For our third quarter Focus on Finance, the Business Times asked our panel of experts to weigh in on market risk, the new Fed chair and the upcoming midterm elections. Our Q&A was conducted via email with Editor Henry Dubroff. Answers were lightly edited.
**Our panelists include:**
Dianne Duva, Managing Partner, Arlington Financial Advisors
Scott Hansen, Managing Director, Wells Fargo
Lloyd Kurtz, CIO, Montecito Bank & Trust
Omid Noori, Senior VP, U.S. Bank Private Wealth Management
Peter Madlem, Partner, Avalan
**Dylan Minor, Founder, CIO, Omega Financial**
Nick Sondgeroth, Managing Director, TSG Wealth Mgmt.
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**Q1: While U.S. equities are hitting records, there’s been talk of a rotation away from the Mag 7 toward traditional names, internationals and small caps. How do you see the rest of the year playing out?**
**Dylan:** I think the broadening of the market is healthy rather than concerning. The S&P 500 is up roughly 10% year-to-date, but the Russell 2000 has gained more than 20%, suggesting leadership is expanding beyond the largest technology companies. That is typically a constructive sign rather than a warning. Recent volatility surrounding the Iran conflict also reminded investors that geopolitical shocks tend to affect sectors differently — energy, defense and value stocks briefly outperformed while oil prices spiked before retreating. I expect AI beneficiaries to remain important, but returns are likely to be driven by a wider set of companies, including quality industrials, financials, and selected international markets where valuations remain more attractive. Rather than abandoning the Mag 7, I view this as a welcome transition from a narrow rally to a healthier, more diversified bull market.
**Nick:** Market leadership has been unusually concentrated, largely reflecting enthusiasm around artificial intelligence infrastructure spending, expectations for future profitability from that investment, and the path of monetary policy. Those themes will likely remain important, but we believe investors should be careful not to let a single narrative dominate portfolio construction. It would not be surprising to see market participation continue to broaden if earnings growth improves outside the largest technology companies, interest rate expectations stabilize, and investors become more comfortable taking risk across other areas of the equity market. That could include more traditional sectors, international equities and small- and mid-cap companies. That said, we do not think the answer is abandoning recent winners or chasing laggards. A more disciplined approach is to maintain exposure to important growth themes while avoiding overconcentration in the highest-momentum areas.
**Omid:** The fundamental backdrop remains constructive, helped by consumer resilience and robust business investment. In a complex environment of elevated valuations and persistent inflation, we believe market leadership is likely to broaden, increasing the importance of diversification, including broader U.S. and foreign equity exposure. We would give an edge to diversified larger U.S. equities. This reflects relative U.S. economic resilience and earnings strength.
**Dianne:** The rotation away from the Mag 7 toward “traditional” value companies, international, and small-cap stocks has been real. Contrary to most expectations, the Mag 7 stocks have provided only minimal returns this year through June 30. Large-cap value stocks are up 16.4%, outperforming large-cap growth stocks by over 10% through June 30. Both the Russell 2000 small-cap index and the MSCI Emerging Markets index returned 22.6%, versus the S&P 500’s 10.3% return over the same period. Developed markets internationally have matched the S&P’s return this year and have outperformed the S&P over the last two years. In recent panels, we have highlighted the historically large valuation discounts of value, international and small-cap markets, anticipating a reversion to the mean in investor returns. Even with their recent significant outperformance, we still see opportunities for strong relative returns in these markets, especially as AI productivity enhancements are widely adopted.
**Scott:** At Wells Fargo, we would suggest the market’s leadership is broadening, not necessarily replacing the Magnificent 7. While AI-driven mega-cap technology remains a key earnings engine, elevated valuations and high expectations create room for traditional sectors, select international markets and smaller companies to contribute more meaningfully to returns. We continue to favor equity exposure but emphasize diversification, selective stock picking, and a broader AI opportunity set beyond the largest tech names. For the balance of the year, we expect a healthier, wider market advance — where Industrials, Financials, international equities and parts of small caps gain share of leadership — while quality large-cap technology remains an important portfolio anchor.
