Equity Markets
Equity returns through the first half of 2024 were broadly positive. US large cap equities outpaced most other asset classes; the S&P is up 15.29% year-to-date thanks to the Magnificent 7 which accounted for 61% of the S&P’s year-to-date return1. Value stocks and US small cap equities stumbled in the second quarter resulting in muted year-to-date performance relative to US large cap growth stocks. The top 10 stocks in the S&P trade now trade at 150% of their average Forward Price to Earnings (“P/E”) ratio since 19961. We expect these valuations will eventually revert toward long-term averages. This reversion typically happens via company earnings growing faster than their stock prices, represented by a flat or slow rising market, or stock prices dropping at a faster rate than their earnings, represented by a falling market.
While valuations are high, equity markets can continue to rally. US large cap remains the core of our equity allocation, but it is important to diversify equity exposure. Not only have we seen the concentration of the top 10 stocks in the S&P 500 grow to an all-time high, but the rise in these predominately technology stocks has resulted in the S&P 500 shifting toward a growth style index. This shift requires a deliberate focus on ensuring an adequate portfolio allocation to blend and value-style stocks. Additionally, asset classes such as US mid-cap, US small cap, and foreign equities have much more attractive valuations than US large cap, which would benefit portfolio returns if US large cap equities stumble. Missing investor expectations or a slight change in fundamental trends may produce meaningful price corrections.
US Economy
The US economy was solid throughout the first half of the year, 1st quarter GDP increased at a 1.4% annual rate and the Atlanta Fed currently estimates 2nd quarter GDP grew at a 2.7% annual rate2, but there were some signs of the economy cooling in recent weeks. Headline labor market numbers remained strong, nonfarm payrolls were up 2.6 million year-over-year in June3. However, underlying labor market indicators imply the headline numbers are weaker than they appear. The household survey (civilian employment) was up only 195,000 year-over-year3, while JOLTS job openings and quit rates have noticeably dropped since their peaks. Less job openings indicate companies are expecting less growth and therefore need less labor, and less nonfarm quits implies slowing wage growth as new job openings are not offering attractive enough compensation increases to lure employees from their current jobs.
There are also preliminary indicators of a slowing economy on the consumer side. Recent data showed consumer spending has slowed and rising delinquency rates in autos and credit cards suggest lower to middle income households are starting to struggle. Despite preliminary signs of economic cooling and high valuations, equity and credit markets are expecting a successful economic soft landing (flat to positive GDP growth and steady inflation with easing financial conditions). Mixed economic data that would change rate cut expectations or jeopardize a potential soft landing may increase market volatility in the second half of the year. Our allocation increase to intermediate-term core bonds will benefit portfolios if market volatility negatively impacts US equity and credit markets.
Fixed Income
Fixed income returns stabilized in the second quarter, for most of the 2nd quarter market participants settled on two Fed Rate cuts (a 0.50% reduction in rates) for the remainder of the year. The clearer short-term rate forecast along with consistently solid economic data resulted in a less volatile 10-year Treasury Bond yield. In early July, lower than expected June inflation (+3.3% y/y core CPI increases versus +3.4% forecast4) led bond investors to readjust rate cut expectations once again. The probability of three rate cuts (a 0.75% reduction in rates) increased drastically and current probabilities are fluctuating between two and three rate cuts during the second half of 20245. Regardless of whether the Fed reduces rates two or three times in its remaining four meetings this year, we think the Fed is entering the cutting stage of the current rate cycle soon. We expect short-term bond and CD performance has peaked, and longer duration intermediate bonds will start to outperform as the Fed starts to enact rate cuts.
Election Year
President Biden recently announced he would not be accepting the Democratic nomination for President. It is too early to draw conclusions about how this event shapes the potential outcome of this election, but we believe focusing on broader political trends is more insightful than focusing on individual candidates. Two specific trends we are watching are calls for a weaker dollar policy and continued lack of fiscal conservatism. A weaker dollar policy is a stark contrast to the strong dollar policy favored by both parties but has specific benefits such as making US exports more attractive globally. From an investment standpoint a weaker dollar would be a boon for foreign equities as foreign returns would be higher in US Dollar terms. This would increase demand for foreign investments and may boost international stock returns.
Both parties’ platforms also point to a continued budget deficit of 5-7 percent of GDP, implying increasing debt. Going forward, the debt ceiling will continue to be an issue especially at current higher interest rate levels. As election headlines continue to develop, we want to remind investors that historically there is no correlation between the performance of the market and which party holds the Presidency or the composition of Congress. Over the past 92 years, the S&P 500 has had positive performance 73% of the time and the average 4-year return after an election was 46.18%6. Although elections increase our anxiety and politicians often play upon our worst fears, staying focused on the long-term is a critical component of investment success.
1 – “Guide to the Markets”, J.P. Morgan Asset Management, June 2024 Morningstar;
2 – GDPNow, Federal Reserve Bank of Atlanta;
3— First Trust Advisors, “How Strong is the Labor Market”, July 8, 2024;
4— CNBC, “Inflation Falls 0.1% in June from prior month”, July 11,2024;
5 – CME FedWatch probabilities;
6 – “Client Resource Kit: Election”, First Trust