The Market Rally Is Relieving. But It Shouldn’t Be Reassuring.

The S&P 500 hit a record high on June 27. (TIMOTHY A. CLARY / AFP / Getty Images)

About the author: Michael Clarfeld is the CFA and portfolio manager at ClearBridge Investments.

When I reflect on U.S. equities performance this year, I feel like pinching myself. Despite trade wars, battlefield wars and deteriorating federal fiscal policy, the U.S. market rose in the first half of 2025. Stocks really do climb a wall of worry.

Investors looking at their June statements must feel good—unless they live outside the U.S. While U.S. investors saw a 6.2% return, the S&P 500 index is down in most foreign currencies. That is because the U.S. dollar has significantly declined. S&P 500 investors in Japan lost 1.2% in yen. In euros, that would be a 5.3% loss. The S&P 500 declined 16.4% relative to gold. Indeed, the dollar is the only commonly used yardstick that flatters U.S. returns.

Created with Highcharts 9.0.1S&P 500 Falls Further in Foreign CurrenciesS&P 500 Performance by Currency, January-June 2025Source: ClearBridge Investments, Bloomberg Finance

Created with Highcharts 9.0.1Feb. 2025June-0.35-0.30-0.25-0.20-0.15-0.10-0.0500.050.10SPX YENSPX USDSPX EURSPX GOLD

A survey of global equity performance drives home this point. Not only did U.S. equities become worth less in the first six months of 2025, they also significantly underperformed global markets. The S&P 500 rose 5.5%, versus the 17.9% for ACWX, MSCI’s ETF tracking mid- and large-cap firms in developed markets other than the U.S. Despite this underperformance, U.S. stocks trade at a record premium to foreign markets, with a trailing price/earnings ratio of 23.8 for the U.S. versus 15.3 elsewhere.

Rising U.S. equity markets make American investors feel good, but that may simply mask a loss in purchasing power. Continued U.S. underperformance also risks becoming self-reinforcing. It is easy to envision cascading outflows with U.S. markets at all-time highs, foreign markets cheaper than ever in relative terms, and global investors over-indexed to U.S. markets.

The S&P 500 currently trades at 22 times forward 12-month earnings, a level matched only twice in the last 35 years, in 2000 and 2022. Investors who put cash to work in those periods lost money over the ensuing 12 months.

Suddenly, those warm and fuzzy feelings about first-half performance seem misplaced.

The past is, of course, no guarantee of the future. Artificial intelligence could prove wondrous. Tariff revenue could pay for tax cuts, and tense geopolitics may be the risk that never comes home to roost. But with the demanding odds embedded in current stock prices, are investors sufficiently incentivized to bet that way?

Given all the challenges, and, more important, the inherent uncertainty of investing, buyers should demand better. U.S. equities offer little margin of safety. They would lose 30% if they were to return to long-term average multiples.

Suggesting the market could decline 30% is provocative. But it isn’t crazy to suggest the market could trade in line with historical averages. In other words, to be bullish today, one must believe the market will sustain levels never previously sustained, rather than trade at the levels it usually trades at. When phrased like that, why would any risk-averse investor bet heavily on the former?

Against such a challenging backdrop, a diversified portfolio of high-quality dividend growers looks attractive. Touting diversification may sound trite—but diversification is anything but commonplace nowadays. The most well-known benchmarks have become highly concentrated, and most portfolios mimic those benchmarks. This concentration leads to increased volatility. But robust dividends can provide an anchor to windward in stormy seas. Valuations for high-quality dividend growers are also generally less demanding.

Real assets stand out. With inflation expectations becoming entrenched and stagflation concerns growing, real assets are a haven. They recoup increasing costs through price increases, while their in-place assets accrete value as replacement costs rise.

Energy and apartment real estate investment trusts look particularly strong. Despite weak commodity prices, energy companies screen reasonably on current earnings and offer torque to rising oil prices. Apartment REITs offer reasonable dividend and cash flow yields. They benefit from higher interest rates and the residual effects of Covid-era inflation, when developers slashed new projects and mortgage rates rose high enough to keep homeownership out of reach for renters. Rents are poised to rise further, driving earnings growth.

Investors pouring cash into AI, crypto, and everything else new recall past episodes of market complacency and euphoria. Buyers gravitated to the companies that seemed like the right bet at the time, yet walked away disappointed because of the high prices they paid.

Given the tremendous uncertainty and change facing markets today, U.S. investors should be relieved that equities have fared so well in the first half of the year. But given record valuations, record concentration, and attractively valued opportunities elsewhere, they shouldn’t get complacent.

Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.