Some of you know that I am an avid gardener and occasionally I like to introduce new plants to my garden. For instance, last year was a fig tree, and this year was ginger. Ginger is a tropical rhizome that loves hot, humid conditions – something that has been sorely lacking in Southwest Ohio for most of the spring and summer. I supplied the humidity through watering, but the plant would only start growing when the soil temperature was warm enough. When it reached that point, it was amazing how quickly the ginger started putting up shoots. In a similar sense, companies involved in artificial intelligence are now experiencing ideal conditions for growth. These stocks have shot up significantly this year in small part because of valuations due to last year’s pullback, but in large part due to a euphoria surrounding AI. The appreciation in the markets this year has been solely on the backs of these names. For instance, the top 5 companies in the S&P 500 index are providing most of the market returns this year.
If you would have asked me a year ago when the bottom of the economic cycle would occur, I would have focused on the end of this year. Now it appears it may be the second or third quarter of next year. The shifting timeframe is due to the Federal Reserve’s policies which try to reduce both peaks and troughs but end up extending the economic cycle in the process. Why is the timing of this so important? Because typically the stock market bottoms 6 to 9 months prior to the economic cycle. With the lengthening of this cycle, the gains this year may be premature, and we potentially could experience a pullback in the market.
Looking forward, inflation is declining and the economy is slowing. However, parts of inflation including shelter and wages are sticky, and tight labor conditions could see the Federal Reserve raise interest rates even further after its breather last month. We are starting to see a few leading economic indicators point toward a bottoming process, and while the consumer is still healthy, retail sales are beginning to slow. Add to this the Fed potentially raising rates further,
reducing the money supply, and a historically significant inversion of the yield curve, and these leading indicators could also be premature. We are watching this closely. We still give a mild recession about a 40% chance of occurring. If we see the Fed aggressively trying to reach its 2% inflation mandate, or aggressively combat the strong labor market, that could create some significant headwinds for the economy. What we do recognize is that the economy is more resilient than what analysts were willing to give it credit for.
For equity markets, as I already mentioned, most of the gains have come from a few select companies. This means that the breadth of the market is very narrow, which is not a recipe for a sustained rally. We would prefer to see the market gains being broad-based across multiple sectors. We are seeing the benefit to the individual stock portfolios of the adjustments we made last year – by taking advantage of lower prices to add in or adjust positions. Challenges that we see are tech stocks being fully valued at this point and tightening in the financial sector because of the banking issues earlier this year.
In fixed-income markets, traditional bonds and inflation-protected funds are performing well this year. After 2022 being the worst bond market in 40 years, this year we are seeing gains in fixed income. For those of you needing income from your portfolio, one of the silver linings that has come from the dramatic increase in interest rates over the past 18 months is the jump in portfolio cash flow. We expect this to continue.
As always, we will continue to take advantage of price fluctuations to add value to the portfolios.
If you have any questions please let us know, and thank you for your trust.
Marc Henn, CFP®
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2026 Q1