By Kyle Plotkin
Investment Advisor Representative
[email protected]
Stock market volatility has remained near the top of investors’ minds in recent weeks. Through July 20, the S&P 500 was still sitting on a decent year-to-date gain of 8.7%, but the big picture doesn’t tell the whole story. The index fell 1.1% in June and was down another 0.8% so far in July. In other words, the market has delivered reasonable results for the year, but the path has not been smooth.
The headline numbers do not fully explain all that has been happening beneath the surface. Recent volatility has not simply been a matter of the entire market moving higher or lower together. Different company sizes, sectors, and investment themes have been moving in very different directions as investors try to determine which areas are best positioned for whatever comes next.
One example is the recent performance of small- and mid-sized companies compared with large-cap companies. Over much of the past several years, large companies (particularly a small group of technology and tech-adjacent companies) drove a significant portion of the market’s growth. Small companies often lagged as higher interest rates increased borrowing costs and investors favored businesses with larger balance sheets and more predictable earnings. Recently, that trend has begun to shift. Small caps have produced stronger relative results, and mid-caps have also gained ground against the largest companies. Of course, there is no guarantee that those trends remain for much longer, but it’s a good example of how market leadership can change after one area has dominated for an extended period of time.
A similar pattern holds across individual market sectors. Tech had been one of the strongest areas of the market for the past several years, driven in part by excitement surrounding artificial intelligence and the companies building the chips, data centers, power capacity, and computing infrastructure needed to support it. The chart below shows rolling one-month S&P sector rankings on the left and rolling three-month rankings on the right. Technology is shown in yellow.
Notice the difference. Tech remained the top-performing sector throughout the three-month ranking period shown on the right. But on the one-month side, it fell from first place in mid-May to tenth out of eleven sectors by last week.
So what changed? Part of the answer involves growing concern around the AI investment cycle, which I covered in a recent column here. Major tech companies continue to commit enormous amounts of money to AI development and related infrastructure needed for it. Those investments may create significant long-term opportunities, but they also carry substantial costs today.
Investors are becoming increasingly focused on how quickly that spending will translate into enough revenue and profits to justify both the investment and the high expectations already reflected in many stock prices. That does not mean that AI has stopped being valuable or that the longer-term tech boom has ended. It simply means that a strong long-term investment theme can still struggle in the short term when expectations become increasingly difficult to meet.
At the same time, money has been moving into other parts of the market. Energy has benefitted from higher commodity prices and geopolitical uncertainty. Financial and real estate company outlooks can be affected by interest rate uncertainty, and healthcare sometimes operates as a defensive sector where investments often go when other areas are shaky.
And then there is the Federal Reserve. The Fed continues to face a difficult balancing act. Persistent inflation creates pressure to keep interest rates higher, while signs of slower economic growth could cause Federal Reserve officials to reduce rates. It seems that every inflation report, employment number, and growth estimate gives investors another data point to try and predict the Fed’s next move.
So what’s the takeaway here? Market leadership changes, and it often changes quickly. Small and mid caps have recently improved in comparison to large caps. Tech remains the longer-term sector leader, but has been one of the weakest over the past month.
None of that tells us what will happen next. At Franklin Retirement Solutions, we are always monitoring market conditions, economic developments, and changes in market sector leadership. As conditions evolve, we continue to evaluate the investment allocations within our portfolios and make adjustments where we believe they are appropriate and necessary. Our goal is to keep our portfolios responsive to changing conditions while remaining focused on their long-term objectives.