SpaceX leadership members and guests celebrate on a balcony at the Nasdaq MarketSite in New York on June 12, the day of the company's initial public offering.Brendan McDermid/Reuters
The market’s tech-driven bull run could face a bumpy road ahead as expectations rise that the U.S. Federal Reserve will lift rates in the face of a surprisingly strong economy and persistent inflation. For some investors, that shift could also create opportunities in investing that have been overshadowed by a relentless rise in growth-focused shares.
“Equity investors are starting to get a little bit concerned around higher rates ... as that impacts valuations,” said Dustin Reid, chief fixed income strategist at Mackenzie Investments.
With the U.S. economy running hot, higher yields across the U.S. yield curve – which could be driven by factors including Fed decisions and heavy capital expenditures on artificial intelligence – could expose “some fragility” in growth stocks, he said.
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While global markets slipped ahead of last week’s SpaceX IPO amid concerns that a tech-fuelled rally might be running out of steam, the S&P 500 index remains near all-time highs and the Canadian S&P/TSX Composite Index has touched new records. The S&P 500 is up around 8 per cent for the year so far despite war and global energy disruptions, and the Canadian stock index has risen more than 10 per cent.
But the gains have been narrow: A recent analysis by Scotiabank found that only 35 per cent of stocks in the S&P 500 have outperformed the index in 2026, and it noted that of the top 20 performers on the S&P 500 over the past two months, 18 have been tech firms. Flows into U.S. equity ETFs have topped US$600-billion so far this year, and inflows to Nvidia Corp. alone have exceeded US$22-billion, according to TD Securities.
Kim Shannon, founder and co-chief investment officer of Sionna Investment Managers, said equity markets were displaying the characteristics of “overdone enthusiasm.”
“We see enormous risks in people chasing this increasingly more expensive market and in particular the leading stocks,” she said.
“I think this is likely one of the three great speculative manias in the past century.”
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Investment strategies “crafted and honed in a disinflationary environment” have pushed more investors to concentrate on growth stocks, while allocations to value – a broad category referring to an investing approach that focuses on stocks calculated to be underpriced – have fallen to all-time lows, Ms. Shannon said.
That could expose investors to significant risks if markets repeat a historical pattern of bull phases followed by extended volatile sideways periods in an environment of higher inflation, she said.
“When you look back at financial market history ... you don’t see an inflation cycle that’s six years or so. They tend to have a minimum of 20-year cycles.”
Analysts say that while the companies driving the rally are profitable, inflation and higher rates could cause pain given heavy spending on AI infrastructure that may take years to translate into concrete benefits. Vicky Redwood, chief economic adviser at Capital Economics, said in a note to clients that she expects AI-related efficiency improvements to arrive “gradually in the late 2020s and 2030s.”
“Higher rates increase borrowing costs,” Stephen Innes, head of trading and market strategy at SPI Asset Management, wrote in an investment note. “They raise the hurdle rate for future projects. They reduce the present value of earnings expected years from now. The farther valuations stretch into tomorrow, the more vulnerable they become when the discount rate rises today.”
On Wednesday, the U.S. Federal Reserve kept interest rates steady in its first meeting chaired by Kevin Warsh. But nearly half of the central bank’s policy makers indicated they will need to raise the Fed’s policy rate this year, according to projections, and Mr. Warsh spoke of the “burden” of persistently high prices.
U.S. shares fell following the announcement, while interest rate futures priced in higher expectations of rate hikes at the Fed’s September meeting.
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Given the outlook, Mr. Reid at Mackenzie Investments said he sees value in the global market for “linkers” – inflation-protected bonds, such as U.S. Treasury Inflation-Protected Securities, or TIPS, for “the next number of months, if not quarters.”
With the Canadian economic and policy outlook diverging from the U.S., he said he also expected Canadian fixed income securities to outperform their U.S. counterparts with prices rising and yields falling.
Ms. Shannon said barring a financial calamity, stock markets could be poised for a repeat of the 1966-82 period. The S&P 500 rose from 92.43 points in December, 1965, to 120.4 points by the end of 1966, an annualized rise of less than 1.6 per cent.
But while overall market returns were low during that time, it was “very good for value investors,” and a value-focused approach is likely to outperform again, she said.
“This is the time and place to be in this contrarian bet. ... There’s not as many people out there shouting from the rooftops, talking about value.”
With files from Reuters