the hard data and the major themes we are watching as we head into the second half of the year and continue to look for opportunity.

The "Micro" is Doing the Heavy Lifting

While an easing geopolitical outlook and falling oil prices have provided some much-needed relief at the pump for upstate New York families, we are still navigating persistent rate hike fears and a deeply divided macroeconomic landscape. As I write this blog the price of oil and energy hints at further spikes as the president makes remarks in Turkey regarding the ongoing war with Iran. This is a day-by-day and minute-by-minute element of the market to watch. I can't imagine how difficult it must be for shipping & freight companies to price these things, not knowing how much their costs will be.

So, why are stocks still rallying so hard? The answer lies in the fundamentals. The corporate "micro" picture has more than held up its end of the bargain. Despite facing a lot of anxiety and the unknown, companies are reporting great numbers, and those tell a different story.

American businesses aren’t just sitting on their hands. What good would that do? Fueled heavily by a generational capital expenditure cycle in technology and artificial intelligence (AI) infrastructure, corporate earnings have been incredibly resilient. S&P 500 earnings growth is expected to surpass 20% in the second quarter. These are the kinds of things you'll want to focus on if you're looking to make money investing. They're the sort of clues that help give you some perspective on the overall health of the economy.

We are also seeing consensus earnings per share (EPS) estimates rising significantly across the board. Yay, that's a huge win for them and for our investors! The consensus for S&P 500 earnings this year jumped substantially during this quarter alone, and 2027 estimates are strengthening. Again, these are positive indicators for the remainder of this year and are spilling over into the next. Historically, we only see these massive levels of growth and positive revisions when we are emerging from a recession, which we aren't. When companies are making money, producing efficiently, and keeping their margins intact, the market responds. In some cases, it's that simple. Eventually, the numbers matter. Sometimes the numbers don't match optimism, and that can impact individual positions. When this happens, and the news catches up to the stock, you'll see a jump of ten or twenty percent in a single trading session.

Halfway through, and A Market of Diverging Sectors

Unsurprisingly, the technology sector—specifically semiconductors and computer hardware—led the charge this quarter with eye-watering returns. Not a shocker or news to most, but it's worth asking, how long can this continue? Some of the major players saw triple-digit growth in the first half of the year. That is absolutely bonkers! The finance sector also performed impressively, soaring nearly 11% in Q2, driven by a surge in capital market volumes and fading fears of an economic slowdown.

However, looking strictly at the headline index performance masks the violent churn happening beneath the surface. It hasn't been a rising tide that lifts all ships, more like a few engines powering the entire train, or is it?

• The Plungers: Software and certain online service providers were hit hard as investors worried about eventual losses of market share to new AI tools. Some household names in the software space actually fell over 40% in the first half of the year. That seems justifiable. After all, Elon and other market "experts" suggest that none of us will be working in 15 years because AI will "do it all." I don't believe that, and I think people are starting to realize that as software stocks are now just starting to show a change of heart.

• Low Volatility Leaders: Sectors like Health Care and Financials are experiencing the lowest implied volatility right now. They’ve been the beneficiaries of recent rotations out of crowded, overvalued mega-cap tech names. This happens when fund managers and hedge funds look for undervalued, unrealized potential. However, investors should remember that volatility tends to mean-revert; these unusually calm sectors could see some price swings ahead.

• Small Cap Comeback: After being left for dead for months or longer, small-cap stocks finally started showing real life, having their strongest run in years. Again, they are the first part of the market to jump when coming out of recession. It may not be the typical way these stocks have responded in the past, but again, it all boils down to the numbers. This is a massive signal that the market breadth is widening beyond just a handful of massive tech companies.

The Strong Dollar: A Safe Haven with a Catch

Finally, we have to talk about the U.S. dollar, which recently staged a decisive bullish breakout, climbing to a 13-month high. This rally is partly fueled by anticipated Federal Reserve positioning, but it’s heavily driven by international risk aversion. When the globe gets messy, foreign capital seeks the safety of the American dollar.

While a strong dollar reflects robust underlying demand and is great if you're taking a vacation to Europe this summer, it presents a tangible headwind for multinational corporations, which is basically all of the large and some of the mid-sized companies. For large U.S. firms that earn a massive percentage of their revenue overseas, a stronger dollar reduces the value of those international revenues when converted back home. It is the ultimate double-edged sword, and it's emerging as a key macro headwind we are monitoring closely for the second half of the year. It's one of those damned-if-you-do, damned if you don't situations.

The Final Score

The surface-level calm of the broader market indices capping off a nearly 15% quarterly gain is fantastic, but it drastically understates the elevated dispersion and sector rotation happening underneath. Like digging deep into the bottom of a cookie jar, some are only left with crumbs. You can't just buy a blind index fund, go to sleep, and expect smooth sailing forever. With a little elbow grease, some patience, and dedication to a plan, you feel a lot better over time.

We remain highly encouraged by the sheer strength of corporate earnings and the structural tailwinds of AI and infrastructure investments. I still use a general improvement AI can inflict on small and mid-sized companies, and those enhancements get better and better each day. There is a ton of money being thrown at these enhancements, so a lot can happen over just a few months. Corporate America is proving once again that it knows how to adapt, survive, and profit, even when the government and global geopolitics are making a mess of things. However, as we navigate stretched positioning, currency headwinds, and the upcoming election cycle, tactical risk management and a diversified approach will remain your greatest assets.

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*** (Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk, including the potential loss of principal. Past performance is no guarantee of future results.)