A Strong First Half and a Cautious Summer Outlook
The first half of the year delivered a series of impressive milestones across the equity markets. The Russell 2000 recorded its best first six months since the early 1990s, and the Dow posted its strongest first-half performance since 2021. Yet the strength of that rally does not mean the path forward is without hazards, and the composition of the market is changing beneath the surface.
The single greatest concern heading into the summer is the semiconductor space. Semis have become dangerously over-owned and highly concentrated, and volatility in the group has spiked considerably. A sharp rise in volatility of this kind is frequently a warning sign that some larger change is coming. In response, a healthy and constructive dynamic is now underway: the market is broadening out. Rather than a handful of mega-cap technology names carrying the indexes, gains are spreading across a wider range of sectors.
Repositioning Portfolios for the Broadening
Acting on this view, I have already begun making tactical adjustments. At the start of the month I trimmed technology exposure — justified by the enormous run tech has enjoyed — and rotated the proceeds into healthcare. I also reduced holdings in the standard, market-cap-weighted S&P 500 and moved that money into the equal-weight S&P. That shift has been rewarded: the equal-weight index has outperformed the SPY over the last five-plus weeks. This is the mechanical signature of a broadening rally — when the market broadens out, the area that gets sold is precisely the one that is most heavily owned, which right now is big tech and semiconductors.
Several forces point toward a volatile summer. The Fed may tighten monetary policy, and certain areas of the market are simply too crowded. As a result, I expect a spike in volatility during the summer months. Rather than something to fear, this should create better opportunities to "re-gross up" — to rebuild technology exposure — sometime around August, at more attractive prices.
The near-term caution does not change the longer-term conviction. By year end I expect the market to rip again and make new highs; I am bullish for year end in a big way. The current posture is simply a short-term tactical decision to be more defensive: underweight semiconductors, and within technology, favoring software over semis. Software already went through a fairly sizable correction, so it carries less downside risk than the semiconductor names that have run so far.
Inflation and Rates Have Already Peaked
A central pillar of this outlook is the belief that both inflation and long-term interest rates have already peaked. If that is correct, then investors — who spent the entire first half of the year worrying that inflation would keep climbing and fretting about rates and the yield curve — may now be underestimating just how strong the macroeconomic backdrop truly is.
The evidence sits in the bond market. The long end of the yield curve has been coming down. A useful corroborating proxy is housing: housing stocks, housing-related ETFs, and homebuilder names have started to come back to life, which is typically very bullish for the direction of rates. My expectation is that over the next 12 to 18 months, long-end rates will continue to decline, because inflation is set to cool over the next 6 to 12 months.
Oil is the clearest tell. Crude sits well below its highs — down more than 30 percent. As the year-over-year comparisons roll forward month after month, that decline should mechanically produce deceleration in inflation readings. Inflation remains sticky, but crucially there is no acceleration. The bond market is signaling exactly this, and the bond market is smarter than any individual forecaster. Its message — that the rate of change of inflation is heading down — is deeply bullish for the broad market. This is also why economically sensitive areas are catching a bid as the rally broadens. The bull market itself is very strong; there are simply certain pockets that will have to navigate through corrections along the way.
The Housing Market and the New Normal
Housing deserves more attention than it is currently receiving amid the fixation on the AI boom. Mortgage rates remain very elevated, which raises a fair question: if rates come down only modestly, will that small drop be enough to revive the housing sector, given a genuine affordability crisis? The average cost of a home continues to rise every quarter, and many buyers are simply priced out.
My answer is that buyers will have to adjust to the reality that today's higher rates are the new norm. Buyer psychology is the key variable. When people are confronted with war, volatile oil prices, and a steady stream of frightening headlines, they freeze and refuse to commit to a purchase. But now that oil markets have shown some stability, yields have begun to come down, and the economy has stayed strong, buyers should regain the confidence to move forward.
Because markets are forward-looking, the current signal is that roughly six months out, the housing market should begin to pick up meaningfully again. Housing has struggled for a long stretch, but the pendulum now looks set to swing back in the other direction — provided the calls on inflation and rates prove correct.
Healthcare: An Under-Owned Beneficiary of Two Tailwinds
Healthcare is the other sector I find compelling. It has lagged the broader market throughout the AI-driven rally, yet a growing chorus of observers flags it as a major beneficiary of AI. The reason it has not yet performed is straightforward: investing should be based on where asset prices are going, not on where they have been over the trailing twelve months. Healthcare has been a big underperformer, but the sector has a strong tendency to do well precisely when the market broadens out or when concerns about Fed tightening and volatility spikes emerge — exactly the environment now taking shape. Over the last few weeks, healthcare has genuinely started to catch a bid.
The healthcare thesis rests on two tailwinds, not one. Yes, the sector will benefit from AI. But it will also benefit from the macro cycle we are entering. That combination makes it an excellent way to broaden a portfolio, because it performs well under either scenario: if the market stays strong, healthcare will do well; and if the market gets a scare, healthcare will hold up far better than the technology trade. For that reason, a portion of the money sold out of technology was rolled directly into healthcare names.
The positioning is being expressed three ways. The first is the XLV, the healthcare sector ETF. The second is UnitedHealth Group. The third is Eli Lilly. These represent the best of breed in the space. I intend to broaden that exposure even further if healthcare continues to post higher highs and demonstrate strength, because it remains a very under-owned area. In markets, when an under-owned sector begins to turn bullish, a great deal of money tends to chase it. The goal is to be positioned before that money arrives — which is why the healthcare buying began at the start of last month.
Key Questions Answered
How does the rest of the summer and back half of the year look after such a strong first half? The summer should bring a spike in volatility, driven largely by over-owned semiconductors and possible Fed tightening, creating a chance to add back tech exposure around August. By year end the market should rally to new highs — a strongly bullish outlook — even as the near-term stance turns tactically defensive with an underweight in semis and a preference for software.
Are investors underestimating how strong the macro backdrop is? Yes. After spending the first half worrying about rising inflation and rates, investors are overlooking that the long end of the curve is falling and housing is reviving — both bullish signals that inflation and rates have peaked.
Will a small drop in mortgage rates be enough for housing, given the affordability crisis, or must people accept higher rates as the new norm? Buyers will have to adjust to higher rates as the new norm, but returning confidence — from stable oil, falling yields, and a strong economy — should reignite the housing market roughly six months out.
Why hasn't healthcare's AI benefit shown up yet, and where are the opportunities? Healthcare has lagged simply because prices reflect the past, not the future; it is poised to gain from both AI and the coming macro cycle. The favored plays are the XLV ETF, UnitedHealth Group, and Eli Lilly, with room to expand as strength persists.
