The Market Had a Fantastic Second Quarter. But Here's the Warning No One Is Talking About.

The market is booming, with the S&P 500 (SNPINDEX: ^GSPC) up 9% year to date, driven by artificial intelligence (AI). Or that's the story at the surface level.

After a rally from April lows, the S&P 500 gained 15% in the second quarter of the year. However, that masks what's been happening more recently; the S&P 500 is roughly flat over the past month. Here's what's going on, and what investors should do.

Oil, inflation, and interest rates

The market is back to record highs, although it hasn't moved much over the past few weeks. It recouped its April losses, caused by the Iran war and spiking oil prices, since oil prices have eased. However, the economic data coming in is mixed, at best.

Image source: Getty Images.

In his first meeting as Federal Reserve chairman, Kevin Warsh declined to cut interest rates, which was expected. While he didn't provide future guidance, the Federal Open Market Committee (FOMC) expects a rate hike before the year is out. This is as inflation continues to rise faster than the Fed would like; the Consumer Price Index (CPI) rose 4.1% in May, while the Fed is targeting a 2% rate.

Finally, as of Wednesday morning, President Donald Trump has said the ceasefire with Iran is over, and oil prices are already spiking again.

What should investors do?

The market has been factoring all of this in over the past month, and AI isn't necessarily providing more growth juice right now. In fact, many of the largest AI companies, like Nvidia, Amazon, and Alphabet, are also flat or down over the past month.

On top of that, the market is near its most expensive level ever. Not only is it at record highs, but its P/E ratio adjusted for inflation, or CAPE ratio, is 41, right behind a peak of 44 it reached in 2000. That preceded a major market crash and three back-to-back years of S&P 500 losses.

If you're worried, the worst thing you can do right now is get out of the markets. Historically, successful investors have stayed in the market and benefited from rebounds. You can't time the market, and you can only see the best exit and reentry points in hindsight.

What you can do, though, is make sure your portfolio is set up for any kind of circumstances. That means having the growth stocks you want to take advantage of the strong bull market, but also the safe stocks you need to protect your assets in the case of a market crash. If you're not well positioned to weather it, you might want to reshuffle your portfolio and make sure you allocate enough of your holdings to protective stocks.