BakerAvenue Prudence Indicator Says...
Long Term: Positive | Short Term: Neutral
Summer's Shifting Narratives
"The way I see it, if you want the rainbow, you gotta put up with the rain."
- Dolly Rebecca Parton
The S&P 500 spent August consolidating within a series of all-time highs, though the composition beneath the surface shifted far more than the index level did. High expectations, crowded positioning, and scrutiny of artificial intelligence-related capital spending drove a disconnect between growth rates (strong) and stock reactions (weak) across last month's leadership group. One of the sharpest momentum factor unwinds we have tracked broadened participation into non-technology and defensive corners, with energy leading returns and financials and healthcare among the strongest non-energy sectors. We view the rotation as a healthy release valve for a market grown too reliant on too few names.
A backup in bond yields, continued geopolitical volatility, and profit taking in leadership groups kept investors on edge this summer. Surging corporate profits, broadening market participation, and resilient economic data were encouraging offsets that made the seasonal transition more palatable for investors. Our base case remains moderate growth, and we remain prudently guarded, but optimistic. Record profitability and broadening earnings growth remain, in our view, underappreciated. We are, however, entering the seasonally weakest month of the calendar, compounded by the midterms and higher rates acting as a speed limit rather than a tailwind. Should consolidation materialize, we would view shallow pullbacks as buying opportunities, not warning signs.
Our investment process is built to remove emotion from portfolio decisions. At BakerAvenue, we maintain analytical independence from pre-written market narratives. We remove preconceived biases and defer to our analytical output. Ultimately, our views are only as optimistic or pessimistic as our technical, macro, and fundamental analyses indicate. Currently, our short-term metrics are in a neutral position while our longer-term view is positive.
For those who have been following our market updates (view previous market update videos and commentaries), you will be familiar with several of our key concerns and opportunities. We have continually stated our expectations of moderate growth. There are plenty of adjustments to consider, but our overarching views remain the same. Ultimately, economic and earnings growth will support a grind higher in equities. We believe it is a good time to be active and want to be thoughtful regarding portfolio construction and risk control.
The Technical Perspective
Price trends remain constructive, with the S&P 500 setting a fresh series of all-time highs while both its 100-day and 200-day moving averages slope upward and sit comfortably below current levels. Leadership has rotated toward cyclicals and away from the mega-cap growth names that dominated earlier stages of this advance, and we are intently focused on this shift as we consider tactical portfolio tilts. The more notable development, in our view, is that rolling correlations among S&P 500 constituents have fallen near an all-time low, and single-stock volatility and dispersion have risen accordingly (e.g., a ‘market of stocks, rather than a stock market’).
We are watching for a sustained momentum thrust to help the market extend, or at minimum defend, its highs into a seasonally difficult stretch. Internals are supportive but leave room for improvement, with the S&P 500 overall at a respectable 63% of constituents above their 200-day moving average. Encouragingly, sentiment reads remain constructive for the bull case precisely because they are unremarkable; bull-bear surveys register a neutral bias rather than euphoria, and bull markets tend to die on euphoria, not skepticism. Elevated money market balances continue to provide a buffer against sizable pullbacks. While the bar for adding equity exposure is higher than it was in an era of near-zero rates, our view remains that investors have room to increase allocations, particularly as lower stock-to-stock correlation widens the opportunity set for disciplined, active security selection.
The Macro Perspective
Economic growth remains resilient on balance: third-quarter GDP is tracking around 3% with estimates accelerating in the fourth quarter and into early 2027. Incoming economic data continues to surprise to the upside on net. The industrial economy remains a particular area of focus for us, as a beneficiary of increased capital spending, favorable tax treatment, and re-shoring trends, all of which bode well for broad market profitability. Geopolitical and policy risk has picked up, most notably around midterm election positioning. We expect the midterms to produce few material legislative changes and thus limited broad market influence, though sector- and industry-specific impacts (e.g., around data center and AI infrastructure policy) are more likely.
Interest rates remain the dominant swing factor in our macro assessment. New Fed Chair Warsh’s recent characterization of the Committee’s inflation objective as “a firm, fixed target” pushed rates higher across the curve, with the 10-year Treasury yield near 4.8% and the 30-year near 5.2%. We are mindful of the rate impacts on the capital markets. Encouragingly, the current rate backdrop, while elevated relative to post-pandemic lows, remains modest relative to the 10-year yield’s 50-year average of 5.9%, and we continue to view it as manageable provided economic growth remains intact. The Treasury has also signaled limited tolerance for a further, disorderly rise in long-term rates, an important backstop for risk assets.
The Fundamental Perspective
Corporate fundamentals remain in good shape, and we continue to see upside to consensus earnings and revenue estimates. Second-quarter S&P 500 earnings grew 33% year-over-year, nearly 11 points ahead of the consensus estimates. Forward guidance was equally impressive, with the share of companies raising present-quarter guidance near its highest level since the pandemic. Profit margins remain near record levels, an encouraging sign of pricing power and cost discipline even amid an uncertain macro backdrop. Importantly, growth is broadening beyond the Magnificent Seven: earnings growth for the “Remaining 493” companies is accelerating into the high-20% range through 2027 even as Magnificent Seven growth decelerates from last year’s 40%-plus pace, a convergence that should support improved market breadth.
Valuations have come down and remain reasonable on balance: the equal-weighted S&P 500’s forward price-to-earnings ratio sits at roughly 17x, essentially in line with its long-term average. Credit spreads remain well-behaved and supportive of risk assets, a key input to our risk management process. On the AI capital spending debate specifically, we continue to view recent weakness in AI infrastructure-related names as reflecting positioning and technical factors rather than deteriorating fundamentals. We are aware of the scale of the hyperscalers’ purchase commitments, now roughly $1.5 trillion, and circular financing concerns. However, we continue to see demand outstripping supply as the early returns on that investment start to accrue. We will be diligent in our exposure here.
Concluding Thoughts
Summer’s shifting narratives — a rotation in market leadership, a backup in bond yields, and rising geopolitical noise — did not derail the bull market, but they did tweak the narrative. Adapting to these new inputs, rather than resisting them, remains our priority. Encouragingly, factors within our technical, fundamental, and macro disciplines continue to skew positively on balance. As we approach a seasonally volatile stretch, we remain constructive as growth resiliency has proven sustainable.
Our investment philosophy is based on a dual mandate of growing and protecting client assets. We continue to focus on "how" one is positioned, not "if" they should have exposure at all. We are staying active, using volatility to harvest losses while opportunistically deploying capital where appropriate. At this point, our cash weightings remain residual in nature, and we are focusing on strategy positioning vs. our respective benchmarks to control risk. Of course, should the backdrop destabilize, we will take a more defensive stance.
Should you have any questions or comments, please contact BakerAvenue. We are happy to share our thoughts in greater detail, and we welcome the opportunity to speak with you.
Disclosure: Past performance is not indicative of future performance.