PCBT's Focus on Finance panel looks at market volatility and potential stress points

May 31, 2023

Q1: We’ve seen records in key indexes and then dramatic pullbacks. Is there a single indicator or benchmark that you’re watching to gauge the health of the market?

Lloyd and Tom: Indicators that have proven their value over time are pointing in different directions this year, prompting us to hold broadly diversified portfolios, with neutral weights of stocks vs. bonds. The positive story for the U.S. equity market rests on monetary policy: The Fed is still in easing mode – futures are pricing in one or two more interest rate cuts this year — and that is usually a good setting for stocks. A recent study found that in years where the Fed was easing and economic growth was above trend (the current forecast for 2026), the U.S. stock market almost invariably saw strong performance. The concern is that investors must pay up for this opportunity. While valuation has not been a good guide for short-term trading, studies show that longer-term stock market returns are usually subpar when starting valuations are extended. That’s the case now: the S&P 500 trades at 24x earnings, an unusually high figure. Fancier indicators tell the same story, e.g., Robert Shiller’s Cyclically Adjusted Price/Earnings ratio is now at a level that was only surpassed in the 1990’s tech bubble. What might break the impasse? An exogenous event, such as the war against Iran that began last week, certainly increases the risks. The price of Brent crude oil was 60 in early January and has risen to 100. This could increase price pressures and slow economic growth around the world. The Vix index, which measures the level of concern in options markets, has nearly doubled since the start of the year. If we had to pick a single indicator for overall market health, we would focus on the 10-year U.S. Treasury bond yield. As of today, U.S. bonds are finding buyers and the rate paid (4.1% at this writing) has been stable recently and is consistent with our fundamental situation. But the combination of demographic pressure on social programs and fast-growing military expenses means that we cannot take this for granted. The government will have to work very hard to get its budget house in order over the next few years. If it is done badly, investors will pay the price.

Q3: AI seems to be driving much of the momentum. Is it time to look elsewhere — small caps, international for equity investments?

Lloyd and Tom: Tensions and conflict are on the rise around the world. We believe a broadly diversified portfolio is the best defense during times of stress. We began adding to international stocks (both developed and emerging markets) in 2022 and 2023. They outperformed significantly in 2025 as tariff concerns, a weaker dollar, and favorable valuations worked in their favor. As 2026 gets underway, the technology stocks have underperformed after several years of market-leading returns. Concerns about the impact of AI on the job market, potential obsolescence for software and other companies, and stretched valuations have taken their toll. Value stocks have performed well, particularly in the Energy sector. With credit quality issues cropping up with increasing frequency, we continue to emphasize quality in both equities and fixed income. The artificial intelligence boom has had a significant stock market impact, but we are also seeing its effects in the real economy. The largest investors in AI (the “hyperscalers”) are expected to spend $670 billion in 2026, almost triple the $240 billion spent in 2024. Utilities are expected to spend another $1.1 trillion over the next five years as they race to increase capacity to meet AI-driven demand. It will be years before we know if these investments will pay off.

To see more of the article please click here