SpaceX’s initial public offering (IPO) on Friday dominated market news last week, but behind the scenes, the S&P 500 edged higher after the big drop on Friday, June 5. Could some more June choppiness be in store? Sure, but we do believe this bull market is still alive and well and the possibility of a surprise summer rally is still well in play.
Bad Days Happen
Friday, June 5, saw the S&P 500 fall 2.6%, the worst day of the year. Yes, it didn’t feel good, but after the historic nine-week rally, it would have been foolish not to expect some type of give-back at some point. Even the best years have bad days. In fact, in the 22 years that the S&P 500 gained at least 20%, the average worst one-day return was a loss of 3.5%. There was even a day in 1997 that saw the S&P 500 tank nearly 7%, yet the index still gained more than 30% that year.
Breadth Is Holding Up Well
Yes, technology has been taking a well-deserved break, but other areas and sectors are holding up quite well. In fact, on Tuesday, the S&P 500 fell, yet advancers outnumbered decliners by a 2-to-1 ratio, an extremely rare development.
We’ve been encouraged that the number of S&P 500 stocks above their 20-day, 50-day, and 200-day moving averages have all been increasing recently, even as overall market price has weakened. This is a clue that despite some index weakness, under the surface, things are doing well as flows are diverted from megacap stocks to a broader range of stocks that may be more representative of the overall economy.
What a Two-Month Rally
The S&P 500 soared in the two months following the late-March lows, so some weakness in June isn’t a big surprise. Here’s a nice way to show this.
Putting more context around this, the S&P 500 gained 19.5% in only two months off the late-March lows. This was one of the greatest two-month rallies in history, and previous large rallies were all quite bullish going forward.
We found only seven other times in history stocks gained more than 19% in two months, and incredibly, stocks were higher one, three, six, and 12 months later every single time, with a median return a year later of more than 30%.
Forget The 1990s, Here’s Why This Could Be Like the Late 1960s
With the huge run-up in AI-related stocks, the obvious comparison everyone makes is to the 1990s. However, beyond the fact that we have transformational technology in the works now, akin to the internet in the 1990s, there’s not a lot else these periods hold in common.
For one thing, real GDP growth averaged 4.5% from 1996 to 1999, whereas it has clocked in at an annualized pace of 2.5% from 2023 to 2026 (Q1), which is not too different from the 2010-19 trend when economic growth was lackluster. In fact, despite increasing proliferation of AI over the past year, real GDP growth has slowed from an annualized pace of 2.9% in 2023-24 to 1.9% over the past five quarters (2025 Q1-2026 Q1). At the same time, nominal GDP (which is what matters for company revenues and profits) looks very similar:
- Nominal GDP growth averaged 6.1% from 1996 to1999.
- Nominal GDP growth has averaged 5.5% from 2023 to 2026 (Q1).
Of course, the difference between nominal and real GDP growth is inflation, and that gets to a key difference between the current environment and the late 1990s: Inflation is running way hotter right now. The headline consumer price index (CPI) averaged about 2.3% from 1996 to 1999. We just got the latest inflation data for May, and headline CPI is up 4.2% from last year and running at an annualized pace of 8.2% over the past three months. These readings are well above anything we saw in the late 1990s.
Headline inflation is running hot in large part due to higher energy prices, but there’s heat in food prices and core services outside of housing as well. Core CPI is up 2.9% year-over-year and running at a 3.2% annualized over the past three months. Core CPI averaged just 2.3% from 1996-2000. The current pace of core inflation is well below what we saw in 2022, but as you can see in the chart below, it’s above the peak levels we saw in the late 1990s or even the 2000s expansion. Moreover, it’s trending higher now.
We also got a hot Producer Price Index reading for May, and combing the CPI/PPI data tells us that the Fed’s preferred inflation gauge, the Personal Consumption Expenditures Price Index (PCE) is also going to come in hot. In fact, core PCE is likely going to be hotter than even core CPI, with an estimated 3.5% year-over-year increase and a 4.0% annualized pace over the last three months.
Where’s the Productivity Boom?
