Second Quarter 2024 Write-Up

Equity markets were strong in the first half of 2024.  For the first six months of the year, the Dow Jones Industrial Index gained 3.8%, the Standard & Poor’s 500 Index added 14.5% and the Nasdaq surged 18.1%, mostly on the back of outsized performance from a handful of mega-cap tech stocks.  If this sounds familiar, it is because the returns resemble almost a carbon copy of last year’s second quarter.  The first quarter of 2024 saw a rising tide that lifted most stocks, while the second quarter saw broad weakness in most stocks countered by extreme outperformance among a few mega-capitalization technology stocks.  The economy is still growing, but some indicators suggest that the growth trend is weakening.  Bond yields declined from the start of the year (current 10-year Treasury yield: 4.17% vs. Q4 2023: 4.45%), but are still far above pre-Covid levels in the +/-2% range.   Equity risk premiums are very low, and it makes sense for most investors to increase their exposures to select fixed income investments.

Let’s look at recent consumer sentiment readings and the current trend in GDP.  According to the University of Michigan Consumer Survey, consumer sentiment readings declined 10% this May (the most recent available survey) following three consecutive months of very little change.  This 8.1 index-point decrease to 69.1 is statistically significant and brings sentiment to the lowest reading in five months.  The year-ahead outlook for business conditions saw a particularly steep decline, while views about personal finances were little changed.  Consumers expressed deepening concern over labor markets: they expect unemployment rates to rise and income growth to slow. The prospect of continued high interest rates also weighed down consumer views. These deteriorating expectations suggest that multiple factors pose downside risk for consumer spending. Still, sentiment remains almost 20% above a year ago and about 40% above the all-time historic low in June 2022, reflecting how much consumer views have improved as inflation declined.  Preliminary consumer sentiment readings for June continued to deteriorate (to a reading of 65.6), while June’s preliminary reading of current economic conditions declined markedly to the lowest reading in the last twelve months.  The U. of M. Inflation Survey has been pretty steady in 2024, with consumer expectations of one- and five-year inflation rates pegged at around 3.0%, or about 50% higher than the Federal Reserve’s long-term goal of 2.0%.  The latest report from the Bureau of Labor Statistics pegged the June CPI at 3.0%, a slight decrease from the May report.

The New York Federal Reserve Bank’s Survey of Consumer Expectations June survey was generally consistent with the University of Michigan’s findings.  The latest Bureau of Economic Analysis report of first quarter real GDP came in at 1.4%, down from the fourth quarter reading of 3.4% and down significantly from the third quarter 2023 reading of 4.9%.  More important than the headline GDP number is the addenda item: Final Sales to Domestic Purchasers, which removes intra-period reporting anomalies like exports, government sales and inventory fluctuations.  Here, the 2.4% increase was weaker than the previous quarter’s 3.5% reading, but in-line with the range of 2.0-3.8% in the last year or so.  GDP growth appears to be decelerating, but the evidence seems less than conclusive at this point.  

 

Looking at the domestic equity market, the first half of 2024 looked a lot like the first half of 2023, with a few mega-cap tech stocks driving S&P 500 Index returns.  The Magnificent Seven (Apple, Amazon, Meta Platforms, Microsoft, Nvidia, Tesla and Alphabet) increased 31.0% in the first half of 2024, versus an increase of 14.5% for the S&P 500 Index.  The S&P 493 (that is, the S&P 500 less those seven stocks), gained 7.4% in the first half.  While the S&P 500 Index added $5.8 trillion in market capitalization through the first half of 2024, three Mag Seven stocks (Nvidia, Alphabet and Microsoft) added $2.9 trillion of market capitalization during the period.   If the S&P 500 Index were equally weighted among all its constituents, rather than market capitalization-weighted, it would have gained 4.1% in the first half, not 14.5%.  Currently, the ten largest market cap stocks make up 37.0% of the S&P 500, up from 14.0% a decade ago.  However, the ten largest market cap names also contributed 26.8% of S&P 500 earnings, and as a whole, are growing earnings faster than the S&P 493.  The current concentration in the ten largest stocks is extreme for recent times, but not unprecedented.  In the 1930s and early 1960s concentration levels of the ten largest stocks reached over 30%, and in the early 1900s reached 38%.  What might be very different this time is that the enormous spending of three of the Magnificent Seven (Amazon, Alphabet and Microsoft) is driving the out-sized performance of the Magnificent Seven’s greatest contributor (Nvidia).  Interesting times.  

The Magnificent Seven are growing quickly, and sport valuations (31x forecast earnings) that presuppose flawless execution and benevolent economic conditions.  The S&P 493 are growing slower, but have more forgiving valuations (17.5x forward earnings versus a long-term average of 15.7x).  Equities do not look like a bargain at these levels, but bonds offer good relative value.  U.S. Treasuries’ current yield of 4.8% is well above the ten-year median yield of 1.8%; Municipals’ (tax-adjusted) current yield of 6.3% is well above the median yield of 3.9%; Corporate bonds currently yield 5.5%, versus a ten-year median yield of 3.3%.  Put a little hay in the barn.  Buy some bonds.  

 

Sincerely,

Your Team at Baxter Investment Management

* Municipal yields are adjusted for taxable benefits at the highest marginal tax rate

 

 

Source: J.P. Morgan