A Broad Approach in a Narrow Market

The second quarter of 2026 stood in stark contrast to the first. Our last letter concluded with our suspicion that markets were looking for a reason to go back up. They found one over and over again with each new announcement of an on-again, off-again ceasefire in the war with Iran. Concerns about oil prices and their potential inflationary impact were quickly cast aside, freeing investors to refocus on AI. The result was a historically strong quarter for semiconductor stocks. As semiconductors and the factors closely associated with them, such as high momentum and high beta, drew investor attention, the broadening we saw in the first quarter gave way to significant narrowing in the second. Outside of this singular theme, there were few opportunities to outperform the major indices. Against this backdrop, we have been impressed by our strategies’ ability to generate performance from a differentiated set of positions. We have been encouraged by the results year to date, particularly given that they were achieved without significant exposure to what we view as the biggest risk in global equity markets. Although our strategies were not positioned for the sudden shift in sentiment in April, they held their ground more steadily as the quarter progressed. After a historically active first quarter, trading was relatively muted in the second. Our models generally held firm, neither chasing the highest-momentum sectors nor retreating from their consistent, albeit reduced, energy exposure. The Growth strategy benefited most from the quarter’s risk-on sentiment and continues to hold a substantial lead over both its asset-allocation benchmark and global equity indices for the year. The Moderate and Conservative strategies held fewer higher-risk positions and gave back more ground, but each also remains ahead of its asset-allocation benchmark. All three strategies maintained above-neutral equity exposure during the quarter, but the market’s narrow leadership made it difficult to fully capture index gains. Weakness in energy and natural resources was the primary headwind, while limited AI exposure also weighed on relative performance. For most of the quarter, we held a fairly eclectic mix of equity sectors. These positions are often volatile individually but were not highly correlated with market indices or with one another, nor were they representative of the prevailing AI trade. This diversification allowed us to hold additional equity exposure while keeping overall portfolio volatility in check. Japan and Biotech were substantial positive contributors across all three strategies. The Growth strategy also benefited from indirect AI-infrastructure exposure through Clean Energy, as well as another esoteric winner in China A-shares. AI supplier sentiment hits a “fever pitch”. AI stocks driving the recent market rally look increasingly risky. Semiconductors marched steadily higher through April, but volatility increased over the remainder of the quarter, ultimately reaching a fever pitch as moves of several percentage points in either direction became the norm. Strong returns can come on the back of high volatility, but that volatility more commonly follows a large drawdown or market pivot. What is particularly unusual about the current environment is how many assets are exhibiting high volatility while sitting close to all-time highs. Within our pool of ETFs, the only situation similar to this one occurred during the final run-up of the tech bubble, notably the only period where the spike preceded the market drawdown rather than represented its recovery. While volatility may not be a risk itself, it does create a less favorable distribution of o...