Is the Economy’s Divergence Starting to Catch Up With the Market?

There’s a widening gap in the US economy that markets are still choosing to overlook — but they are unlikely to be able to ignore it for much longer.

On the surface, things look orderly. Stocks are climbing, Big Tech is smashing expectations, and the banking sector appears resilient.

Yet beneath that calm exterior, significant parts of the real economy are starting to buckle. The divergence between a handful of dominant stocks and the broader corporate landscape is becoming too wide to rationalise. It is, I believe, one of the most serious mispricings we’ve seen since the post-pandemic rebound.

While the top 10 stocks in the S&P 500 — mostly tech and financial giants — are delivering quarterly earnings growth of over 40% and 12% respectively, large parts of the rest of the index are telling a far more cautionary tale.

Consumer staples, industrials, and materials businesses are reporting margin compression, even when their revenues are rising. That is a crucial detail: companies are selling more but earning less, which signals rising costs and falling pricing power.

The illusion of strength is being propped up by a narrow slice of the market, and that concentration is masking what is, in many sectors, a slow-motion earnings downgrade. Investors taking comfort from index-level performance are at risk of misunderstanding what’s really happening across the broader economy.

At the same time, we’re seeing aggressive trade measures being deployed from the White House, with fresh tariffs now imposed on goods from Canada, Taiwan, Switzerland, and India.

These aren’t marginal policy shifts — they’re taxes on supply chains and consumers. We should stop sanitising the terminology. These measures are better described as Trump’s Main Street Tax.

Tariffs like these are inherently inflationary. They raise import costs, which work their way through manufacturers and retailers before landing in the pockets of consumers. At the corporate level, they increase production expenses and compress margins, especially for firms without the leverage to pass costs on. In this context, the idea that the Federal Reserve can simply lower rates to offset economic softening becomes far less convincing.

Job growth has already slowed significantly, with the US economy adding just 106,000 jobs between May and July, down sharply from 380,000 in the prior three months. At the same time, GDP growth has fallen to 1.1% in the first half of the year, from 2.9% at the end of 2024. These aren’t the figures of an overheating economy. They suggest loss of momentum, but the market isn’t behaving like it.

Investors are, in effect, treating these signals as noise. There’s a widespread assumption that strong stock performance in one part of the market offsets weakness elsewhere, and that any future downturn will be short-lived or easily contained by policy action. That’s the kind of sentiment that often leads to painful miscalculations.

An Opportunity (SO:FTCE11B) in Disguise?

However, this kind of environment also creates an opportunity for investors who are willing to step back from the consensus view and reassess where real value lies. Periods of distortion, notably when sentiment diverges from underlying fundamentals, are often when the most attractive entry points emerge.

Rather than chasing what’s already run, I believe investors should be seeking undervalued sectors where earnings have been hit temporarily by cost pressures but where balance sheets remain strong and pricing power is likely to return.

Globally diversified portfolios will also benefit as the dollar, currently strong, begins to come under pressure from deteriorating economic data and trade dislocations. Companies with international exposure and adaptable cost bases are likely to emerge stronger over the coming quarters.

I also see opportunities in selected emerging markets and digital assets, where capital has been slow to return despite improving fundamentals and growing institutional interest. The combination of lower valuations, long-term thematic growth, and better monetary conditions outside the US creates a compelling setup for investors with a medium-term horizon.

Still, there’s little room for complacency. Earnings season has made it clear that companies missing expectations are being punished far more severely than in recent years. This reflects fragile sentiment beneath the surface and a market that has become increasingly intolerant of surprises.

The most important thing now is for investors to stop assuming the calm will last simply because it has. History shows that divergences of this kind rarely persist indefinitely.

Eventually, something gives — and when it does, positioning ahead of the curve becomes the difference between riding out volatility or being caught off guard by it.

This is a moment to focus on fundamentals, global positioning, and real diversification. Those who do are likely not only to shield themselves from the risks ahead but to be in the strongest position to capitalize when clarity returns.