The S&P 500 fell all five days last week, losing nearly 2%, and is currently down seven of the past eight days. After a historic 15% gain in April and May, June has been weak, which isn’t a total surprise. In fact, the current 3% loss for the month isn’t all that bad, especially when you look under the surface.
It isn’t called the June swoon for nothing, and right on cue in 2026, we’ve seen weakness during this historically challenging period. As you can see below, the second half of June is when trouble tends to come. The good news is we are nearing the end of this seasonal weakness.
Rotation Is Happening
Even though the S&P 500 fell close to 2% last week, this was mainly due to large cap tech falling, with other sectors higher. In fact, the Magnificent 7 (seven well known tech-oriented megacap stocks) fell nearly 6% while the other 493 stocks were virtually flat on the week. Influential sectors like financials and industrials were up slightly while healthcare had a huge week, up nearly 8%.
If this was a true risk-off environment, we’d expect to see broader-based weakness. Instead, we are seeing rotation out of tech and into other areas. Looking under the surface shows that the number of stocks in the S&P 500 above their 20-day, 50-day, and 200-day moving averages continues to trend higher. Again, this is a clue that under the surface things are going ok. In fact, more than 65% of S&P 500 stocks are above their 200-day moving average, the most since early March.
July Is Here
Well, can you believe the year is about half over? We will dive more into our Outlook for the rest of 2026 over the coming weeks, but for now, just be aware that July is one of the best months of the year.
No, some of the weakness in June hasn’t been fun, but sometimes that is necessary to flush some of the weak hands before a July rally. We’ve been on record saying this surprise summer rally isn’t quite over yet, and we think a strong earnings season could be another driver for a rally in July.
July has been the best month on average for the past 20 years and overall ranks as the fourth best since 1950 (with only November, April, and December better). The past 10 years, July ranks as the second-best month (to November), and in a midterm year, it is the third best.
How We’re Learning to Stop Worrying and Love the Bubble
There, we said it, the word “bubble.” To be honest, we don’t know if we’re already in the middle of a bubble, and certainly not when it might burst if we are. But we do believe we’ll look back on this period several years from now and recognize it as part of an expanding bubble. Just remember, from a market perspective an early bubble is a great place to be and mid-bubble is still usually very good. Also bubbles often last much longer than people think, although they can also transition from middle to late to popping quickly. The point is, using the “b” word doesn’t mean run and hide. But it’s a good time to raise situational awareness if you can do it without starting to jump at shadows, and that’s what we aim to do.
There’s clearly something huge happening right now with AI. AI is increasingly setting up a potentially significant technological transformation for the economy and is already having a huge impact on markets. On the markets front, AI is clearly on a massive run. Here’s a comparison of a basket of AI stocks versus the S&P 500 and S&P 500 excluding AI-related stocks. Since 2023, shortly after ChatGPT was released, AI-related stocks have raced ahead of everything else.
From January 1, 2023 through June 23, 2026:
- Broad AI (the Goldman Sachs US Broad AI Index): +458%
- S&P 500: +101%
- S&P 500 ex AI (Goldman Sachs S&P 500 ex AI Enablers Index): +38%
These sorts of return differentials raise bubble concerns. Valuations tend to be the more popular indicator of a bubble, but valuations can remain stretched for a long time. The CAPE ratio (cyclically adjusted P/E ratio, with earnings averaged over the prior 10 years) is currently at 41, more than three standard deviations above its long-term average of 18 (since 1880). At the same time, it’s been above two standard deviations for over two years now and above the one standard deviation level for over a decade.
At the same time, if you look at P/E ratios using next 12-month earnings per share (EPS), the current level of 20.9x is just one standard deviation above its average level (1995–2025). That’s far from the stretched levels we see when looking at the CAPE ratio.
This is a result of corporate profits growing well above their long-term trend, and analysts projecting strong growth ahead as a result. Next 12-month EPS estimates are going almost vertical.
