Global Market Review and Outlook

Capital market returns for the second quarter of 2024 were mixed. Within U.S. equities, large-cap stocks continued to shine, with the S&P 500 advancing 4% on the back of further momentum related to artificial intelligence (AI). Smaller and midsize domestic stocks languished in the quarter, however, each declining 3%. Internationally, emerging markets advanced nicely (+5%) as fiscal support in China improved the outlook, but developed markets fell modestly (-0.4%). Lastly, fixed income eked out a very modest gain (0.1%), but volatility was high as interest rate clarity was in flux. Overall, the disparate performance across and within asset classes and geographies reveals a very narrow investing environment as investors focus on secular themes while the broader markets grapple with mixed economic signals.

Source: Factset

Economic growth in the U.S. in the quarter remained positive, but data softened throughout the period. This has some calling into question the economic resilience that characterized in 2023. In April, job growth moderated, retail sales declined, and manufacturing data surveys suggested an upcoming slowdown. In May, pending home sales hit an all-time low, raising concern about the strength of the consumer. With consumption accounting for roughly two-thirds of economic activity in the U.S., the pace of further economic growth will likely hinge on the consumer’s ability and willingness to continue to spend. With savings dwindling and financing rates high, future spending seems dependent on the strength of the labor market. The labor market remains in good shape; job creation is healthy and wage gains have outpaced inflation for the past year. This should help support continued consumer spending, albeit at perhaps a slower pace.

Amid weakening economic results, the U.S. equity market headline return of 15% for the first half of the year may be perplexing. The devil is in the details, however, as only a quarter of the underlying companies are beating the index year-to-date. Instead, most of the S&P 500 advance can still be attributed to just a few large technology companies that are bolstered by the game-changing promise of AI. Nvidia, Apple, and Google accounted for more than 100% of the S&P 500’s 4% second-quarter return. This contrasts to the performance of the average large-cap stock in the S&P 500 index, which was down 3% in the quarter.

Another way to think about the disparity in large-cap performance is shown in the chart below. The S&P equal-weighted index (a proxy for the average performance of large stocks) is lagging the S&P 500 index, which is a market-capitalization-weighted index (larger companies have higher weights), by over 10 percentage points year-to-date. Companies on average are 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)

[The outperformance of these select mega-cap companies is not without merit. These largest companies (dubbed the Magnificent 7) are in the sweet spot of technological advancement and AI-related tailwinds and as such growth and profitability has been robust. Earnings for these companies are expected to grow nearly 30% in the second quarter, while earnings for the rest of the 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

Smaller and midsize businesses have also been left out of the AI-fueled stock advance. The Russell 2500 index, which is a representation of small and midsize companies, was down 4% in the second quarter, while the S&P 600 small cap index declined 3% for the second period. Both are essentially flat on the year and trail the S&P 500 on the year notably.

Year-to-Date Total Returns

The lackluster returns for smaller companies are driven by the perception that these firms struggle in an economic environment where inflation is sticky and interest rates remain high. With typically less financial flexibility (higher debt) and more restrained pricing power, small businesses are in a tougher position to protect and grow profits. This could all change if the Federal Reserve begins to lower interest rates; access to cheaper capital would enable these companies to increase profits over time. Until then, lowered expectations and more attractive valuations set the stage for solid future performance. Interest rates remain a key focus of the markets. The silver lining with a weakening demand picture is less pressure on inflation, and there was good news on that front recently. June inflation data showed the Consumer Price Index declining 0.1% month-over-month. This was a much-sought-after outcome after sticky inflation numbers caused concern of a flare-up earlier in the year. As a result, there is cautious optimism that the Fed will lower rates in the second half of the year. Admittedly, the market has mistaken the timing of these potential rate cuts for some time now. As we started the year, the market expected six to seven rate cuts in 2024. That expectation is now down to just one as the Fed waits for clear signs that inflation is trending toward its 2% target. Regardless of timing, a rate cut in the current economic environment would be well received by the markets and a signal that the Fed believes that inflation is under control.

We expect the second half of 2024 to be eventful. There is a renewed sensitivity on economic data and the economy’s trajectory. There is the specter of interest rate cuts, and the second-quarter earnings season will provide an opportunity to hear updated commentaries from companies. In addition, the elephant (or donkey) in the room is the presidential election. During re-election years, the market has historically been up 16% on average. Technically, we are no longer in a re-election year given President Biden’s recent decision to drop out of the 2024 race. Still, we expect the uncertainty and antics of a normal election to be on full display this fall, and with that typically comes 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.

Regards,

John, Cam, Lauren, and team