“What goes up must come down
Spinnin’ wheel got to go ’round”
(From “Spinning Wheel” by Blood, Sweat & Tears, 1968)
By Scott Welch, CIMA®, CEPA®, Chief Investment Officer & Partner
Reviewed by Carter Mecham, CMA®, IACCP®
To say the least, this has been an interesting year for global equities. The first quarter saw a general downturn in the markets as investors became concerned about high valuations and the enormous amount of debt AI-oriented firms committed to raise to finance the expansion of data centers and energy production and transmission.
Then the Iranian war broke out in late March. We saw the expected downturn in risk assets for a short while, followed by an incredible rally in mega-cap tech and semiconductor stocks.
This trend, perhaps somewhat inevitably, potentially ended with the recent release of unexpectedly strong US labor market statistics. This economically positive news had an adverse effect on these interest rate-sensitive stocks as investors began to price in rate hikes by the Fed (a topic we discussed in detail in our three previous blogs on “What Moves the Fed”).
Source: Bloomberg and John Auther’s “Points of Return,” June 8, 2026. These are estimates and may change as additional data come in.
And then, as we write this, the US and Iran have announced a potential “peace deal” (specifics still TBD) and the market has rallied back again.
So, here we are, approaching the end of Q2 and enduring somewhat of a “Mr. Toad’s Wild Ride” in terms of stock market performance.
Where do we go from here as we move through Q3 and the rest of the year? Let’s dive in.
Global Market Performance
The first thing we notice is the “v-shaped” evolution of global equity prices so far in 2026, for the reasons we summarized above.
We note the US has been less affected (but not unaffected) by the Iranian conflict, because of our relative energy independence. Europe in particular has been hit much harder because of its relative lack of a robust technology sector and its heavier dependence on Middle East oil (first chart).
Like many technology-focused stocks, US mega-cap tech firms are sensitive to changes in interest rates and, when market sentiment around rates changed recently, these stocks took a tumble before rallying back after the announced potential peace deal, which sent interest rates down, which is good for the mega-caps (second and third charts).
Although still negative for the year, Tesla got a not unexpected boost from the recent successful launch of SpaceX (puns fully intended).
Source for the three previous charts: Ycharts, YTD as of June 12, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Interestingly enough, non-US markets have performed well in US dollar terms despite the recent rise in the dollar due to a “flight to quality trade” following the onset of the Iran war. This followed a noticeable slide in the dollar throughout 2025, which provided a nice tailwind to non-US investments for US investors.
Should the dollar return to its general decline (which the Trump administration hopes for) following the end of the Iranian conflict, this may provide an additional catalyst to the performance on non-US investments.
Source: Ycharts, 3-year data through June 12, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Asia is also heavily dependent on Middle East oil but the broader Asian markets have been held up by three semiconductor/chip companies – TSMC in Taiwan and Samsung and SK hynix in South Korea.
Source: Bloomberg and John Auther’s “Points of Return,” May 27, 2026. You cannot invest in and past performance is no guarantee of future results.
Like the US mega-cap tech stocks, however, these three stocks fell following the change in sentiment regarding interest rate changes.
Source: Reuters and MarketWatch, indicative performance from June 1 – June 8, 2026. This is for illustration purposes only and does not represent investment advice. Past performance is no guarantee of future results.
Despite the remarkable rally in the US markets over the past two months, the calendar year performance thus far is not excessive relative to previous calendar years going back to 1928. It is at the higher end but remains within historical ranges.
Source: Leuthold Group, June 2026 Chart Packs. You cannot invest in an index, and past performance is no guarantee of future results.
US Mega-Cap Tech Stocks
Continued Dominance
Let’s visualize the continued market cap domination of the mega-cap tech stocks in the US. We dislike the phrase “Magnificent Seven” because it is overused and seemingly disparages the other 493 stocks in the S&P 500 index. However, we acknowledge it has become an industry cliché term, similar to the “Nifty Fifty” and “Dot.com.” We prefer the more generic “mega-cap tech” stocks, but the idea is the same.
In any event, we see that these stocks represent 30%-35% of the S&P 500 market capitalization index, 25%-30% of its forward earnings projections, and 15%-20% of its forward revenue projections.