The S&P 500 has doubled since the end of 2022 (+101% return), and only 26 percentage points of that can be attributed to multiple expansion (valuations becoming more expensive). Profit growth contributed 66 percentage points, while dividends added almost 10 percentage points to the total return. Incredibly, this is not just a story of sales growth. Profit growth was almost equally split between sales growth (+35 percentage points) and margin expansion (+31 percentage points).
Bubble Watch: Extreme Price Dispersion
Rather than focus on valuations, which depend on the kind of measure you’re looking at, we lean toward looking at price-based measures for potential signs of a bubble. And even economic data. And right now, several numbers look quite stretched.
One thing you see during bubbles is momentum outperforming the broad index by a lot. The S&P 500 Momentum Index is up 30% YTD versus an 8.2% return for the S&P 500 (as of June 23). No surprise, this is on the back of AI-related exposure, with technology making up almost 55% of the momentum basket. The top five names have all outperformed the S&P 500 this year and make up almost 40% of the basket.
Here’s a historical perspective as to how strong momentum is. We compared the current excess return for the S&P 500 Momentum Index relative to the S&P 500 and looked at the percentile rank relative to the last 40 years, both on a 1-year rolling basis, and 3-years.
Over the last year:
- S&P 500 Momentum: +37.2%
- S&P 500: +19.3%
- Excess return: +17.9%
- Percentile rank: 94th
It’s even more extended if you look at the last three years:
- S&P 500 Momentum: +40.1% (annualized)
- S&P 500: +18.5%
- Excess return: +21.6%
- Percentile rank: 99th
That’s as extreme as it gets and almost as high as it got back in March 2000 (the peak of the dot-com bubble). Of course, it could go further (and remain in the 99th–100th percentile), but usually a pullback beckons.
Along these lines, dispersion across stocks has also surged since April. Looking at some research from Acadian, the following table shows the five highest dispersion months from 1995 to 2026 (May). April/May 2026 were extraordinary, ranking below only December 1999 and February 2000. Today’s high dispersion does not merely reflect the market’s high concentration into a small number of names. We’ve had high concentration for several years now. But the high dispersion is new.
Of course, this is in large part because of the AI story playing out in places like South Korea and Taiwan as well.
- The MSCI South Korea Index is up 112% YTD and up 127% in local currency terms, driven by large semiconductor manufacturers.
- The MSCI Taiwan Index is up 68% YTD and up 69% in local currency terms, driven by a major semiconductor manufacturer.
All this to say, be careful using international stocks to diversify AI exposure.
Equity Supply Is Rising
Another thing you see during bubbles is a lot of equity supply. Over the past couple of decades, helped by low rates, corporations were mostly reducing the supply of stocks with stock buybacks. That’s flipped as of Q1 2026, with net issuance turning positive—and that’s likely to continue into Q2 and the rest of the year, especially in a year with several huge, high-profile IPOs. This is the first time since Q1 2021 that net issuance has turned positive, and we saw a similar net supply increase back in Q1 2000.
The Secret to Investing in AI May Be to Diversify
We wrote about riding the AI wave in our 2026 Market Outlook, focusing on overweighting equities and taking advantage of momentum. But we also discussed avoiding a wipeout with appropriate diversification. That’s obviously easier said than done right now, as AI is flowing to almost every corner of the market.
Even “Value” Is Tied to AI
You would think AI is a “growth” story. But if you look at more popular baskets of “value” stocks, whether the traditional style box definition of value or a factor-based approach, they aren’t really lagging the S&P 500 by a significant amount. In some cases, they’re doing much better. Hear are some year-to-date total returns as of June 23, 2026:
- S&P 500 Value ETF (SPYV): +7.5%
- iShares Russell 1000 Value ETF (IWD): +15.4%
- iShares MSCI USA Value Factor (VLUE): +45.3%
- S&P 500: +8.2%
Well, a big reason for this is that these baskets also have significant exposure to AI-related stocks.
- The largest sector within the S&P 500 Value ETF (SPYV) is technology (21%).
