By Tim Courtney, Chief Investment Officer
Markets continue to navigate several variables as we move into the second quarter. Below, we examine three areas that may affect market behavior over the next few months: where AI will drive productivity, renewed recession discussions and market leadership.
AI Impact. One of the key areas we’ll continue to watch is how AI productivity will show up in the economy. So far, much of the focus has been on where it could disrupt existing business models. Notably, software stocks have fallen in recent months, with the S&P 500 Software & Services Index down over 20% year-to-date1 from fears AI tools could replace or reduce demand. It’s still unclear if those predictions will come to be, and in the second quarter, we anticipate the market will find other sectors that could be disrupted by AI.
Ultimately, if AI is not just a competitive threat but an effective tool for users, it will drive productivity and efficiency across most of the economy. But we yet to see this in a broad or consistent manner.
Recession Odds. Another variable affecting prices is how the market interprets the risk of recession. The conflict in Iran has pushed oil and energy prices higher,2 which has revived concerns around inflation and the potential for elevated interest rates. So far, broader market behavior is not suggesting high levels of concern. There are pockets of weakness in the market, primarily in credit, which has seen some signs of increased default rates and illiquidity.3 However, we aren’t seeing those concerns spill into other areas. For example, lower quality credit in public markets is holding up as are small value equities, two areas you would expect to see faltering if the market believed the economy was moving closer to recession.4
Market Leadership Rotation. Another factor to watch is a potential shift in market leadership. As we mentioned earlier, small value companies are holding steady and are actually positive year-to-date while large cap growth names are negative.4 This pattern has not been limited to this year, but has been developing over the past several months, going back to around October 2025.5 Five months is a relatively short timeframe, but it is enough to raise the question of whether a broader rotation may be happening following a long stretch where large growth companies have led the market.6
Amid the continuing optimism around large AI and tech names, a market shift may be occurring due to the high valuations of many of these companies. Earnings and fundamentals may need to catch up with prices that remain very cheery about future growth. High prices require these companies to constantly meet or beat expectations, and this becomes more difficult to do decade after decade.
Taken together, these variables highlight the importance of maintaining a diversified and disciplined approach with portfolios. We encourage anyone with questions to reach out to your advisor.
Sources:
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