Much to everyone’s surprise, equities put in their strongest quarter in six years during Q2 with the S&P500 index rising more than 14%. While this was driven by the largest technology companies, especially semiconductors, returns across the much more diversified equal-weighted S&P500 index were also up more than 12% reflecting broad strength across the economy. Fixed income returns were also slightly positive, up about 0.6% during the quarter while interest rates rose slightly.
Concerns over economic disruptions coming from the Middle East declined significantly as evidenced by the price of oil dropping more than 30% while settling under $70 a barrel at quarter-end, just slightly
above pre-war levels. After the initial geopolitical shock at the start of the war, investors looked through short-term, supply driven disruptions and focused on strong secular growth provided by the AI
infrastructure buildout economy.
During the Q1 reporting season (April & May), many management teams provided upbeat earnings reports that handily exceeded analysts’ expectations for double-digit earnings growth. Looking forward, managements generally maintained or increased earnings guidance for the full year. We view this as optimistic considering Q2 expectations are for more than 15% earnings growth across the equal- weighted S&P 500 companies.
It would be normal, even healthy, for equity markets to pull back some after such a strong quarter, and after 3 1⁄2 years of strong returns. At the same time, we see solid earnings growth and only modest
upside risks in interest rates given the current price of oil. We continue to adjust our portfolio risks by trimming some of the significant AI-related outperformers and putting cash to work in underappreciated
opportunities, many with meaningful dividend growth.
One of the main risks to the current economy would be a greater than expected deceleration in the AI infrastructure buildout. As we’ve discussed, this multi-year increase in capital investment has dominated
our economy and markets over the past few years. There is great potential for new industries, new products & services, enhanced productivity and increased earnings growth. This secular growth phenomenon is considered the 4th industrial revolution and offers exciting investment potential for those with a longer-term investment perspective.
As America turns 250, a cornerstone to our global leadership is the strength of our Treasury. While the growing federal deficit represents a potential existential risk, we have confidence it will be managed by our vast resources and capabilities. The Federal Reserve Bank’s recent stress tests of our largest banks showed strong capital reserves which would survive even a draconian depression. The US$ is not in danger of being replaced as the global currency anytime soon. In absolute terms, the US government collects the largest amount of tax revenue of any country. Yet, we have a relatively low tax rate among developed countries. We have choices to make going forward and significant opportunities to improve government productivity and efficiency. The American economic framework is unsurpassed.We believe it will not only survive current political turmoil but thrive as it always has.
Disclosure Statement
SFE Investment Counsel is a Registered Investment Adviser. This presentation is solely for informational purposes and not a solicitation to invest. The results reflect the
deduction of fees and the reinvestment of dividends and other earnings. Advisory services are only offered to clients or prospective clients where SFE and its representatives
are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may
be rendered by SFE unless a client service agreement is in place. Please contact a financial advisory professional before making any investment.
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