There has been a lot of focus on downside risk over the past several years. The overall U.S. stock market has traded at lofty valuation levels, the economy has appeared shaky at times, economic policy proposals have roiled the market, geopolitical risks are everywhere, and confidence among both businesses and consumers has been eroding. Accordingly, investors have been on high alert to what could go wrong. But it may be time to start thinking about what could go right.
Through all the insanity, the stock market has generally been advancing with just a few interruptions. In fact, the S&P 500 closed the second quarter at an all-time high. That is remarkable given our start to the year. Looking ahead, tariff turmoil seems to have given way to trade deal and geopolitical optimism.
This rally could continue, but it will probably look much different than the stock market rally we’ve enjoyed since 2009. For many years, the stock market has been dominated by the largest and “growthiest” tech stocks. More recently, they have been dubbed the Magnificent Seven, but a relatively small number of tech stocks have been driving the market higher for quite some time.
This same phenomenon has happened historically on a few occasions. Most recently, there was the Dot-Com Boom, but other tech rallies (Nifty Fifty in the 1960s and 1970s, and even the runup in the late 1920s) have come and gone. Usually, they end with a nasty bear market, but that isn’t always the case, and it seems somewhat unlikely today.
The largest stocks are still overvalued compared with how they have been priced historically, but that doesn’t necessarily imply disaster is on the horizon. It does, however, suggest that changes in stock market leadership may be coming. Nothing can defy gravity forever. And while it is too soon to know for sure, there are signs developing that a slow, orderly rotation out of the most expensive stocks is starting. That likely implies at least stagnant performance for the once-hot tech sector, but there are upsides to that.
For starters, we could see a more egalitarian market. Instead of a narrowly led bull market, it would not be surprising to see much broader participation by stocks across industry sectors. That broadening has already begun, most notably among international stocks, but even in the U.S., a much larger set of stocks has been contributing to the market’s recent advance.
President Trump’s proposals favor domestic energy producers (drill, baby, drill), manufacturers, industrial goods companies, utilities, and perhaps financials. An improvement in earnings growth in these sectors could result in explosive stock performance since they would also likely benefit from growing valuation multiples.
Currently, most of the market, outside of tech, trades at historically low valuations. These stocks have been neglected and ignored. However, any boost in their profitability could garner renewed attention and cause growth in their stock prices far in excess of their earnings growth. In some cases, notably small-cap and value stocks, valuations are below the tenth percentile when ranked historically. That means they are trading at bargain basement levels.
Generally, these stocks tend to snap back after a recession when a new growth leg to the economy kicks in. We haven’t exactly had a recession recently, but economic growth has been sluggish. Could it be that a resurgence is afoot even if not from an official recession? A bull case would be that interest rates come down, regulatory hurdles are removed, corporate tax rates drop, and other proposed initiatives allow for greater corporate profits growth. That could ultimately drive increased employment and subsequently a boom in consumer spending as well.
A renewal in earnings growth could lead to continued stock market gains and a healthy rotation that allows for sustainable moves upward for years to come. Let’s hope we’re right.
For more information on Armbruster Capital’s investment management philosophy and approach, contact us via our website, call (585) 381-4180 or email us at info@armbrustercapital.com.
**Disclaimer**
As portrayed in this post, Armbruster Capital Management’s views are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Investing involves risks, and the value of your investment will fluctuate over time, and you may gain or lose money. Past performance does not guarantee future results.