Q2 2024 Market Review

The quarter started with investor concerns of continued inflation subduing expectations of multiple rate cuts due to higher inflation readings and the Fed’s April release of their March meeting continued that. Those thoughts caused bond yields to rise, and, by extension, bond prices to drop.  Yet in May the Fed’s preferred inflation indicator showed a surprise drop to 2.7% y/o/y and a further slight decrease in June to 2.6% creating further optimism that the Fed will begin rate cuts this year.

Last quarter we saw Equity market performance diverge from its previously high negative correlation to the bond markets.  This quarter that correlation re-emerged, with stocks broadly having a slightly positive quarter.  The positive returns were centered solely around U.S. Large Cap Growth, with major divergences and losses in most other areas giving most investors flat results on their portfolios for the quarter.

Equities up and Bonds down for the year

Equities continued their positive performance for the quarter and the year, with the S&P 500 clocking in a 15% return YTD.  The smaller cap component of the U.S. market was significantly lower at only 2% on the year, while foreign stocks returned a respectable 6%. 

Real estate stock valuations followed bonds; as they contend with not only higher funding costs due to interest rates; but relatively less “yield demand” as their dividend yields compete with higher bond yields.

Equity Market broad gains mask concentration of a few U.S. Tech Giants

As discussed last quarter, the equity market’s returns continue to be concentrated in a very small handful of stocks, the “Magnificent 7[1]” due to the market’s thirst for anything AI related and their indifference to the funding costs from the bond market.  As the S&P 500 is a market-weighted index; these 7 stocks now make up over 30% of the S&P 500’s market capitalization; but more surprising is that they contributed 63% of the S&P 500’s returns YTD.  In other words, the other 98.6% of the companies, provided only a third of the total S&P 500 return.  In short, if you have market exposure to the S&P 500 (you do) then you have exposure to these handful of stocks. 

But wait, there’s more!   Nvidia’s 150%+ return for 2024 is responsible for 31% of the S&P 500’s return and has grown its market cap (and weighting of the S&P 500) to become nearly equal to Apple and Microsoft. 

Tech Valuations are high

This optimism in this narrow handful of stocks has made the Tech sector pricier.  While the methodology and timeframes used in creating a Price to Earnings ratio can yield significantly different results, either way, we can see that the current Price to Earnings ratio of 30-35 (depending on the calculation method) is high relative to other sectors and its historical P/E ratio. 

Many of the promises of AI, like those of the internet, will likely come true and it will become valuable and widely used.

Valuations, nor the general mania, haven’t nearly approached the levels at the peak of the internet bubble; however, it is beginning to feel somewhat similar, and we wonder when and how the reversion to the mean will occur. 

Diversification

As this concentration of returns has spread to the U.S. indices, coupled with a decade of outperformance, it obviously results in a valuation divergence between the U.S. and the rest of the world that is historically relatively high.

These valuation gaps should eventually revert to the mean, rewarding diversified portfolios with lower volatility and, most likely, higher returns.

[1] Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla