“I am unable to think of any critical, complex human activity that could be safely reduced to a simple summary equation.” – Jerome Powell
Second Quarter Insights: U.S. Stocks Continue to Shine
The second quarter of 2024 brought another round of impressive returns for equity investors, who have seen the S&P 500 record 31 all-time highs through the first half of 2024. Volatility remains well below historical averages, and stocks in the U.S. continue to find ways to move higher.
First-quarter earnings once again proved resilient, highlighting the impressive earnings power and profitability of the U.S market. In bonds, the volatility has been more pronounced, as the markets continue to grapple with the future path of inflation and monetary policy. On the economic front, most measures of inflation appear to be moving closer to the Fed’s target and could open the door for rate cuts as soon as September of this year. Meanwhile, the economy continues to expand despite more restrictive fiscal and monetary policy.
Stocks – Performance Gap Widens
It was another rewarding quarter for most equity investors, although there was a significant dispersion in returns. The S&P 500 posted a total return of more than 4% in the second quarter. Meanwhile, small cap stocks faded from their strong start to the year, and fell by 3% during the quarter. Stocks in the technology, communication services, and utilities sectors were amongst the top performers this quarter, while materials, industrials, and energy stocks rounded out the bottom. International developed stocks were basically flat for the quarter, while emerging market stocks led the way, rallying more than 5.4%.
Market Leadership Narrows
In last quarter’s commentary, we discussed the expansion of market breadth and leadership beyond the megacap tech stocks here in the U.S. Looking back on the past quarter, that trend has since reversed with a much narrower subset of stocks accounting for the bulk of recent gains. Over the past quarter, just three of the 11 S&P 500 sectors posted positive returns, a stark contrast to the first quarter of the year.
The so-called Magnificent Seven stocks continue to lead the market, particularly following Nvidia's relentless move higher – rallying 150% this year and briefly dethroning Microsoft as the largest company in the world by market cap. Other areas of the market, such as value stocks, international stocks, and small cap stocks, are still higher, but continue to lag. As we look ahead to the remainder of 2024 and beyond, we believe that current valuations should support the merits of diversification within equities.
Bonds - Attractive Yields Going Forward
Interest rates moved higher over the course of the second quarter, leaving bonds mostly unchanged from a total return standpoint. After starting the year at 3.86%, the yield on the 10-year Treasury note finished June trading around 4.39%. As a result, the Bloomberg taxable bond index is lower by about 0.7% on the year, while the Bloomberg municipal bond index is lower by about 0.40%. In general, we continue to view most areas of fixed income as relatively attractive for investors looking to their portfolio for stable cash flow and diversification to equities. We believe bonds should once again be able to earn their keep in portfolios, with yields on the taxable and municipal bond indexes sitting around 5% and 3.7%, respectively, as we head into the second half of 2024.
Federal Reserve – Rate Cuts on the Horizon
The most recent FOMC policy-setting meeting in June marked the seventh consecutive meeting at which the Fed opted to hold interest rates steady at the current target range of 5.25%-5.50%. Notably, the Fed revised its expectations for future rate cuts this year from three to just one and continued to stress the importance of further progress on the inflation front. Inflation has been uneven but starting to head in the right direction again after stalling earlier this year. Most recently, the Fed’s preferred measure of inflation, the Core PCE Price index, fell to 2.5% in May, from 2.8% in April. However, uneven progress on disinflation, especially in areas such as shelter and auto insurance, has caused the Fed to take a cautious approach toward easing policy. The bottom line is the Fed needs more evidence inflation is sustainably moving back toward its 2% target before acting. With just four policy-setting meetings remaining this year, we believe rate cuts could begin as early as September, contingent on several key economic data reports between now and then.
Economy – Expansion Continues
Economic indicators in the second quarter continued to point toward a growing but slowing economy. The final estimate of first-quarter GDP showed the U.S. economy expanded at a 1.4% annualized rate. Looking forward, the Atlanta Fed’s GDP Now model projects real GDP growth of 2.2% for the second quarter of this year. On the labor front, the most recent nonfarm payrolls report showed the U.S. economy added 272,000 jobs in May, with broad-based job growth across most sectors. With that said, we have seen some downward revisions to employment readings, and continuing jobless claims have been moving higher, indicating some normalization of this historically tight labor market. In aggregate, the economy continues to expand while the labor market remains strong. However, a weaker consumer, tighter financial conditions, and slowing business investment could begin to weigh on growth ahead.
