July Wrap Up - Too much, too soon, too concentrated?

The US share market has risen by over 27% to an all-time high since its post-liberation day, tariff induced sell-off. Markets outside the US, as measured by the MSCI EAFE Index in local currency terms, are also back to all-time highs. Artificial intelligence related stocks are soaring in price, the percentage of the share market made up of the very biggest tech names has blown past previous peaks and investor enthusiasm is fizzing. What's not to like? While we remain constructive on markets and while we believe the AI megatrend will drive significant shareholder value creation, we are conscious that prices may have rallied ahead of underlying fundamentals. They look stretched. Measured caution, finding smart ways to play the AI theme and identifying reasonably priced assets are the cornerstones of how we are managing portfolios in this environment.

The share market has had an incredible run since the major sell-off we had in April this year. The US S&P 500 share market index is up over 27% from its 8 April lows, hitting new all-time highs. Shares in the rest of the world have been hitting all-time highs as well. 

Below the surface, the price action has been even more wild. According to a recent report from respected investment firm GMO: "The most speculative sectors didn't just climb the 'wall of worry' - they catapulted over it. Unprofitable tech, meme stocks, and bitcoin-sensitive stocks surged approximately 55-115% in just fifteen weeks." 

It has been a retail investor led party focused on the most speculative stocks - those least anchored to fundamentals.

As a long-term investor, we are entirely informed by fundamentals, focused on the things that ultimately set long-term asset prices.

For share prices, three things matter in the long run:

1. How much companies earn - Here we focus on free cash flow, the dollars left over for investors once a firm's bills are paid and any capital investments made.
2. Interest rate levels - All other things being equal, higher interest rates equal lower share prices and vice versa.
3. Share market valuation - The equity risk premium. This is the extra return that investors demand for taking the risk of being invested in shares.

Let's step through each of those.

US companies are in the process of reporting second quarter earnings right now. It has been a solid earnings season with some notable wins; Microsoft and Meta's results were absolute standouts. According to data from financial information provider FactSet: "The year-over-year earnings growth rate for Q2 2025 is 10.3%, which is below the 5-year average earnings growth rate of 12.7% but above the 10-year average earnings growth rate of 9.2%. If 10.3% is the actual growth rate for the quarter (once all results are in), it will mark the third consecutive quarter of double-digit earnings growth."

In short, earnings from US companies are solid, albeit not particularly surprising on the upside versus previous expectations and somewhat scattered, with some industries performing really well. Others, like energy, are less strong. Earnings results do not seem to explain the mania in share prices since 8 April lows. 

US interest rates - we tend to focus on 10-year government bonds - are largely unchanged since early April. That doesn't explain the market rally.

That leaves the equity risk premium. Changes in investors' perception of risk seem to be the key reason for the market's remarkable rally. This is somewhat justified. The excessive tariff risk of early April seems to have dissipated (although policy variability is ever present!), inflation has been reasonably well behaved and macroeconomic data generally supportive. This seems to have lit up market confidence. GMO says it well: "Animal spirits are roaring, and strong momentum has pushed both valuations and signs of speculation to risky levels."

Herein lies our concern. The inflation risk from tariffs has yet to be fully worked through the system in our view. Macroeconomic data is softening, investors are over-enthusiastic, never a great sign, and valuations are now at extreme levels. Caution is warranted.

Our portfolio strategy with that backdrop is all about finding reasonably priced assets, supported by long-term mega forces that haven't been caught up in the mania. Two key positions in our portfolio are worth highlighting. 

Our exposure to emerging markets in portfolios benefits from owning companies that are more reasonably priced than the bubbly sectors of the developed markets. These investments are underpinned by strong demographics, a key mega force identified by BlackRock, and the strong economic growth outlook of these countries.

Similarly, our investment in global infrastructure gives the portfolio exposure to sectors like electricity generation and telecommunications, as well as transport infrastructure. Companies in this strategy include the likes of NextEra Energy and Duke Energy, which in addition to general electricity supply, both provide electricity to the data centres driving the AI revolution. This is a smart way for the portfolio to benefit from mega forces like AI and the green energy transition at a much more reasonable price than the 'flavour of the day' stocks that have driven the market since the 8 April lows.