Source: Yardeni Research, as of June 5, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
It is no exaggeration to say that, should the mega-cap tech stocks sneeze, the overall market index will catch cold. And that is before factoring the impact of the recently successful “mega IPOs” of Space X and the impending IPOs of Open AI and Anthropic.
There is an ongoing discussion regarding how to incorporate these ultra mega-cap firms into broad market indexes and the corresponding impact they will have on index performance going forward.
As we write this, the S&P indexes plan to “stick to their guns” and not include these names until at least one year of GAAP-qualified net income.
The NASDAQ, on the other hand, introduced “fast entry” rules to allow these massive new public companies after 15 trading days.
This is going to cause significant differences in index-level performance over at least the next 12-15 months.
What many investors may not realize is that, despite the recent rally in the mega-cap tech stocks, US small cap stocks continue to outperform YTD.
This may not continue but we highlight this to illustrate that there is more to the US stock market than simply the mega-cap tech stocks (first chart).
And, in fact, small cap earnings are expected to grow at a faster pace than large cap stocks over the remainder of 2026. (second chart).
Source: Ycharts, YTD as of June 12, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Source: Yardeni Research, as of June 4, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Earnings Expectations
Given the importance of this earnings season, what are the expectations?
According to Zacks Earnings Report, Q2 earnings for the S&P 500 index are estimated to be up almost 22% year over year, on almost 11% higher revenues.
We’ve commented on this in previous blogs, but what we find most notable about the following chart is the expectations for continued earnings growth despite relatively flat revenue growth.
The market clearly is pricing in AI-driven productivity gains as we move through the rest of 2026 and into 2027.
Source: Zacks Earnings Report, as of June 10, 2026. The green bars represent earnings and the orange bars represent revenues. The hatched bars are estimates and subject to change. You cannot invest in an index, and past performance is not guarantee of future results.
Estimates for economic growth and inflation outside the US have come down since the advent of the Iranian war and the corresponding oil shock due to the closing of the Strait of Hormuz, but GDP growth estimates remain positive and inflation does not appear to be “running away” despite the spike in oil prices.
We believe this is due to the general market belief that the war in Iran will not last long and oil prices will correspondingly return to “normal.”
Hopefully the recently announced potential peace deal between the US and Iran will prove this true.
Source: OECD World Economic Outlook, as of June 2026. These are estimates and will change as additional data come in.
Valuations
First, let’s look at US vs. non-US valuations. Historically, non-US valuations have been lower than the US for a variety of reasons, but the gap today is as wide as it has been in decades.
Source: Yardeni Research, as of June 12, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Source: WisdomTree, as of May 29, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Now let’s look at US large cap versus small cap. As mentioned above, US small caps have outperformed US large caps YTD. Despite this, they continue to trade at a lower valuation than large caps (first chart). The mega-cap tech stocks contribute significantly to this higher valuation (second chart).
And small caps still continue to trade at a discount to large caps that is as wide as it has been in more than 20 years (third chart).
Source for both charts: Yardeni Research, as of June 12-16, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Source: WisdomTree, as of June 11, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Next, let’s look at the growth versus value comparison. We see that, on a broad market basis, after a period of outperformance value has fallen behind growth over the past twelve months. The April-May rally of the mega-cap tech stocks is the primary driver of this outperformance.
Source: Ycharts, 12-month data as of June 12, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
As with the US versus non-US, we see the growth versus value valuation gap as wide as it has been in decades. We note, however, that the gap is closing as value stocks have performed relatively well over the past twelve months.
Source: Yardeni Research, as of June 4, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
We’ve mentioned that a significant part of the increase in global equity valuations have been driven by increased earnings versus multiple expansion, which we view as a healthy development.
But when we consider the current relative difference in valuations, we can see that it is almost entirely because of the differences in earnings expectations between the different asset classes and styles.
Source: Goldman Sachs and The Daily Shot, as of June 15, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
If we look across the global equity landscape, we see no “screaming buys” from a valuation perspective – the market is “fully priced” by historical standards.
Source: JP Morgan “Guide to the Markets,” as of May 29, 2026. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass. You cannot invest in an index, and past performance is no guarantee of future results.
Risk Factor Performance
Finally, let’s look at risk factor performance. Regular readers of these blogs know we are believers in both asset class and risk factor diversification. We believe this can help deliver a more consistent performance over full market cycles.
