2026 Second Quarter Commentary
- Jul 16
- 10 min read
For a printable version, click here.
If you are a client, click here for a copy of the client commentary which includes discussion of recent investment activity.
A Tale of Two Opportunities
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair.” – Charles Dickens
The opening line from the 1859 novel A Tale of Two Cities by Charles Dickens sets the stage for a story contrasting London and Paris during the French Revolution. Mr. Dickens uses the juxtaposition of the two cities as well as different characters to add depth to the story and highlight differences to dramatic effect. After a quarter in which the S&P 500 was up 15% (its best quarterly performance since the second quarter of 2020 and second-largest quarterly gain since the 2008 Great Financial Crisis) and FRM’s composite equity portfolio was down slightly, we thought it might be interesting to compare two different investment opportunities from today’s stock market. One which piqued our interest and resulted in the newest addition to your portfolios and the other one from which we will stay far, far away despite the market’s intense interest.
The S&P 500 performance was driven by the Information Technology (IT) sector, highlighted by a historic 88% quarterly gain in the Philadelphia Semiconductor Index (see the Portfolio Updates section for a discussion of where most FRM client accounts benefitted from that increase). This outperformance by the IT sector has driven it to a historic high of 40% of the S&P 500’s total market capitalization compared to the next largest sector, Financials, at 13%. (And the IT sector does not even include Alphabet Inc. (Nasdaq: GOOGL), Meta Platforms, Inc. (Nasdaq: META), Amazon.com, Inc. (Nasdaq: AMZN), Tesla, Inc. (Nasdaq: TSLA), or SpaceX (Nasdaq: SPCX).)
As shown in Chart 1, the IT sector is trading at a forward Price-to-Earnings (P/E) ratio of 26.2x while the S&P 500 trades at 20.2x. Importantly, FRM’s composite equity portfolio is valued at 11.3x forward earnings. Another important valuation metric is the last twelve months (LTM) Price-to-Sales and on that metric the IT sector is trading at 11.2x compared to the S&P 500 at 3.6x and
FRM at 1.3x as shown in Chart 2. As our two following examples will show, investing opportunities are much more interesting to us at reasonable valuations. We believe that has strongly contributed to our soon-to-be 36-year track record.
The first opportunity we present is the one that piqued our interest and resulted in a new position in your portfolios this quarter: the U.S. housing market. High mortgage rates, continued increases in the cost of living, and AI incited job market uncertainty have kept many prospective buyers on the sidelines and have led to four years of depressed sales. Existing home sales have hit near-historic lows not seen since 2009 with current homeowners reluctant to move and give up their 3% mortgage rates. Homebuilders have resorted to offering incentives, such as paying part of buyers’ mortgage cost, just to unload inventory. Data from the U.S. Census Bureau shows single-family housing starts were down 7% in May from the year before.[1] The latest NAHB/Wells Fargo Housing Market Index survey revealed that 35% of builders cut prices in June, up from 32% in May.[2]
How could we be excited about a market with this kind of backdrop? For starters, the U.S. housing market has favorable long-term fundamentals. U.S. Households continue to grow as shown in Chart 3.
The country also has favorable demographics with the largest age cohorts in Generation Z and Millennials entering their peak homebuying years as shown in Chart 4.
Moreover, the current homebuilding pace will not fully address the deficit resulting from a decade of underbuilding as shown in Chart 5.
The shortages of U.S. housing have reached upwards of four million homes. While mortgage rates around 6.5% are high relative to the 25-year average of 5.1%, buyers are likely to return to the market if mortgage rates come down, which would trigger pent-up buyer demand. It is possible that if rates come down in the next recession, that could actually benefit the housing market.
There is also potential in repairing and remodeling existing homes. As Chart 6 shows, the U.S. housing stock continues to age with the median age greater than 40 years. Spending on repair and remodel projects remains stable and could see increasing activity if housing demand returns to more normal levels.
Beyond the prospects for housing demand to improve from depressed levels, there is a chance to boost innovation in one of the least productive parts of the U.S. economy. Labor productivity in single family construction fell by more than 30% since 1970 and is essentially the same as it was in 1948. This productivity decline compares to labor productivity in the broader economy that has more than tripled over the period 1948-2023, according to data from the Bureau of Economic Analysis.[3] Factors outside the industry’s control, like land-use restrictions, are responsible for 40% of the productivity gap, Goldman Sachs estimates. But a lack of innovation explains 20%. American homes are still largely built the same way they were a century ago, often referred to as “stick-built.” More widespread adoption of modular construction, which is only used in 3% of new U.S. homes today, could be a way to make homes more affordable for buyers and more profitable for builders. A UBS study found that switching from traditional stick-built walls to modular open wall panels, which arguably represents the next logical possibility following roof trusses, can generate up to a 30% reduction in framing days with 20% less waste.[4]
We see plenty of reasons for optimism in today’s tough housing market, not least because of the opportunity we see in the market’s current valuation of industry participants. During the 2nd quarter, we purchased shares in one of the largest national lumber and building materials distributors with ~18% market share. This company is an active participant in pushing innovation with 48% of its sales from value-added products including prefabricated components. We were able to purchase shares in the company for around 0.5x sales and 13x normalized earnings. Our clients can read about the most recent addition to their portfolios in the Portfolio Updates section of this commentary.
The contrasting opportunity is a decidedly less terrestrial affair, which is part of the reason it has garnered much more excitement. By now most of you have guessed that the opportunity we are referring to is the recent initial public offering (IPO) of SpaceX (Nasdaq: SPCX). While we discuss above the stock market’s lack of excitement about the U.S. housing stock being underbuilt by the amount needed to house around 10,000,000 people,[5] somehow SpaceX’s goal to build housing and a city for 1,000,000 people on Mars has generated far more interest and market capitalization!
