US equities: Euphoria, fragility, and the search for clarity

US equities rally as market-friendly policies and AI boost optimism, but concerns about stretched valuations and concentration risks persist. How can investors reposition amid ongoing market fragility and uncertainty?

US equities have posted remarkable gains in recent months. The S&P 500’s three-month rally through July 31 ranks in the 96^th percentile since 1988, and the Russell 2000 Index has surged 35% from April 8 through September 2.¹

This performance has reignited concerns about valuation excess and concentration risk, particularly as macroeconomic uncertainty, geopolitical tensions, and fiscal ambiguity continue to loom large.

Markets continue to climb, despite risks

Investors now face a market that feels euphoric on the surface, but remains fragile underneath. And while the paradox of rising markets amid uncertainty is not new, today’s environment presents a unique blend of drivers boosting investor sentiment and captivating markets:

• The anticipated easing of monetary policy by the Federal Reserve has lowered discount rates 
• In Q2, 82% of S&P 500 companies beat earnings estimates, led by Tech, Financials, and Communication Services²
• Artificial intelligence continues to transform productivity and profitability
• Washington’s market-friendly policies—expanded small business deductions, 100% expensing for new investments, and tax relief on tips and overtime—seem likely to continue

And for good measure, the US will host the World Cup next year, where FIFA projects an economic output of $47 billion to the US and the creation of 185,000 event jobs.

Echoes from the dotcom era spark concerns

But this broad optimism is not without caveats. Valuations are stretched: the S&P 500’s forward price-to-earnings (PE) ratio stands at 22x, a 33% premium over its 30-year average of 17x.³ Market leadership is increasingly concentrated in a handful of stocks, with the weight of the top 10 constituents in the S&P 500 at a historically high 38%.⁴ And the S&P 500’s earnings yield currently sits at 3.4%, below the 4% yield on 3-month Treasury bills—a negative spread not seen since the dotcom bubble.⁵

Historically, such conditions have preceded periods of weak long-term returns.

Also, corporate earnings aren’t without risk. NVDIA, now the largest name in the S&P 500, currently accounts for 8% of the index. The company’s recent earnings report revealed that 88% of its Q2 revenue came from its data center business, and half of that was from large cloud service providers—other Mag 7 members.⁶ This significant interdependence raises the possibility of an AI-driven bubble, reminiscent of the dotcom era.

Readers of a certain age will recall that the dotcom bubble burst with the realization that not all technology companies were profitable. In fact, many had burned through cash and incurred heavy operating losses.

And today, the verdict’s still out on AI monetization. While it may be premature to forecast a repeat of 1999, the dotcom echoes are hard to ignore.

But the market’s not operating like it’s 1999

While some market conditions resemble the late 1990s, there are important structural differences:

• Individual investors have greater access to diversified products and platforms, and some have longer investment horizons and higher risk tolerance, which can help stabilize market behavior
• Global liquidity remains abundant after years of low interest rates
• Wealth concentration has freed up capital that is actively seeking investment opportunities

These factors suggest that while today’s market may be fragile, it’s supported by structural shifts that have occurred over the past two plus decades.

How should investors reposition portfolios?

Staying invested is critical because timing market peaks and troughs is nearly impossible. In fact, sitting out of the market on just the day after the worst 20 single-day declines for the S&P 500 since 1960 would cut an investor’s returns in half.⁷

So, how should investors respond to this challenging market? The answer depends on your goals, timelines, and risk tolerance.

• Institutional investors with a long-term investment horizon should not retreat, but rebalance and take profits when they align with investment objectives. It’s important to recognize that the market can appear expensive for extended periods of time—diminishing the efficacy of valuation-based metrics, particularly during periods of structural shifts like technological innovation and monetary easing. Striking a balance by diversifying across geographies, sectors, and styles is key.

• Individual investors with shorter-term horizons or immediate cash needs should consider diversifying beyond the 60/40 portfolio. Holding assets with offsetting risks, returns, and economic sensitivities—such as gold and defensive equities—can help position portfolios for potential geopolitical shocks and build resilience.

As a market defined by both euphoria and fragility continues to evolve, the clarity investors seek will come from the discipline to stay invested, rebalance with conviction, and diversify differently.