For most of this year, we see the momentum factor dominating performance, but we always take this with a grain of salt, as we believe momentum is a secondary or derivative risk factor. As a reminder, the momentum factor reflects that when a stock, sector, and asset class or style is rallying, that rally tends to continue until an underlying market condition changes.
In other words, if one of the fundamental risk factors is rallying, then momentum will rally as well. During the course of 2026 we’ve seen a rotating lead of primary factors from growth to value to size to dividends and back to growth – momentum takes advantage of all of these rallies.
As we have noted in many previous blogs, quality remains the most consistent performer of the fundamental risk factors. We define quality as companies with stronger earnings, cash flows, and balance sheets.
Source: Ycharts, YTD data as of June 12, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
As we’ve discussed, we anchor our risk factor exposure to quality. It is rarely the best or worst performing factor, but it is the most consistent.
Quality is illustrated in the blue line in the chart below, while the diversified “factor mix” is illustrated by the teal line. We see that both have been the most consistent performers over the past three years.
Source: State Street Global Advisors and Bloomberg Finance, L.P., as of May 29, 2026. Past performance is not a reliable indicator of future performance. Min. Vol = MSCI USA Minimum Volatility Index | Value = MSCI USA Enhanced Value Index | Quality = MSCI USA Quality Index | Size = MSCI USA Equal Weighted Index | Dividend = MSCI USA High Dividend Yield Index | Momentum = MSCI USA Momentum Index | Factor Mix = MSCI USA Factor Mix A-Series Capped Index. Div. Grower = S&P High Yield Dividend Aristocrats Index. The indexes used above were compared to the MSCI USA Index. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
Remember the magic of compounding – if you don’t lose as much in a down market you don’t have to gain as much in an up market to still come out ahead over a reasonable investment horizon.
Summary and Interpretation
Summer is usually fairly quiet with respect to the markets – people are away on vacations, and trading volume tends to be lighter. This is what prompted the market adage, “Sell in May and go away.”
We think this summer may be lining up to be different. We may still have some slower trading days as the “doldrums” set in, but with the potential end of the Iranian war, a new Fed Chair in Kevin Warsh, the continuing mania regarding Artificial Intelligence, and an impending mid-year US election in November, we may find that the usual September-October market volatility comes a little earlier this year.
After disappointing Q1 performances, the mega-cap tech stocks once again are leading the way, which is why we believe the Q2 earnings reports will be so important.
The artificial intelligence craze has very much returned, and these handful of stocks once again dominate the market. But the consequences are elevated valuations – these firms will need to post robust earnings growth and future expectations to maintain those valuations.
Kevin Warsh is walking into a different market environment than he probably expected when he was nominated to be the next Fed Chair several months ago when the market expected the Fed to cut rates at least twice in 2026.
If we had been writing this even two weeks ago we would have suggested the next Fed move would be a hike rather than a cut, but the potential end of the war with Iran and corresponding re-opening of the Strait of Hormuz has the potential to “re-pivot” those expectations once again – though we continue to believe the arguments for rate cuts anytime soon remains fairly weak.
Perhaps two under-reported stories are the facts that US small cap stocks have outperformed large cap stocks this year and EM stocks continue to thrive despite the war and spike in oil prices (Asia is heavily dependent on Middle East oil).
We believe these performances have been driven by (a) a belief in the continued growth of the US economy, which often benefits small caps, (b) continued productivity gains in small caps as AI broadens out its reach and impact, and (c) the remarkable performance (again driven by AI) of semiconductor companies in Taiwan and South Korea.
As long as earning are maintained and the AI phenomenon remains in place, we don’t question the continuing strength of the mega-cap tech stocks – they are quality companies generating huge earnings and cash flow. But they will need to maintain their earnings performances to maintain their market leadership – we saw in Q1 what can happen if that comes into question.
At the risk of repeating ourselves, we continue to recommend focusing on a longer-term time horizon and the construction of “all-weather” portfolios, diversified at both the asset class and risk factor levels.
Now is the time for patience, discipline, and a focus on longer-term investment objectives. The summer, especially, is no time to be a “day trader.”
We hope you find this helpful and, as always, we welcome your feedback and questions.