| Index | YTD | 2Q | 1Y | |
|---|---|---|---|---|
| S&P 500 | U.S. Large Cap | 15.29% | 4.28% | 24.56% |
| DJIA | U.S. Large Cap | 4.79 | -1.27 | 16.02 |
| Russell 3000 | U.S. All Cap | 13.56 | 3.22 | 23.13 |
| Russell 2000 | U.S. Small Cap | 1.73 | -3.28 | 10.06 |
| MSCI EAFE | Developed International | 5.34 | -0.42 | 11.54 |
| MSCI EM | Emerging Markets | 7.49 | 5.00 | 12.55 |
| Bloomberg U.S. HY | U.S. High Yield | 2.59 | 1.09 | 10.44 |
| Bloomberg U.S. Agg | U.S. Core Bond | -0.71 | 0.07 | 2.63 |
| Bloomberg Muni | U.S. Muni Bond | -0.40 | -0.02 | 3.21 |
| MSCI U.S. REIT GR | U.S. Real Estate | -0.24 | 0.08 | 7.60 |
Total Returns
Source: Factset
The market continued its upward trajectory in the second quarter, with the S&P 500 rising an additional 4%. The index increased 15% in the first half of 2024. While this performance was exceptional, once again mega-cap growth stocks led the way, with most other major asset classes declining. This year, a rising tide has not lifted all boats.
On the economic front, there was good news later in the quarter on inflation, although most other economic indicators turned down. This confluence is likely the result of the lagged impact of interest rate increases finally starting to bite. May inflation data showed the Consumer Price Index softening to 3.3% year-over-year, a much-sought-after outcome after sticky numbers caused concern of an inflation flare-up earlier in the year. While the Federal Reserve has not yet started cutting rates, there is cautious optimism that there will be a step down in interest rates in the second half of the year. As we started the year, the market expected six to seven rate cuts in 2024. That expectation is now down to just one or two cuts as the Fed waits for clear signs that inflation is trending downward. High interest rates cause the most pressure on small businesses, which have greater borrowing needs, and on the consumer, where sentiment is weak and has been for some time. In May, pending home sales hit an all-time low, reflecting the impact of interest rates on affordability of housing. With unemployment at 4%, most people have jobs, but initial claims are increasing and rising wages have not kept up with inflation, causing the average American to feel worse off.
Amid weakening economic results, the stock market overall had strong returns, but performance underneath the surface was uneven. Surprisingly, with the S&P 500 up double digits this year, only a quarter of the underlying companies are beating the index year-to-date. Moreover, the phenomenon of the big getting bigger has led to enhanced market concentration; the top 10 companies in the S&P 500 now account for 37% of the index, the highest in history. Along those lines, the performance of the market has been on the backs of just a few companies. As shown in the chart below, the S&P equal- weighted index (a proxy for the average stock) is lagging the S&P 500 index, which is a market-capitalization-weighted index (larger stocks have higher weights), by over 1,000 basis points year-to-date. The average company is up a few percent this year, while “the market” is up over 15%.
S&P 500 vs. S&P Equal Weighted Year to Date
(Indexed to 100, 1/1/2024)
Astonishingly, 32% of the market return this year is attributed to just one stock, Nvidia. Triple-digit returns in Nvidia two years in a row catapulted it from relatively unknown to a market capitalization of over $3 trillion, becoming the largest stock in the index for a few days before settling back to No. 3 behind Microsoft and Apple. It is important to note that these mega-cap companies that have done so well have been backed up by exceptional profitability coupled with better-than-average growth. In the past, the law of large numbers has made it hard for mega-cap companies to grow their profits as fast as smaller companies. More recently, this axiom has been turned on its head. The largest companies are in the sweet spot of technological advancement and artificial-intelligence-related tailwinds. On top of that, they have superior profitability. In the second quarter, the Magnificent 7 stocks are expected to grow earnings 28%, while earnings for the remaining 493 stocks in the S&P 500 are expected to decline slightly. This dynamic existed in 2023 and is expected to narrow but persist through 2024.
MAG 7 vs. S&P 500 Ex. MAG 7
Net Income Growth
A few items to keep in mind: 1) price/earnings ratios are significantly higher than the overall market for the Magnificent 7, leading to a high bar for financial results; 2) declining interest rates will likely favor smaller companies; and 3) as artificial intelligence shifts from an idea to implementation, the perceived long-term beneficiaries may change.
Recent dynamics have made keeping up with the concentrated S&P 500 elusive. Investors are naturally questioning the rationale behind active investing and portfolio diversification. While U.S. large-cap stocks have led the global stock market returns since the Great Recession, historical market leadership shifts over time between geography and company size. As a former trusted colleague used to say, trees don’t grow to the sky. Right now a small group of large companies are reaching for the stars.
Our focus is on playing the long-term trends and helping our clients achieve their goals while being mindful of risk. With this objective, we believe having portfolio exposure across asset classes, styles, and geographies is prudent, limiting volatility and leading to smoother returns for client portfolios over time.
The elephant (or donkey) in the room is the presidential election. During re-election years, the market has historically been up 16% on average. As of this writing in early July, it is in question if President Biden will continue as the nominee for the Democratic party—so we don’t even know if it is a re-election year. The uncertainty and antics of the election will cause many to feel a sense of stress and may also bring on market volatility. If dislocation takes place, we will be looking for opportunity. As future leadership becomes clear, and there is a more certain path forward (regardless of which party wins), the pattern has been for the market to regain strength. One thing is without question: it will be a fascinating summer and fall of politics. With a deep belief in the ingenuity of the American people, our confidence in the future is high.
Have a wonderful summer!
