Is It Time For Less Drama in Your Portfolio?

Analyzing the Growth Scare: What Investors Should Know

Markets have experienced volatility resulting from the Trump administration’s tariffs and the Department of Government Efficiency’s (DOGE’s) pruning of the federal government. Recent actions by the administration have slowed economic growth expectations and may contribute to a growth scare, which occurs when investors worry that weakness in one area of the market will spread to others.

The current scare comes after U.S. stocks climbed more than 25% in each of the last two calendar years. Enthusiasm for artificial intelligence (AI) and stocks benefiting from a momentum tailwind helped drive market gains in 2023 and 2024. Going into 2025, the S&P 500^® Index had earnings metrics and high prices similar to those present during the tech bubble of the late 1990s and early 2000s.

As the pace of growth in AI-related spending slows and the earnings growth of the Magnificent Seven decelerates from a scorching hot 30% year-over-year rate, we anticipate that investment will begin to flow to other areas of the market. This could include overlooked asset classes such as non-U.S. stocks and value-related industries like consumer staples and health care.

Is It Time to Consider Overlooked Asset Classes?

The possibility of European fiscal stimulus has provided a spark to performance this year for European stocks, which have lagged in recent years. Given the valuation disparity between U.S. and non-U.S. equities, we think capital could continue to flow to European equities.

Within the U.S., small- and mid-cap stocks have significantly underperformed large-cap stocks for the last two years. Similarly, value stocks, dividend-payers and stocks less sensitive to market movements have lagged over the same period. These smaller and less volatile companies may present compelling opportunities, particularly when large companies are highly valued and decelerating.

Investors Are Becoming More Price-Sensitive

Recent market turmoil has already caused capital to flow to value, low-volatility and dividend stocks. We believe that this rotation could be long-lasting. Historically, when valuations for the S&P 500 reach extremely elevated levels, as they were at the end of 2024, price returns over the subsequent five to 10 years tend to be negative. We believe that environments like these can result in indices that track value stocks delivering strong returns.

We think of it this way: If a company’s stock price is already high relative to its profitability, investors are reluctant to bid the price even higher. Therefore, when a broad swath of the market is overpriced, we think less expensive value and dividend-paying stocks present opportunities. Currently, we think such stocks trade at attractive prices.

Certainly, near-term fears about slowing growth and a potential recession have spurred volatility for small- and mid-cap stocks due to their sensitivity to economic conditions. However, investors looking out further than three to six months may find an opportunity to consider these overlooked asset classes while the market is choppy.

But small- and mid-cap stocks have more going for them than what we see as attractive valuations. They could benefit from unique growth drivers such as deregulation, reshoring and the potential acceleration of mergers and acquisitions. As a result, we see potential for their earnings to improve this year, regardless of the economic backdrop.

Glimmers of Hope Amid the Economic Downturn

With recession risk rising, investors are expecting interest rate cuts this year, which could help in a couple of ways. Lower rates would help reduce the cost of refinancing the nation’s ever-growing fiscal debt. In addition, lower borrowing costs would be a relief to corporations and encourage some to invest in capital projects.

Another major potential positive is that lower mortgage rates could awaken a sleepy housing market where demand far outstrips supply. An improved housing sector could benefit small- and mid-caps, which have more exposure to housing-related industries than large-caps.

The current growth scare has accelerated the rotation away from Magnificent Seven and AI stocks that started in the second half of 2024 and into less flashy but more steady asset classes.

According to the CFA Institute, cycles that alternate between growth and value, or large-caps versus small-caps last nearly a decade on average. So, the market may be at the dawn of a multi-year run for unloved and overlooked asset classes.

In other words, we believe it’s a great time to be boring.