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Market Recap
From a seasonality perspective, August during the first year of a U.S. presidential term or cycle tends to be challenging for investors, but this month, equities defied expectations. The S&P 500 closed August 2025 up 1.9%, and it has added 9.8% this year so far. This year-to-date performance would have been impressive for any year, but what makes it particularly impressive is that the S&P 500 had two consecutive annual gains of more than 20% in 2023 and 2024.
For equities investors, this year has really been characterized by three phases:
- Phase I: Tariff fears; Jan to April
- Phase II: Most Hated V-shaped rally; April to now
- Phase III : Dovish Fed and ISM recovering to >50; now beginning
There is no need to provide a detailed recap of the tariff period, but it’s worth recalling how many economists and investors at the time said equities would not recover, particularly since the Fed would not unleash liquidity. Yet our stance back then was that such waterfall declines are typically followed by “V-shaped” recoveries, unless there is a recession.
Many also thought that a recession was possible or even likely, but the fact that high-yield spreads did not widen dramatically caused us to judge the risk of a recession as low. This proved to be the case. So far, corporate America has proven to be very resilient.
Some market participants remain concerned about inflation. These concerns were amplified on the morning of Aug. 14, when July core PPI came in very hot. The reading was a blazing +0.92% MoM (versus Street expectations of +0.23%). Yet on that day, the S&P 500 closed up 0.13%. Even Fed rate-cut expectations barely changed. As implied by the day’s Fed funds futures trading, the odds of a September cut remained at 90% on Aug. 14, and implied number of cuts by year-end were relatively unchanged, at 2.3.
In other words, markets did not react to these higher incoming inflation reports. Part of this could have resulted from a market view that such inflation readings are transitory.
However, as an old adage says, when one’s only tool is a hammer, everything looks like a nail, and we think the broader implication from the post-PPI reaction is that there are too many investors carrying “inflation hammers” who were already positioned bearishly before the numbers came out.
This sort of bias is not new. There have been many “hammers,” or cognitive biases, that investors have carried in the past 15 years:
- 2002-2015: Tech valuations are a “bubble”
- 2009-2019: “Lehman moment” could come again
- 2009-2019: “The Fed is the only reason stocks rise”
- 2020-2024: “Another pandemic can happen”
- 2023-now: “Inflation can surge again”
- 2025-now: “Tariffs will cause a recession”
Though we disagree, many continue to argue that the July core PPI reading was evidence that inflation will accelerate in coming months. Admittedly, the core PPI reading was not pretty. Trade services saw a rise, and there was a notable rise from financial services. However, we believe it is important to keep in mind that June core PPI was negative. This opens up the possibility that there was a statistical aberration at work behind the July PPI numbers.
This month saw some worries emerging regarding the outlook for stocks related to artificial intelligence. Price movements for Nvidia ahead of its earnings on Aug. 27 (atypically, the stock was largely flat ahead of its earnings-report release) signaled to us that investors are apprehensive or uncertain about where we are in this AI cycle. OpenAI founder Sam Altman’s recent comments about a potential AI bubble likely have not helped.
To us, however, NVDA remains the most important company in AI, and AI remains one of the most important structural themes for the next decade for the U.S. and global economy. There is a dearth of pure play AI stocks, and NVDA is the best of these. To us, until we see many IPOs of AI stocks, we can hardly view this as peak AI.
In addition, since 2022, NVDA has seen a median gain of 30% from 8 weeks before the release of earnings to one month post-earnings report. So, we think the probabilities favor a sizable move for NVDA post-EPS. More importantly, NVDA is a stock that has shown every dip has proven to be profitable. So we would recommend buying any dip.
Looking forward
Seasonality-related concerns will continue to be something to monitor as we head into September and October. Typically, volatility begins to rise in both Septembers and Octobers, and this can cause risk books to shrink and stocks to go down.
Although this is important to keep in mind, we see several reasons why investors should not make seasonality concerns their base case for the month. In fact, we expect September to be an up month.
This is the main reason why: In the last 50 years, there have been two historical precedents in which the Fed had been on hold all year before cutting in September – in 1998 and 2024. In 1998, the market rose into the Fed cut and then fell. In 2024, the market fell in the first part of September but ultimately rallied after the cut. Both precedents saw September ending up. Also in both cases, markets ultimately surged as we headed into the year-end. We believe that this is more important than September seasonals.
Strategic Sector Rating
In this month’s sector allocation model update, Tom did not make any changes to his sector ratings. However, given the volatility in August and notable sector leadership rotation, Mark implemented relatively more adjustments compared to prior updates.
- Communication Services (N –> OW): Over the past month, Communication Services has been one of the top-performing sectors. Alphabet surged after winning a key lawsuit, and other media and internet stocks also delivered strong gains. On an equal-weighted basis, Communication Services reached its highest level relative to the S&P 500 since the 2022 bear market. Mark believes this trend could continue into year-end, and he therefore upgraded Communication Services to Overweight.