**Lloyd:** After falling by nearly 20% in 2022, the U.S. stock market has now delivered three and a half stellar years, with the S&P 500 total return index at double its level at the start of 2023. The Magnificent Seven had a lot to do with this. They are impressive companies: as a group they now account for about 1/3 of the S&P 500, and Apple, Microsoft, Nvidia and Meta appear in the top 10 holdings of a leading index of high-quality stocks. But over the past 12 months, their stock market performance has wavered, and today’s momentum leaders are primarily AI-related semiconductor stocks. The AI theme is widespread, and diversifying is harder than it looks. For example, the top three holdings of one emerging markets index are all AI-related chip stocks, and they account for almost 30% of its total value. Today, U.S. utilities, traditionally defensive issues, are making big investments to meet AI-related electricity demand. We believe European stocks provide a good diversification opportunity. The dividend yield of 3% is about triple that of the S&P 500. We see health care and consumer staples as sectors that are low-volatility alternatives within the S&P 500. Finally, the relative appeal of Treasury bonds appears to be increasing, with the 10-year now yielding 4.5%. Treasuries can be useful, if less-than-exciting, portfolio diversifiers.
**Peter:** The bull market is broadening, and that’s one of the healthiest developments we’ve seen all year. While the Magnificent 7 has regained some momentum recently, it’s no longer carrying the market on its own. The group is up just 2.6% year to date, compared with 14.3% for the S&P 500 excluding the Mag 7. That’s what we’d expect in a more durable expansion. S&P 500 companies are on track for roughly 22% earnings growth this quarter, with strength extending well beyond mega-cap technology. Forward earnings for mid- and small-cap companies are also reaching record highs, profit margins continue to expand, and market concentration has declined meaningfully. That doesn’t mean growth stocks are finished. AI remains a powerful secular driver, and we’d view pullbacks in semiconductors as opportunities. However, expectations for technology are exceptionally high, creating room for capital to rotate toward Financials, Industrials, Health Care, and other value-oriented sectors if earnings merely meet expectations. We expect occasional bouts of volatility during earnings season, but we believe dip buyers will remain active and continue to see the S&P 500 advancing toward our 8,200-year-end target.
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**Q2: Fed Chair Kevin Warsh has been making big changes at the Federal Reserve. How do you evaluate his performance and what will be his first real test?**
**Lloyd:** We believe the first real test has arrived. The U.S. economy has low unemployment at 4.2% in the latest report, and GDP is growing at a reasonable pace of 2%. But inflation is well above the Fed’s 2% target and has been for over five years. The case for tightening seems clear-cut, and both the bond and futures markets have shifted to reflect the probability of one or two 25-basis-point hikes before the end of the year. In recent testimony on Capitol Hill, Warsh committed to bring inflation down to the target level, saying “inflation is a choice. The members of our committee have no tolerance for persistently elevated inflation, and we share a resolute commitment to restore price stability.” Investors will be watching closely to see if he means what he says. Warsh has also initiated a series of panels to review and improve the operations of the Fed. It’s an appropriate step, in our view, but those projects will take time. For now, the fundamentals should be the primary focus.
**Omid:** It is early in Chair Warsh’s term, but the market appears to have adapted to the Chair’s initial communications. Investors and Fed comments remain focused on inflation as a near-term threat. Interest rate markets appear patient in awaiting the results of announced task force studies for likely changes to Fed communications. We note the MOVE index of interest rate volatility remains at the lower end of this year’s range.
**Peter:** Kevin Warsh’s first months as Fed Chair have been less about changing interest rates and more about changing the conversation. During his confirmation hearing, Warsh argued that artificial intelligence would boost productivity, suppress inflation over time, and give the Federal Reserve greater flexibility to lower rates. Since then, however, the Fed’s internal discussion has shifted. Policymakers increasingly view AI not as today’s disinflationary force, but as tomorrow’s; and that’s an important distinction. The AI buildout is fueling demand for labor, electricity, semiconductors and capital long before its productivity gains fully materialize. The result is stronger economic growth accompanied by persistent inflationary pressure. In other words, AI is creating demand today while promising efficiency tomorrow. Warsh has wisely resisted offering forward guidance, instead launching a broad review of the Fed’s communications, balance sheet, data collection, productivity and inflation framework. His first real test won’t be whether he cuts or raises rates. It will be whether he can convince markets to focus less on predicting the Fed’s next move and more on interpreting the economic data themselves. If successful, that may prove to be his most meaningful and lasting reform.
