Punching Above Their Weight

The first half of 2026 was marked by highly unusual circumstances. Stocks representing less than 1% of the S&P 500 market value were responsible for 24% of the 8.3% index return in the first half of 2026. The question now is whether these are the next new growth stocks or just expensive cyclical stocks? We believe they can grow for a while longer, but eventually come back down to earth.

The S&P 500 is a collection of the largest publicly held companies in the U.S. For several years now, the performance of that index has been dominated by a handful of mega cap tech companies, the so-called Magnificent 7. These seven companies have the largest weights in the index (34.84% as of 12/31/25) and therefore have an obvious ability to dominate index performance, but the performance of three small memory stocks in the first half of 2026 has been truly remarkable. These three companies—Micron (MU), Western Digital (WDC), and SanDisk (SNDK)—had a combined weight of just 0.69% of the S&P 500 on 12/31/25, yet they accounted for 24% of the index’s 8.3% first-half gain, according to a report in Bloomberg.

How could that happen? This outsized impact occurred because their individual first-half returns were astronomical, with Western Digital gaining 271%, Micron surging 305%, and SanDisk skyrocketing 858% (data from Koyfin.com). Obviously, chasing those returns in the first half paid dividends for active traders, but investors had a difficult time keeping up. The unusual performance of these three small players made it extraordinarily difficult for investors to beat, or even meet, the index performance in the first half, unless you happened to be overweight the memory stocks or were invested in passive index funds.

Now the question is whether these chip stocks, which have long been considered cyclical companies, have transitioned into secular growth stories due to the AI memory bottleneck. Here are the arguments:

The case for secular growth:

  • Long-Term Contracts: Historically, memory was a pure commodity and sold volatile spot pricing. That is changing. Companies like Micron are signing 3-to-5-year binding contracts with strict pricing bands. Micron expects up to 50% of its total revenue to be locked into these agreements.
  • The High-Bandwidth Memory (HBM) Bottleneck: HBM memory, used for AI applications, is significantly more complex than ordinary memory, making it difficult to bring new capacity on-line quickly. Micron and SanDisk have both reported that they are sold out through 2027.
  • AI Memory Intensity: Memory is a key AI bottleneck and the demand for AI appears to be insatiable, implying that memory demand will continue to outpace supply.

The case for a return to cyclicality:

  • The cure for high prices is high prices. Shortages for goods that are in demand will invariably create higher prices, and those higher prices create very attractive profitability for those able to address the market. However, high profits also invite the rapid expansion of capacity, whether from existing market participants or new competitors. Unless there is some reason that demand cannot be satiated under any conditions (which would be highly unusual), then over capacity (cyclicality) is likely to return. It is just a matter of time.

This question is highly important because cyclical companies have earnings that vary heavily with the economic cycle. Profits are high when the economy is strongest and earnings are low when the economy is weakest. That unique dynamic makes valuing cyclical companies counter-intuitive. Cyclical stocks look cheap at their earnings peak because the market knows they cannot maintain peak earnings indefinitely. As a result, P/E ratios are typically low when earnings are high. In general, you want to buy cyclical companies when their P/E is high (low earnings, bottom of the cycle) and sell them when their P/E is low (high earnings, top of the cycle). Right now, the memory stocks trade at very low P/E ratios, but it’s only a deal if these companies have successfully transitioned from cyclical to secular growth; otherwise, they represent dangerous value traps at the peak of a boom.

The long-term contracts should keep the secular growth hypothesis alive for a while longer, but eventually the chips are commoditized and demand is satiated, which ultimately should return them back into cyclical companies.

Have a great week!

 

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Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All information has been obtained from sources believed to be dependable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

All information has been obtained from sources believed to be dependable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that no such statements are guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

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By: Adam