“A fool and his money are easily parted.” — Old Anglican Church Proverb
Second Quarter Recap
Equities continued to rally in the spring, but at a slower pace than the first quarter. The S&P 500 and NASDAQ 100 had solid increases, while the more cyclical Dow Jones Industrials and Transportation indices dipped. Foreign bourses were mixed, with emerging markets leading.
As the period progressed, market breadth or the number of stocks participating in the rally began to narrow. Overall, the top ten stocks in the S&P accounted for nearly three quarters of the gain with only five sectors out of eleven rising in the second quarter.
Fixed income rose slightly despite a late quarter swoon, while commodities such as gold and oil continued to rise, though not at as torrid a pace as the first quarter.
Artificial Intelligence (AI), Obesity Drugs and Everything Else
An important reason for growing market participation is the emergence of two new investment themes – Artificial Intelligence and Obesity Drugs.
The promise of AI has evolved into reality, with “hyperscaler” companies such as Alphabet, Amazon, Apple and Microsoft heavily investing into this innovative technology, aiding semiconductor companies such as Nvidia, Micron Technology and others. The main question among investors is now how long will the rally in AI-related stocks last. At some point, hyperscalers will need to see actual end-user demand from customers, outcomes which may not be known for at least a another year.
Also taking the markets by storm are GPL-1 diabetes drugs, found to promote significant weight loss in obese patients. This is a $100 billion-plus market with tremendous potential, since most weight loss programs have proven to be ineffective in the past. The news has sparked much interest in this subset of healthcare, with Eli Lilly and Novo Nordisk at the forefront of participating companies.
There are many lagging stocks, not just in the S&P 500, but also in smaller capitalization indices such as the Russell 2000, where one-third of the companies are not currently profitable. Contributing to the headwinds, small and midcap equities rely heavily on floating rate debt, whose cost of servicing rose as the Fed hiked interest rates. Meanwhile, larger companies were able to refinance at lower fixed rates during the pandemic and push out maturities.
Elections Both Here and Abroad
This year features elections in many nations around the world. The people of Mexico, India, France and the UK have already voted, with some changes, but mostly expected outcomes leading to stable markets in their respective countries. One potential consequence: Governments in both the UK and France may increase spending and budget deficits in turn, may increase inflation.
The November general election in the U.S. has already provided changes in public expectations, with more twists and turns developing. At this stage, markets are discounting a potential GOP win with 81-year-old President Biden’s ability to continue for four more years is still in question. There are many possibilities: Biden may continue and either win or lose. Or another candidate may emerge for the Democrats. Also, control of Congress is at stake with Republicans and Democrats hanging on to razor thin majorities in the House of Representatives and Senate. Markets crave certainty and should have that after Election Day unless there is a situation similar to the 2000 election, where results were not known for a month. At present, such a scenario is possible though not likely — but there are still five months to go.
One thing to note is that neither political party is currently addressing the issue of Federal government deficit. Although the problem is not immediately acute, it could become serious if not addressed over the next decade. Its effects would manifest in such things as higher inflation and interest rates, as well as the standing of the U.S. dollar.
The Fed and the Path of Interest Rates
The Federal Reserve has not changed short-term Fed Funds rate for a year, waiting to see inflation get closer to its 2% target before lowering rates. The economy (especially consumer spending and employment) and inflation have been moderating since April. The question is now whether this is a prelude to a hard landing or merely the normalization of economic conditions post-pandemic. With the Fed being data dependent, every economic report will be carefully scrutinized for its future economic implications. Although forecasting is not a science, we predict two rate cuts by year end.
The Outlook for the Rest of 2024
- Historically, when stocks have a strong first half as they have so far in 2024, the balance of the year tends to be positive as well.
- Although the second half does also tend to be more choppy, and with the economy moderating and the general election in focus, we still believe this will hold true again.
- Longer maturity bonds may improve if the economy slows and the Federal Reserve cuts the Fed Funds rate. However, with lack of progress regarding the budget deficit, the gains may be muted.
The best strategy, especially in this environment, is a diversified portfolio featuring high quality securities with growing profitability, cash flow and good balance sheets, which is the hallmark of our investment philosophy. It is an approach which served our clients well during the initial dark days of the pandemic in March 2020, when uncertainty and risk were much higher than they are now.
As the great investor Sir John Templeton once observed, the market is normally characterized by at least some uncertainty and potential negative outcomes. Investing only when there are no perceived negatives is probably the worst time to invest, he said, because by that time almost everyone is fully invested, and the market is very vulnerable to any unwelcome news which will eventually happen.