**Nick:** The most notable shift so far has been less about the rate decision itself and more about communication. Chair Warsh appears to be moving the Fed toward shorter statements, less forward guidance, and less reliance on the dot plot as a market signal. There are tradeoffs to that approach. Transparency has value, but markets have also become highly reactive to every phrase from the Fed Chair and every projected dot, even though economic conditions frequently evolve differently than the path implied at the time. His first real test will be whether the Fed can reduce some of that overreliance on forward guidance without creating unnecessary confusion. If inflation remains firm while growth data softens, markets will need to understand the Fed’s framework even if the Fed is less explicit about the exact path of rates.
**Dianne:** Kevin Warsh’s tenure as our Federal Reserve Chair has been somewhat surprising. During his confirmation hearings and prior comments, he was seen as being somewhat dovish on rates, in line with President Trump’s stated desire to see lower interest rates. Instead, the Fed’s early statements have been, we think, appropriately hawkish on inflation: “The committee has unambiguous and unanimous resolve to deliver price stability.” We really like this commitment from the Fed, even though bond yields moved up anticipating tighter interest rate policy. It demonstrates the discipline and independence needed to effectively guide policy through inevitable challenges. Warsh’s first real test may well be sustained tongue-lashings from the President, who keeps expecting lower interest rates to materialize. We also like the five policy review task forces set up by Warsh, covering communications, balance sheet policy, data, productivity, and inflation. The leaders of the task forces have strong, independent qualifications.
**Scott:** Our recent outlook suggests the key issue for the Fed isn’t growth — it’s inflation. The economy remains resilient, and earnings are holding up, but inflation is expected to remain above the Fed’s 2% target through year-end, keeping pressure on policymakers. Against that backdrop, we would characterize Chair Warsh’s performance as proactive but still unproven. He has moved quickly to review Fed communications, the balance sheet, data usage and the inflation framework while emphasizing a commitment to price stability. His first real test will be managing sticky inflation without derailing economic growth. If inflation remains elevated while growth and labor markets stay firm, he may need to maintain a tighter policy stance despite investor expectations for easier policy.
**Dylan:** Thus far, Chair Warsh has struck me as measured and pragmatic. His first FOMC meetings have emphasized restoring price stability while maintaining the Fed’s independence and keeping policy relatively unchanged despite considerable political pressure. His real test will come if inflation remains stubbornly above the Fed’s 2% objective while economic growth begins to soften. Current unemployment is approximately 4.2%, GDP growth is running near 2.1%, and inflation remains elevated, partly reflecting tariffs and recent energy disruptions associated with the Iran conflict. The difficult question is whether higher inflation proves temporary or becomes embedded in expectations. Successfully navigating that tradeoff — without unnecessarily tipping the economy into recession — will ultimately define his tenure far more than any organizational changes made during his opening months.
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**Q3: How do you see the midterm elections impacting the investment climate, and particularly the bond market and the dollar? Anything investors should do now to brace for impact?**
**Dianne:** We don’t see the midterm elections having significant impacts on the markets if the Democrats win the House and Senate. Without a veto-proof majority in the Senate, we can’t see how major financial legislation from a Democratic House could pass. We think interest rates and the dollar will be much more impacted by macroeconomic conditions, Fed policy and geopolitics than the midterm elections. Longer term, a decisive Democratic midterm victory combined with a seeming lack of charismatic Republican leaders to carry forward the Trump coalition could lead to broader Democratic Party victories in 2028, including the presidency. Combined with our ever-expanding deficits and debt, the effects could be generational shifts in tax policy, regulation, health care policy, Social Security and defense spending.