The problem with elevated inflation is that it means inflation-adjusted income growth is weak. That’s not what you’d expect if productivity growth is running strong, which is what the narrative around AI is. If productivity growth is strong, you should see living standards rise amid strong real wage growth, which is what we’ve seen historically:
- 1996-2004: Productivity growth averaged 3.1% annually, while real wages grew 2.1% a year.
- 2023-24: Productivity growth averaged 2.9% annually, while real wage growth grew 2.1% a year.
On the other hand, periods of weak productivity growth have coincided with weak real income growth:
- 1973-82: Productivity growth averaged just 1.0%, and real wage growth grew just 0.6% annually amid high inflation in the 1970s.
- 1983-95: Productivity growth clocked in around 1.8% annually, but real wage growth picked up to just 0.8% a year.
- 2005-19: Another period when you had lackluster economic growth, with productivity growth clocking in at 1.6% and real wage growth growing 0.7% annually.
- 2020-22: Productivity growth averaged 1.5%, not too different from the prior decade-and-a-half trend, but strong nominal wage growth was almost entirely eaten up by inflation, and so real wages grew just 0.4% annually.
The last five quarters have been interesting from two angles:
- Productivity growth has averaged 2.1%, which is above the 2005-22 trend but a step down from the 2023-24 pace of 2.9% (contrary to the AI narrative).
- Despite above-trend productivity growth, real wage growth has been weak amid elevated inflation (about a 1.0% annualized pace).
Time to bring in some national accounting math. Productivity growth is essentially the sum of real wage growth and margin expansion. Margin expansion is essentially the opposite of the change in labor share—or, more simply put, if margins are expanding, then labor share of national income is falling (and vice versa). We’ve always seen some margin expansion, including periods when productivity growth ran strong (1996-2004 and 2023-24). However, margin expansion has run especially strong over the past five quarters, and that’s good for stocks. But one company’s margin expansion is someone else’s inflation, and thanks to elevated inflation, real wage growth is weak.
Could this continue? It’s hard to say, because we really haven’t seen a situation like this in recent history. Over the short term, productivity growth is likely to run strong with all the AI-related capex spending, and that’s going to keep profit margins strong. But by the same token, we’re also likely to see elevated inflation and weak real wage growth.
How This Cycle Could End: The 1960s Analogy
One thing that could end this current expansion is the Fed, and from that perspective, we do have a historical analogy: the late 1960s. We wrote about this in our 2026 Outlook. The policy picture leading into 1967-68 was similar to now. Thanks to Great Society programs (Medicare, Medicaid, education, anti-poverty, and housing programs), fiscal deficits were running high, around 2.0% to 2.5% of GDP. (Seems laughably low compared to the current level of 6.5%.) There are even some innovation parallels. The largest publicly traded companies then? Tech innovation giants IBM and Bell Telephone. More importantly, the Fed cut rates by almost 2 percentage points between the end of 1966 and mid-1967, believing they had squelched inflation.
But they had not, and inflation picked up over the next two years, rising from a low of 2% to almost 6%. The Fed kept chasing inflation higher, raising rates all the way from 3.5% to 7.9% across 1968 and 1969, slowing the economy in the process (the recession began in December 1969). The S&P 500 had rallied about 50% through November 1968 from the prior bear market low in October 1966. But a hawkish Fed that was trying to get a handle on inflation sent the index down by 37% from November 1968 through May 1970 — an 18-month bear market that saw the S&P 500 fall back to where it was in 1963! Bonds didn’t fare well during this period either, as rates were rising.
We’re not saying the expansion will end in 2026. We think the Fed will remain dovish under new Chair Kevin Warsh and will simply stand pat on rates this year. But there’s the risk of higher inflation volatility, even more so if the Fed remains accommodative and then has to correct for that as the 2020s draw to a close.
For now, we ride the wave of a hot economy (in nominal terms) and momentum-driven markets. But we’re increasingly careful about portfolio construction, and look to be as diversified as possible, as we want to avoid a possible wipeout down the road.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly traded companies from most sectors in the global economy, the major exception being financial services.
The views stated in this letter are not necessarily the opinion of Cetera Wealth Services LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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