Earnings – Supportive of Equity Rally
Bringing it all together, we believe a good deal of the recent enthusiasm in stocks is warranted. A significant portion of the broader rally in stocks can be attributed to higher profits, not just multiple, or valuation expansion. For the first quarter, the S&P 500 grew earnings at an impressive 6.2%, with eight of the 11 S&P 500 sectors reporting positive year-over-year earnings growth. Analysts expect this trend to continue, with earnings growth of around 9% in the second quarter of 2024. While there is plenty of good news currently priced into the markets, there have been strong fundamentals to support a good deal of this rally.
Outlook – Expect Higher Volatility Ahead
The first half of 2024 brought strong returns in stocks with relatively low volatility, particularly in June, where the largest single-day drop for the S&P 500 was just 0.4%, the calmest month for stocks in nearly five years. The S&P 500 hasn't seen prices fall by more than 1% in a single day since April, which is quite uncommon. One measure of volatility we like to keep an eye on is the VIX index, otherwise known as the "fear gauge", which measures implied volatility in the stock market over the next month. A lower index reading indicates lower expected volatility, while a higher reading suggests higher expected volatility. Since 1990, the VIX index has averaged right around 19.5. Today, the VIX sits at right around 13, which is certainly low, but not necessarily unusual to see given where we are in the market cycle. Low volatility and calm markets do not mean stocks will have to move lower from here, but we do believe investors should brace for higher market volatility in the second half of this year, given key Federal Reserve policy decisions, the elections, and the potential for geopolitical unrest. As we move into the second half of 2024, we expect broadening profit leadership across sectors could lead to a more broad-based market rally in stocks, and we believe current valuations should support the merits of diversification. In bonds, solid income levels along with the potential for price appreciation given falling rates make this an attractive addition for income and diversification in the overall portfolio allocation.
Please let me know if you would like to set up a meeting to discuss any questions about your portfolio.
Alex Mayrand, CFP®
Partner, Chief Investment and Information Officer, Senior Financial Advisor
This letter was created by a third party and was not written or created by the Advisor named above. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Investments in individual sectors may be more volatile than investments that diversify across many industry sectors and companies. Certain sectors of the market may expose an investor to more risk than others. An investment cannot be made directly into an index. Securities offered through Avantax Investment Services℠, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory Services℠ and Avantax Planning Partners℠. Insurance services offered through licensed agents of Avantax Insurance Agency℠, Avantax Insurance Services℠, and Avantax Planning Partners. 3200 Olympus Blvd., Suite 100, Dallas, TX 75019, 972-870-6000. Although Avantax does not provide or supervise tax or accounting services, our Financial Professionals may offer these services through their independent outside business. Not all Financial Professionals are licensed to offer all products or services. Financial planning and investment advisory services require separate licenses. For additional information ask your Financial Professional or contact us toll-free at (888) 438-3781.The S&P 500 Index is a market capitalization-weighted index composed of the 500 most widely held stocks whose assets and/or revenues are based in the U.S. The MSCI World ex USA All Cap Index is a free float-adjusted market capitalization equity index tracking performance in the global developed markets. The MSCI Emerging Markets Index is a free float-adjusted market capitalization equity index tracking performance in the global emerging markets. The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based index measuring the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, and includes Treasuries, government-related and corporate securities, MBS, ABS, and CMBS. The Bloomberg Barclays Municipal Bond Index is a rules-based, market-value-weighted index measuring the U.S. dollar-denominated long-term tax-exempt bond market and includes four main sectors: state and local GO, revenue, insured, and pre-refunded bonds. The indices referred to herein are for comparative purposes only and are not necessarily intended to parallel any particular investment vehicle or strategy. Indices are neither managed, nor accessible through direct investment, nor subject to advisory fees or other expenses. Sources: Blackrock, JP Morgan, Bloomberg, Goldman Sachs, Morningstar, and YCharts. This material is being provided for informational purpose only and was obtained from sources deemed to be reliable. It is not represented as being complete, and its accuracy is not guaranteed. The information and opinions given are subject to change at any time based on market and other conditions and are not recommendations of or solicitations to buy or sell any security. Opinions and forecasts expressed herein might not actually occur.