Markets and Economy Why market volatility may be part of the bull case

Secular bull markets don’t move in a straight line. In fact, some of the most powerful advances in market history have included periods of doubt, disappointment, and drawdowns that ultimately served to reset and extend the cycle. The recent experience of the so-called Magnificent 7 is a good example.¹ Since the start of 2024, the group has delivered extraordinary returns while enduring several significant setbacks along the way.² There was the selloff surrounding Liberation Day, the market reaction to conflict in the Middle East, and the more recent momentum-driven pullback fueled by concerns over the return on massive artificial intelligence (AI) investments. Yet despite these episodes of volatility, the pattern remained remarkably consistent. The highs continued to get higher, and the lows continued to get higher. That’s not only for the Magnificent 7 stocks but for the S&P 500 as well.³ That’s what a bull market has often looked like.

Insight from past tech cycles

Most transformative technological cycles eventually generated new reasons for skepticism. Early enthusiasm gave way to questions about valuation, profitability, and whether expectations had run too far ahead of reality. AI is proving no different. Last week, Alphabet reported strong quarterly results highlighted by healthy cloud growth, resilient search demand, and robust advertising revenues on YouTube.⁴ Under normal circumstances, those results might have been enough to drive the stock meaningfully higher. Instead, many investors remained focused on capital spending and the timeline for realizing returns on those investments. That skepticism is understandable. But rising anxiety doesn’t necessarily mean the investment thesis has deteriorated. Often, it reflects a market attempting to reconcile long-term opportunity with short-term expectations.

The bears continued to warn about speculative excesses, overvalued markets, persistent inflation, and geopolitical uncertainty. Those concerns deserve consideration. However, the broader market data has painted a more balanced picture. Consider that the S&P 500 price/earnings-to-growth (PEG) ratio, which measures valuation relative to expected earnings growth, currently sits near 1.27x compared to a 20-year average of 1.78x.⁵ Meanwhile, the index has traded roughly 6.1% above its 200-day moving average.⁶ Over the past two decades, the average premium has been approximately 5.1%.⁷ In other words, valuations and market positioning appeared far less stretched than many headlines suggest.

Some challenges

Of course, the macro backdrop presents challenges. The expanding conflict in the Middle East, higher energy prices,⁸ and rising bond yields⁹ are developments investors would prefer not to see. So, in the near term, markets may need to adjust to this reality. Yet several important considerations remain. First, the share of disposable personal income spent on gasoline by US consumers remained low by historical standards.¹⁰ As we observed earlier this year, higher fuel prices can slow economic activity,¹¹ but that’s very different from causing an economic collapse. Second, financial markets have already absorbed a meaningful repricing of monetary policy expectations.¹² Investors moved from anticipating multiple rate cuts to contemplating the possibility of rate hikes. Yet credit markets remained orderly throughout the adjustment.¹³ My own view remains that the Federal Reserve is likely on hold. Third, inflation expectations over the next five years remained near 2.3%¹⁴ a level that should be consistent with price stability. Finally, geopolitical developments can shift rapidly. A ceasefire can emerge just as quickly as it disappears.

Structural bull market

In the end, this looks less like a structural shift in markets and more like a market grappling with higher expectations for the AI opportunity alongside rising macroeconomic anxiety. Periodic corrections and investor skepticism aren’t signs that the secular story is broken. They are often part of the process. The structural bull market remained intact, in my view, supported by an investment theme that’s likely still in its early innings and an economy that continued to demonstrate resilience despite a growing list of concerns.