Before we go any further, we want to clearly establish a few points: 1) we are not rooting against, betting against or shorting SPCX shares and 2) we humbly submit that we do not know exactly what the future holds for either of these situations. This whole discussion is to help frame our investing discipline, explain why fundamental research and valuation matter to FRM, and explain why we prefer to maintain a margin of safety when investing our clients’ hard-earned dollars.
SpaceX was founded by Elon Musk in 2002 with the goal of lowering the cost of space transportation, in part by creating a reusable rocket, and ultimately making life multi-planetary and colonizing Mars. While it is the most distant of the operating goals for the company, we do think the Mars colonization contributes to the excitement around the company and its high IPO valuation. Ultimately the company states that “establishing a self-sufficient city on Mars will require upwards of one million people and millions of tonnes of cargo to be delivered to the Red planet. By launching more than 10 times per day to maximize transfer windows that open up every approximately 26 months, several thousand Starships…”[6] Colonizing Mars is a fantastically ambitious goal. Starship is currently being developed and, while not yet operating commercially, it has completed 12 launches. Designing and successfully launching the biggest and most powerful rocket ever built in history is an amazing achievement. However, SpaceX will need thousands of operational versions launching 10 times a day to achieve its extra-terrestrial goals. SpaceX currently maintains an active fleet of 24 reusable Falcon 9 first-stage boosters, and they average about one launch every two or three days.
SpaceX operates across three core business divisions: Space, Connectivity, and Artificial Intelligence (AI). Space is the segment discussed above that designs, builds, and operates reusable rockets for commercial and government payloads and will ultimately operate in the smallest addressable market among the company’s business segments as shown in Chart 7. The Connectivity segment, the only profitable segment, operates Starlink’s global satellite internet constellation providing broadband and wireless services to consumers, businesses, and mobile networks worldwide. Starlink will target the company’s second largest addressable market. Lastly, the AI division is the company’s segment focused on AI, including xAI, the large language model Grok, its recent $60 billion acquisition Cursor, data centers, and the X platform. This is the largest potential addressable market by far, mostly driven by the company’s estimates of the Enterprise Application market size of $22.7 trillion (which is 75% of 2025 US GDP). The Total Addressable Market (TAM) figures in Chart 7 were published in Form S-1 that SpaceX filed before the IPO.
Interestingly, they did not include a timeframe for each market to reach the size stated. (For context, the current size of the US broadband market is somewhere around $138 billion, with FRM holding Comcast as the largest provider with around 29.4 million residential subscribers. The current size of the US mobile (wireless telecommunications) market is around $336 billion, with FRM holding Verizon, the largest wireless provider, with around 146 million subscribers.) Starlink, a very successful business, currently generates $11.4 billion in revenue and has around 12 million global subscribers with 2.7 million located in the US.
If SpaceX is correct about the potential size of the markets in which the company operates, there is plenty of room for growth. If growth does maintain at such high levels, an open question is how much competition these fast-growing markets will attract. We have already referenced the competition that is present in the market for SpaceX’s most profitable business, Starlink. For the space segment, the company is the dominant player with an 82% share of all US space launches and revenue of $4.1 billion. The segment currently loses money and Blue Origin, one potential competitor backed by Jeff Bezos, just completed a new $10 billion round of fundraising. The AI segment is likely the most competitive market in which SpaceX operates, at least on Earth. The company has pointed to the prospect of developing and operating solar-powered data centers in space where they have none operating today. (Interestingly, there is exactly 1 high-end Nvidia H100 GPU (Graphics Processing Unit) operating, in space and it is not operated by SpaceX. It is aboard the Starcloud-1 satellite operated by AI-startup Starcloud.) A small AI data center on this planet might have 300 to 400 GPUs, while a hyperscale AI factory has 50,000 to over 200,000 GPUs. Nvidia’s base enterprise units, like Nvidia DGX H100, pack 8 GPUs into a single chassis. We believe it will take some time to develop a scaled AI data center presence in space.
SpaceX completed the largest IPO in history on June 12 and has since been valued at somewhere between $1.75 trillion and $2 trillion. As shown in Chart 8, the return so far has been tremendous for early investors. However, SpaceX must have many things go right for investors purchasing shares at the current valuation to earn a reasonable return. The company is not profitable, so we cannot compare a P/E ratio to judge the reasonableness of its valuation. However, SpaceX does have revenues and in 2025 they grew 33% to reach $18.7 billion. Shares are currently trading at over 100x sales. If the company continued this level of growth (33% a year) for a decade and the stock price did not change over that timeframe, it would bring the price-to-sales ratio to 6x. That is almost twice where the S&P 500 trades today. This also does not consider the amount of money SpaceX is likely to need to raise to fund its ambitions by selling shares and diluting existing shareholders.
We hope this juxtaposition of investment opportunities continues to reinforce our investing approach and discipline. We view stock ownership as ownership of the underlying business. We enjoy the hard work of research and fundamental analysis to understand and appraise the value of the underlying business. We continue to believe that paying an attractive price for that ownership is a very important part of the overall investing equation. The enthusiastic attention paid to the extremely overvalued parts of the stock market continues to give us a chance to own and invest in undervalued gems. For that reason, we are optimistic about the prospects for our clients’ portfolios.
[5] 4,000,000 units x 2.53 (the average U.S. household size)
Disclosure
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Foundation Resource Management, Inc. “FRM”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from FRM. Please remember to contact FRM if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services or if you would like to impose, add, or modify any reasonable restrictions to our investment advisory services. FRM is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. FRM claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. A copy of FRM’s current disclosure Brochure (Form ADV Part 2A) discussing our advisory services and fees or our GIPS-compliant performance information is available by emailing Abby McKelvy at amckelvy@frmlr.com.
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