Market Navigator – July 2024 edition

A strong but split market

After posting an impressive 26.3% return in 2023, the S&P 500 has managed to tack on another 15.3% in the first half in 2024. This is the 16th strongest start to a year since 1950, and the S&P 500 has now risen in seven of the past eight months. The market has suffered only one relatively modest (5.5%) setback this year that was recovered in the blink of an eye. On the surface, it has been smooth sailing. This, however, belies a split market below the surface and globally.

The average large cap U.S. stock, as proxied by the S&P Equal Weight Index, is up 5.1%, which would be a solid showing for most years, but trails the traditional market cap weighted index by a wide margin. Moreover, roughly 40% of stocks in the S&P 500 are down for the year. Mid caps are up about 5%, but small caps, being squeezed more by the higher interest costs and economic crosscurrents, are slightly down for the year.

A similar dynamic is seen overseas. International developed markets, which tend to be more leveraged to economically-sensitive areas of the market and have less technology exposure, are up 5.3%. Emerging markets (EM) are doing slightly better, with a 7.5% return. EM gains have been aided by strong performances in India and semiconductor heavyweight Taiwan, though offset by weaker returns in Latin America and China, despite increased government stimulus in the latter. The split market analogy is also evident in other market segments, where core U.S. bonds are down 0.71%, though commodities are up about 5%.

“Strong first halves tend to lead to further gains by year end, albeit with normal corrections along the way.”

Where to next?

Our big picture view, supported by the weight of the evidence, is stocks are in a bull market that deserves the benefit of the doubt.

The median price gain during previous bull markets since 1950 is 108%, and these have tended to last four to five years. Since the current bull market commenced in October 2022, the S&P 500 is up 53%.

Moreover, strong first halves tend to lead to further gains by year end, albeit with normal corrections along the way. There have been 27 previous instances where the S&P 500 had a first half total return of more than 10% since 1950:

• By the end of the year, stocks added to their gains in 24 instances, or 89% of the time, with average second half returns of 9%. Thus, a trend in motion, tends to stay in motion.
• During the second half, the deepest peak-to-trough pullback averaged 9%, even though stocks ultimately finished higher. With markets, it’s often two steps forward, one step back.

As we turn the page to the second half, the global election cycle will only heat up. We have already witnessed sharp market reactions around elections in India, Mexico, and France. And of course, all eyes will turn to the U.S. election as we head into the fall.

And while the election season will be important and will likely add to increased market swings domestically, an objective review of the historical data indicates that Washington’s perceived influence on market returns may be overstated.

Elections matter, but other factors in aggregate tend to matter more, not the least of which will be the path of the economy, inflation, Federal Reserve (Fed) policy, and corporate profits. (See Elections and markets – Conventional wisdom often wrong)

From an economic standpoint, we are seeing modest upward GDP revisions in Europe and China, though upward momentum in the U.S. has eased. We view this more of a sign that the current expectations for U.S. growth are now better aligned with reality.

Indeed, coming into the year, the consensus of economists expected 2024 U.S. GDP growth of about 1%, but that has since been revised to above 2%, a level at which our team suggests growth will settle.

Our greater message is U.S. economic growth is now cooling from the post-pandemic stimulus boom, but not weak. The easing in economic and inflation trends should allow the Fed to cut rates one or two times this year, likely starting in the fall. Importantly, the stock market has typically risen in the 6- to 12-month period following the first rate cut, as long as the economy avoids a recession, which is our current base case.

Positioning

From an asset allocation stance, we remain tilted toward equities, keeping with our long-standing U.S. and large cap bias. Since we upgraded stocks to overweight on the pullback in late April, the S&P 500 has rebounded about 8%. Near term, we anticipate that stocks will trade in a choppier fashion, digesting these recent gains.

Still, the primary uptrend appears intact, aided by forward earning estimates that continue to make fresh highs on a weekly basis and a global monetary easing cycle that is slowly getting underway.

Similarly, we have been positive on large cap tech this year and still are longer term. Yet, after the strongest one-month rolling outperformance was reached in more than 20 years during June, primarily driven by valuation and sentiment, we downgraded the sector to neutral on a short-term basis. Still, our work suggests the tech sector is far from bubble territory and that secular tailwinds arising from artificial intelligence will persist. In the interim, we are neutral, or market weight, not underweight the sector, with our work suggesting there will likely be a better opportunity to deploy capital.

Even with this shift, we keep our U.S. bias, given more stability in the economy and better earnings momentum relative to global counterparts. Moreover, the international developed markets just made a fresh all-time price low relative to the U.S. markets, and EM has also weakened on a relative basis after showing promise earlier this year as the economic results of China’s stimulus appear underwhelming.

On the fixed income side, we remain focused on high quality bonds given the tightness of spreads. The cooling economic and inflation trends should be a positive toward lower yields, though rising budget deficits and high Treasury issuance are offsets that likely result in a continued trading range near term.

Finally, we still see value in holding modest positions in commodities and gold to diversify portfolios, given economic crosscurrents and rising geopolitical uncertainty.

As always, we will continue to track the data and keep you informed as our views evolve.