- Healthcare (UW–> N): While the Trump administration is broadly considered pro-market, Healthcare stocks have been an exception, often targeted with unfavorable scrutiny and policies (particularly managed healthcare). That said, recent price action suggests stabilization, with equal-weighted Healthcare breaking out of a four-month downtrend (April–August). This is consistent with the rebound from the “Liberation Day” selloff running into resistance during a volatile summer. If September proves seasonally weak, Healthcare as a defensive sector could see relative outperformance. Still, as Tom Block often reminds us, “Washington sometimes picks winners and losers.” Technically, a Neutral rating (rather than Overweight) appears justified.
- Energy (N –> UW): At the start of the year, both Tom and Mark rated Energy as Neutral, citing oversupply and weak demand recovery as headwinds for crude oil. Mark briefly upgraded Energy in July amid rising Middle East tensions, but with geopolitical risks easing, the sector has failed to break out of its relative downtrend versus the S&P 500. That downtrend looks likely to persist until stabilized. Meanwhile, OPEC + plans to further boost oil supply despite the oversupply concerns over the weekend. Mark expects crude oil could retest its May lows in September. As a result, Energy was revised back to Underweight.
With these adjustments, Tom and Mark are now aligned on 7 of 11 sectors:
- Overweight (both): Consumer Discretionary, Industrials, Technology, Communication Services, Financials
- Neutral (both): Materials, Healthcare
Four sectors remain areas of divergence:
- Real Estate: Overweight (Tom), Neutral (Mark)
- Energy: Neutral (Tom), Underweight (Mark)
- Utilities: Neutral (Tom), Overweight (Mark)
- Staples: Underweight (Tom), Neutral (Mark)
Tactical Ranking Changes
August’s sector leadership rotation drove notable shifts in tactical rankings:
- For the leaders, Financials and Consumer Discretionary joined Communication Services in the top three.
- Technology saw some weakness recently and fell from the top 3 of last month. Software dragged down the sector despite strong performance from the tech hardware industry. But the technology sector still remains the #1 sector in DQM, #1 in our EPS scoring system, and #3 in our trend measurement. The weakness likely proves to be short-lived, and we could see technology back in the top 3 in next month’s update.
- Utilities fell sharply from #2 last month to #9 this month. Utilities had some decent rallies into August. However, as overall market sentiment stalled and growth—especially AI-orientated names—came under pressure, the utilities sector also performed poorly over the past month.
- Materials saw strong improvement, jumping from #11 last month to #5 this month. Mark has favored metals, especially precious metals, for some time. Recent fears of a deepening fiscal deficit globally and a falling DXY, as the Fed’s dovish pivot further fueled rallies in precious metals. The improvement of materials is largely technical-driven. Fundamentally, materials still rank poorly in DQM and our EPS model.
- Although Consumer Staples was upgraded to Neutral by Mark last month and the sector did bounce well initially, the rebound lost momentum in the second half of August. Therefore, in the latest tactical momentum ranking, it once again slipped into the bottom three.
Compared to last month, the largest increase of our recommended weighting are from:
- Consumer Discretionary: +2.4%
- Financials: +2.1%
- Healthcare: +2.0%
- Materials: +1.6%
And largest decrease of our recommended weighting are from:
- Utilities: -3.9%
- Technology: -2.6%
- Consumer Staples: -2.1%
Mark’s upgrade of Communication Services also added +0.7% to that sector.
Overall, relative to the benchmark index, we continue to overweight cyclicals and underweight defensives. However, compared to prior months, our tilt has moderated with a more neutral stance on Materials and Healthcare, both now recommended at market weight.
*The above-mentioned weights are based on an 85% Sector ETF + 15% Tactical ETF allocation. If you are 100% allocated to Sector ETFs, you can refer to slide 43 in the attached Deck.
Updated ETF Picks
Our five ETF picks gained an average of +2.3% in August, underperforming the S&P 500 by 0.6%. Interestingly, the best and worst performers were both crypto-related: the Blockchain Technology ETF led, while the Bitcoin ETF lagged.
In September, Mark decided to keep IBLC due to its strength and replace the other 4 with ITB, LIT, IBB, and PBW. Many of them are rate-sensitive and, generally speaking, when the Fed resumes rate cutting in September and in the rest of the year, it could also help many of these ETFs.
- iShares U.S. Home Construction ETF (ITB 0.57% )
- Global X Lithium & Battery Tech ETF (LIT 1.71% )
- iShares Blockchain and Tech ETF (IBLC 6.27% )
- iShares Biotechnology ETF (IBB 1.03% )
- Invesco Wilderhill Clean Energy ETF (PBW -0.58% )
