Global Market Review and Outlook

Capital markets across asset classes and geographies bounced back nicely in the second quarter after a troubled beginning to the year. In the U.S., on the eve of the country’s 250th birthday, equities staged a rally worthy of the occasion, recouping the losses in the first quarter and then some as the S&P 500 closed up 10% for the year as June ended. International markets joined the party too, with Asian and European equities each posting some of their best quarters in years. Easing tensions in the Middle East, blockbuster corporate earnings, and relentless enthusiasm for AI-related investment all did their part to support the rally, even as a change in Federal Reserve leadership pushed interest-rate expectations from anticipated cuts toward the possibility of hikes. The potential shift in interest rate policy supplied fixed income with its own fireworks as volatility increased in the sector as yields rose. In the end, bonds, as measured by a core index such as the Bloomberg U.S. Aggregate, returned a modest 0.7% for the quarter.

Source: Factset

The U.S. equity market headline performance in the second quarter deserves further attention. The initial leg of the rally off the spring lows was led overwhelmingly by a small number of very large technology and semiconductor companies riding continued enthusiasm for AI-related capital spending. The Philadelphia Semiconductor Index had one of its best quarters on record, up 88% in the period.

While there is reason to believe AI-driven demand will continue to benefit these companies, we worry about such a meteoric rise. Semiconductors have historically been one of the most cyclical corners of the equity market, prone to boom-and-bust swings driven by the industry’s own capital-spending cycles.  Prior periods of extraordinary semiconductor enthusiasm—including the dot-com buildout of the late 1990s—were eventually followed by sharp corrections once demand failed to keep pace with growth expectations. Such a leap in the sector performance raises the question of how much of that return reflects a genuine, durable shift in long-term demand versus a shorter-term surge in sentiment and momentum that could prove difficult to sustain. Pulling years of uncertain future growth into current stock prices may reflect more about investor sentiment and the momentum in this market than it does about the underlying value of these businesses, which makes us wonder about the permanency of these recent gains. 

Outside of semiconductors and other AI-infrastructure-related companies, the median S&P 500 stock rose only about 6% in the quarter. High-quality businesses in particular lagged the broader index. This fits a broader historical pattern in which quality tends to underperform during the risk-on, momentum-driven rallies like we experienced in the second quarter. Importantly, this dynamic appears to be driven more by shifting investor psychology and a temporary rush toward risk than by any deterioration in the fundamentals of high-quality companies themselves as corporate profit growth remains a genuine fundamental bright spot in the market. 

The S&P 500 is currently more concentrated in a small number of mega-cap companies than at almost any point in its history. The 10 largest stocks in the index account for nearly 40% of the total.  Semiconductor businesses alone account for 18% of the S&P 500. When a handful of stocks account for such a large share of the index's value, the index's fate becomes tied to the fortunes—and the valuations—of those few businesses. The forward valuation of the S&P 500 is now running modestly above both its 5- and 10-year averages, and much of that premium sits in the most crowded areas of the market.

We do not believe that is a reason to abandon U.S. equities—far from it. It is, however, a reason to be deliberate about how portfolios are positioned. A portfolio of well-run, financially sound businesses across a broader range of industries and market capitalizations gives you exposure to the durable earnings power of corporate America without being overly dependent on the continued outperformance of a small group of stocks trading at demanding valuations. Over a full cycle, we believe that kind of diversified, quality-oriented approach offers a better balance between participating in upside and protecting against the kind of sharp reversal that concentrated markets have historically been prone to. This quarter's late-cycle broadening into small caps, value, and cyclicals is an early example of why that discipline matters.

Internationally, equity markets delivered one of the widest performance gaps across countries and regions that we have seen in some time. Markets tied closely to the semiconductor and AI supply chain, notably South Korea and Taiwan, posted outsized gains, while China and India lagged noticeably. This dispersion is a reminder of why international exposure is about more than just one regional bet; different economies, currencies, and policy paths can move very differently within the same quarter, and a globally diversified allocation avoids being overly reliant on any single market's narrative.

