Approaching a 'Humility at the Highs' moment?

As regular readers know, I don't like taking profits in secular bull markets. That’s certainly been the right call for the last 18 months, and our patience has been handsomely rewarded. However, the recent market action, especially as we head into possible summer storms and the earnings season, suggests a little humility is now in order. So earlier this week, we cut our equity overweight from 500 basis points to 300 in our moderate-risk-balanced allocation PRISM^® models. Those cuts came out of large-cap growth and international equities, up 47% and 23%, respectively, since the adds we made there last year. 

This move diminishes but does not reverse our overall bullish stance. We’re maintaining our 6,000 target on the S&P 500 for late 2025. Although that target is now only 7% away, we are keeping all our remaining equity overweights in large-cap value, small-cap growth and emerging markets. We expect these areas will outperform the S&P from here, as they benefit from the “broadening out” theme we’ve been discussing in our recent market memos (see The good news and the bad as we return to normal, for example).

We put the proceeds from our large-cap growth and international trims into money markets. Yields there remain high, and the liquidity will give us the opportunity to reload should a significant correction unfold.

Here are our reasons:

1. The Magnificent Seven run-up in the second quarter (16.9%) seems stretched, even given their solid fundamentals. Ditto for the broader large-cap growth space. With the Mag 7 trading at 41x blended forward earnings and the Russell 1000 Growth Index at 30x, we see these stocks as vulnerable in the back half of the year, absent an accelerating rate of earnings growth. This is nearly mathematically impossible now, and any whiff in the coming earnings season that AI spending is not accelerating off the last several record quarters could hit these stocks hard.
2. EAFE seems increasingly vulnerable to back-half political developments. The French elections leave a big hole in the center of European fiscal policy, and the policy agenda of the new government is broadly Euro bearish. The rising probability of a Trump presidency, while positive for our domestic value and domestic small-cap overweight (see market memo, From here on, the election will matter), would likely not be as positive for Europe. Further, EAFE has a disproportionate dependence on emerging market economies, in which we are already overweight.
3. Our more modest stock overweight of 300 basis points is entirely in large-cap value, small-cap growth and emerging markets. In all three cases, we anticipate the outsized relative earnings growth deficits versus the large-cap growth stocks to close substantially in the coming months. We also expect a muted, though helpful, Federal Reserve rate-cut cycle to begin soon, September or December. And an increasingly likely Trump win would be disproportionately helpful to value and small-cap companies due to expected lower regulatory costs and taxes. All of this against a backdrop of historically cheap relative valuations in these stocks. These factors would probably limit downside risk in these names should a correction unfold, while also offering more upside if the bull keeps charging forward. We’ll see.

One of my biggest lessons in portfolio management over the last 40 years is "Humility at the highs, confidence at the lows, integrity always." Of these three, only integrity is relatively straightforward to measure and to keep on track. But after an historic 9-month, 50% run-up, I am pretty sure we are not at a low. Showing a little humility here by cutting back somewhat our sizable commitment to equities seems prudent. After all, it is summer. Thunderstorm season.