Two Events That Could Actually Cause a Pullback
The S&P 500 rallied last week despite news that was, on balance, slightly negative. Inflation metrics ran hot (CPI was on balance “ok,” but it’s not moving towards the Fed’s 2% target and PPI was very hot), corporate news was mixed (especially in the AI space as AMAT posted soft guidance, while C3.ai (AI) and CoreWeave (CRWV) both dropped sharply) and there wasn’t any substantial geopolitical improvement and expectations for Fed rate cuts softened (a September cut is still widely expected).
Despite the bad news, the S&P 500 rallied on the week and hit a new all-time high and the reason is clear: None of the negative headlines were bad enough to make investors think that 1) Tariffs may cause stagflation or 2) Meaningfully reduce AI enthusiasm. Those two ideas, 1) That tariffs may cause stagflation and/or 2) That AI enthusiasm wanes, are the two ideas that could cause meaningful declines in the markets right now because they push back on the underlying ideas that have sparked this rally (namely, that tariffs won’t spike inflation or hit growth and that AI-driven earnings growth and momentum continue).
Importantly, the news last week did move in the direction of both, as CPI and PPI (combined) incrementally increased concerns tariffs might boost inflation (and prevent Fed rate cuts), while AI corporate news was negative. However, neither of the news items were bad enough to make investors more concerned that tariffs may cause stagflation and that AI enthusiasm may be misplaced, and that’s why markets generally ignored them.
Bottom line, there’s a lot of noise in the markets right now with conflicted economic data, conflicted inflation data, concerns about data validity, geopolitics, AI outlook, etc. But to cut through that noise, we just need to stay focused on these two questions: Did the news make it significantly more likely that tariffs may cause stagflation? And did the news make investors seriously question their AI enthusiasm? As long as the answer to both is “no,” then while stocks may see some volatility, the trend in this market should remain higher.
As a result, I have changed my allocation in my managed accounts. Instead of holding a 25% position in bonds, I have moved that money to growth while maintaining a position in value stocks.
Why holding a minimum of 25% in value stocks helps balance a portfolio:
1. Different Market Behavior
- Growth stocks tend to perform best when the economy is expanding, interest rates are low, and investor sentiment is optimistic.
- Value stocks often perform better during slower growth or recovery phases, when investors seek stability and fundamentals.
This creates a counterbalance: when growth lags, value often holds up better.
2. Lower Volatility & Downside Protection
- Value stocks typically trade at lower price-to-earnings (P/E) ratios and are supported by stronger fundamentals (e.g., stable cash flow, dividends, tangible assets).
- Because of this, they are less sensitive to market hype and tend to decline less during market corrections.
This provides a stabilizing effect in downturns.
3. Sector Diversification
- Growth stocks are heavily concentrated in sectors like technology and biotech.
- Value stocks are often found in financials, energy, industrials, and consumer staples.
Owning both reduces sector concentration risk and smooths performance across different market environments.
4. Dividends & Income
- Many value companies pay consistent dividends, adding a reliable income stream even when stock prices stagnate.
- Growth stocks usually reinvest earnings, meaning less cash flow to investors.
Dividends provide a cushion in volatile or sideways markets.
5. Mean Reversion & Long-Term Balance
- Historically, growth and value go through cycles of outperformance.
- Over long periods, value stocks have matched or outperformed growth, but at different times.
Holding value stocks ensures you don’t miss the rebalancing effect of market cycles.
Bottom line: Value stocks help balance a portfolio because they offer stability, income, sector diversification, and resilience in downturns—counteracting the higher volatility and cyclical nature of growth stocks. As a result, I position value stocks in my portfolios to help mitigate downturn risk.