The bond market repriced sharply this quarter as rate-cut expectations gave way to rate-hike risk, pushing intermediate- and longer-term Treasury yields higher and producing a steepening of the yield curve. In this kind of environment, it can be tempting to reach for yield by extending duration or taking on additional credit risk. We continue to believe that is the wrong trade for most of our clients.

We manage the fixed-income portion of portfolios to do a specific job: generate reliable income and provide ballast against equity market volatility, not to serve as a source of speculative return. That means favoring higher-quality issuers, keeping duration relatively measured, and avoiding stretches into lower-quality credit simply because it offers a higher headline yield. With policy rate expectations fluid, we believe it is prudent to stay conservative and let bonds do what they do best in a diversified portfolio—provide stability and income—rather than ask them to be a growth engine.

Looking ahead, economic growth in the U.S. and abroad is likely to continue, but at a more moderate pace than markets had anticipated earlier this year. Inflation is likely to remain the dominant variable shaping the outlook through the rest of the year. Headline CPI was running at roughly 3.3% year-over-year as of March, up from 2.4% a year earlier, driven largely by the energy-price spike tied to the U.S.-Iran conflict. With oil prices having since retreated toward pre-crisis levels, some of that headline pressure may ease in coming months. Core inflation, at roughly 2.6% year-over-year, is likely to prove stickier, as non-housing services categories like medical care and airfares continue to contribute. The Fed's own projections anticipate PCE inflation ending 2026 near 2.7%, with a gradual cooling toward the 2% target expected to play out over the following two years rather than by year-end.

The Federal Reserve's new interest rate posture is also a key consideration as we enter the second half of the year. Following the contentious confirmation of a new Fed chair in May and an explicit refocus on the inflation mandate, rate expectations have repriced sharply—markets began the year anticipating two to three cuts in 2026 and now are weighing the possibility of hikes instead. We expect this more hawkish stance to remain the operating assumption through year-end absent a clear downside surprise in inflation data, meaning the path of least resistance for policy is likely "higher for longer" rather than the easing cycle markets priced in at the start of the year.

Against this backdrop, the outlook for U.S. equities looks more balanced than one-directional. On one hand, continued AI-related capital spending has concentrated market gains in a narrow group of large-cap technology and semiconductor names—a dynamic that can support further headline index returns but also leaves the broader market more exposed if leadership were to falter. On the other hand, that same AI investment cycle represents a genuine multiyear source of productivity and earnings growth rather than a purely speculative phenomenon, and sectors outside mega-cap technology may find more immediate support from firmer rates and a still-growing economy. The healthier scenario for equity markets overall would likely involve gains broadening out beyond the current leadership group, rather than continued reliance on a small number of stocks to carry the market.

International stocks present a similarly balanced picture. Relatively more attractive valuations abroad, together with less concentration risk in any single sector or group of companies, make international markets a useful complement to a U.S. equity allocation. However, a firmer dollar tied to higher U.S. interest rates could pressure returns for U.S.-based investors.

Fixed-income markets face their own set of crosscurrents. If the Fed holds rates higher for longer—or even contemplates hikes—it would likely keep short-term yields elevated and could pressure the price of longer-duration bonds. However, higher current yields also mean fixed income offers more attractive income generation than in much of the past decade, a meaningful shift from the low-rate environment of recent years. The combination of higher starting yields and a Fed focused on inflation control could continue to make fixed income a resilient portfolio ballast.

As always, the investment environment remains fluid, and periods of volatility and uncertainty are an expected part of the market cycle. Through it all, we remain committed to staying true to what we do: building and managing portfolios with discipline, patience, and a clear focus on your unique investment objectives. We appreciate the trust you place in us and will continue working diligently to help position your portfolio for long-term success. We hope you are able to enjoy the summer and spend meaningful time with family and friends. Please reach out with any questions; we always welcome the opportunity to hear from you.

Warm regards,

John, Cam, and team