Clients and friends have been asking me what has been driving markets to continue to expand after a period of volatility last month. Understanding the drivers behind this latest expansion, while balancing the opportunities and risks ahead, is essential for any long-term investor.
Here are some key factors to consider:
- Markets have been sensitive to expectations around Fed rate hikes. In theory, rate hikes slow the economy and financial markets, leading to volatility in the stock market. The reverse can be true as well - lower rates can spur growth and business investment, supporting the overall stock market. When oil prices jumped in July, markets began expecting up to two rate hikes over the next year. That month, however, energy prices improved, and some signs of job market weakness emerged, so markets tempered those forecasts and helped to push major indices higher. But most recently as crude oil moved past $100 and energy forecasts (like the EIA's updated projections) were revised upward for the second half of the year, markets began pricing in sustained secondary inflation. So, August has seen the S&P 500 sustain a gradual decline of 2%. All eyes are on upcoming CPI/PPI inflation prints and incoming FOMC communications to gauge whether the Fed considers this oil shock temporary or a trigger for action.
- Strong corporate earnings have been a primary engine of market trends this year. Company reports for the second quarter have broadly beaten expectations. Consensus forecasts on Wall Street now anticipate S&P 500 earnings to reach $347 per share, representing a growth rate of over 30%. Not only is this historically strong, but markets also expect double-digit growth rates in the coming two years. This has helped to support valuations and markets. Key drivers supporting growth are not limited to continued AI capital spending, but includes energy sector tailwinds, and operating efficiency & margin expansion for companies across the broad spectrum of the market including consumer discretionary and industrials. This is not just an AI market.
- Beneath the surface, the market’s primary engines remain intact, even as energy pressures intensify. On one side, secular momentum in Artificial Intelligence continues to underpin leadership across Information Technology and Communication Services. On the other, the ongoing conflict in Iran remains a major driver of volatility—with oil anchoring firmly above $100 a barrel as traders weigh persistent threats to maritime choke points like the Strait of Hormuz and the Red Sea against any lingering hopes for diplomatic relief. So the news cycle could continue to feed the market's ups and downs but the fundamentals are intact.
- While year-to-date market gains are a welcome outcome for investors, elevated valuations warrant a disciplined outlook. At nearly 20 times forward earnings, the S&P 500 trades at a noticeable premium to its historical 16x average. However, this headline multiple masks significant dispersion beneath the surface—while high-flying tech multiples inflate the aggregate index, cyclical sectors like Energy and Industrials have delivered crucial fundamental support to broader returns at far more reasonable valuations. This divergence reinforces the argument for sector diversification, demonstrating that portfolios don't need to overpay for mega-cap tech growth to capture durable market upside.
The past few months show that short-term market volatility is a normal part of investing. Staying focused on long-term goals and maintaining a well-balanced portfolio have historically been the best ways to build wealth over time.