- The Russell 1000 Value ETF (IWD) also includes some well-known technology names.
- Meanwhile, the factor-based value ETF (VLUE) has a 25% weight in a single major manufacturer of memory chips.
Maybe value is still “value.” But to be clear, it’s also become an AI play, emphasis on “also.” Your traditional “growth” baskets are not the only place to find AI-related exposure, which also means the traditional “value” baskets are not quite as diversifying to AI-related stocks as one may think.
Prepare for Rotation, but Rotation Could Mean the End Is Here
Another way to think about diversifying away from AI is to look at areas of the market that are not correlated with AI. For a couple of years now, we’ve discussed barbelling some of our momentum exposure with low volatility. Yes, that’s done worse than just solely betting on momentum, but the more momentum keeps rising, the more comfortable we are with low-volatility stocks. If everything in your portfolio is outperforming, that probably means you’re not diversified enough.
Another approach is to look at sectors, but you have to be careful here, as several sectors have closer ties to AI than you would think. We looked at the correlation of constituent names within all 11 sectors with the technology sector since March 31 (when technology stocks surged) and added up the total weight of individual names within each sector that had a significant correlation to tech (over 0.3).
Beyond the obvious suspects like consumer discretionary and communication services, sectors like industrials and materials also have a significant proportion of companies that have a relatively high correlation with technology. For example, for industrials, over 40% of the sector has a 0.3 correlation with technology and over 30% have a 0.4 correlation. On the other hand, sectors like healthcare and consumer staples have barely any weight with a significant correlation with technology.
At the same time, if we do see sustained rotation from AI-related companies (and sectors) to other parts of the market, say for over 6–12 months, that probably means the AI trade is over. The bubble has likely been popped. This is essentially what happened in 2000, after the dot-com bubble bust.
We looked at returns from the end of 1997 through March 2003 (the bottom) for all the sectors, as well as the momentum and low volatility factors (long only). We separated this into three periods:
- January 1998–March 2000 (the bubble)
- April 2000–December 2000 (rotation)
- January 2001–March 2003 (the crash)
Some highlights:
- No surprise, technology and momentum saw huge returns during the bubble and then collapsed after that. Tech-adjacent sectors like communication services (which includes telecom) and consumer discretionary also gained a lot.
- Sectors outside of the top three tech-adjacent sectors had reasonably solid returns during the “bubble,” so there was breadth. Staples was the only sector with a negative return. The low volatility factor was also negative.
- April 2000 through December 2000 saw a lot of rotation, with the three tech-adjacent sectors and momentum collapsing, while most other sectors and low volatility gained.
- The crash (January 2001–March 2003) saw every sector hit quite hard, with tech and momentum taking the hardest blow.
- Over the full period, what’s interesting is that healthcare, energy, financials, and even consumer discretionary had positive returns. Momentum was also positive despite steep drawdowns, though low volatility outperformed over the 5+ years, as did a simple average of healthcare, financials, and energy sectors.
As we noted at the top, we have no idea what stage of the bubble we are in, nor when it will pop. But instead of worrying about it, we feel increasingly comfortable judiciously diversifying outside of AI, despite the opportunity cost of missing out on large gains by going all in. Right now, the main way we’ve been doing that is through low-volatility stocks, a contrarian allocation to the healthcare sector, and staying internationally diversified. At the same time, we still have plenty of exposure to technology stocks and the momentum factor. In a way, it’s an admission that we can’t perfectly (or even near-perfectly) time the top, and “get out in time, before everyone else.” Good luck with that. Instead, the more we see momentum run, the more diversified we’ll try to get, which is our way of riding the wave but trying to avoid a wipeout on the other side of it all.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly traded companies from most sectors in the global economy, the major exception being financial services.
The views stated in this letter are not necessarily the opinion of Cetera Wealth Services LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. This information is from sources believed to be reliable, but Cetera Wealth Services, LLC cannot guarantee or represent that it is accurate or complete.
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