**Scott:** We expect the midterms to add volatility but not necessarily change the fundamental backdrop of resilient growth and earnings. The bigger focus for investors may be how election outcomes influence fiscal policy, deficits and inflation expectations, which can affect Treasury yields. As mentioned earlier, elevated inflation and policy uncertainty could complicate Fed decisions into 2027. For bonds, we expect periods of rate volatility as markets reassess deficits, inflation, and Fed policy. For the dollar, we believe current support from U.S. rate advantages may fade over time as interest-rate differentials narrow, limiting further upside. Rather than making big portfolio changes now, our message is to stay disciplined: maintain diversification, emphasize quality, keep exposure to equities and prioritize income opportunities in fixed income rather than trying to time election-driven swings.
**Dylan:** The larger risks for bonds and the dollar are likely to remain inflation, fiscal deficits and Federal Reserve policy rather than which party controls Congress. If election outcomes alter expectations for government spending or taxes, Treasury yields could move meaningfully, but I would avoid making large portfolio changes in anticipation of a political event. The Iran conflict also reminds us that geopolitical events can influence oil prices and inflation expectations overnight, often overwhelming political headlines. For most investors, the best preparation is not prediction but instead partitioning a portfolio into truly disparate asset classes that will do well in different environments — maintaining exposure across different equities, fixed income and alternative assets so the portfolio is not dependent on any single economic or political outcome. In addition, I currently suggest replacing some equity exposure with call options, so we avoid a negative tail (i.e., large drop in value) while still participating in the upside.
**Nick:** Midterm elections can create uncertainty, but we would be cautious about making portfolio changes based primarily on anticipated political outcomes. Historically, markets have often been softer earlier in midterm years and stronger after election uncertainty begins to clear, but election results themselves are rarely the only driver of returns. For bonds, inflation, Federal Reserve policy, Treasury supply and economic growth should matter more than the election calendar. Political outcomes can influence fiscal expectations at the margin, but yields are still likely to be driven by the path of inflation and interest rates. The dollar is similar. Policy direction matters, but currency markets are heavily influenced by rate differentials, global growth, and risk appetite. Rather than “bracing” for a political outcome, we believe investors are better served by maintaining diversification, appropriate liquidity, and a portfolio structure that can withstand multiple policy scenarios.
**Omid:** Historically, stock-market performance improves after midterm elections, but results alone do not reliably explain market returns. Economic growth, inflation, interest rates and earnings typically have significantly more influence. We see strong earnings growth and moderating inflation as key drivers of equity market returns, especially relative to fixed income. The potential for Federal Reserve interest rate hikes this year is also supporting the U.S. dollar. We recommend diversifying exposure from fixed income into U.S. equities and global infrastructure. The former for solid earnings growth and the latter for steady income growth as the global economy continues to build out to meet energy and transportation needs.
**Peter:** Investors often ask whether midterm elections should change their portfolios. History suggests the better question is whether they should change their behavior. The answer is usually no. Midterm years have historically been among the weakest for the stock market, averaging returns of about 7.5%, and volatility often increases as policy uncertainty builds. But here’s the interesting part: markets have typically begun rallying about a month before Election Day, as polling narrows the range of possible outcomes. Over the following six months, stocks have historically delivered strong returns as uncertainty fades. The biggest mistake investors make is letting politics drive investment decisions. Since 2013, investors who stayed fully invested dramatically outperformed those who moved to cash whenever their preferred party was out of power. Markets reward earnings, productivity and innovation far more consistently than political narratives. For bond investors, expect election headlines to create periodic volatility, particularly if fiscal policy or inflation expectations shift. The dollar could experience short-term swings as markets reassess policy priorities, but long-term trends will continue to be driven by economic growth, interest-rate differentials and capital flows. The best preparation isn’t predicting the election. It’s owning a diversified portfolio designed to weather uncertainty, because history shows markets recover long before headlines do.
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*Originally appeared at https://www.pacbiztimes.com/
