Q2 2024 Capital Market Highlights

Quarterly Investment Updates

“The future is never a simple extrapolation of the present.” - Nate Silver, The Signal And The Noise 

The Market “Haves” and “Have Nots” 

This is nothing new, but there are always segments of the market doing better than others. In recent years, it’s been the relentless push of (large) technology stocks higher while most stocks flounder.

Thankfully, by assembling portfolios of the largest and smallest companies, your portfolios have benefited from the tailwinds in technology even when their dominance has become too obvious.

The 2nd quarter was another example of this effect, with a few well-known tech names rallying and most stocks just dreaming of keeping up. A good illustration here of just how hard it’s been for most stocks to keep up:

We remain firm believers in holding a diversified collection of assets capable of delivering growth and income, no matter the urge to chase or abandon the market’s current obsession. We’ll continue using math and sound judgment to keep risk at appropriate levels as individual holdings go in and out of favor.

State of the Market 

We find ourselves in an interesting place as 2024 passes the halfway point. While it sometimes feels like stocks can’t possibly go higher with all that is happening in the world, the fundamental backdrop appears quite healthy. We’re not growing at the pace we were a year or two ago, but that means inflation is no longer the headwind it was back then either:

And while we’re not experiencing the worker shortages we were in the 2021-2023 period; we have historically healthy employment:

And that’s resulting in compensation growth, which is unequivocally a positive for the overall economy:

This combination of strong employment and falling inflation feeds directly into corporate earnings, ultimately driving stocks higher over the long term. We’ve already experienced an “earnings recession” and are now seeing a broadening expansion of improving results:

On top of that, analyst forecasts are drifting higher, which has historically been a solid guide to further corporate prosperity (or lack thereof):

Q2 Actions  

We discussed a handful of ideas throughout the quarter but ultimately decided we were satisfied with the positioning. We continue to face a battle in the Growth sleeve between:

• Compelling prices in the broader list of stocks and,
• Compelling strength in the narrow leadership at the top.

We’ll keep monitoring this historic divergence, but we take comfort in the fact that we’ve been able to find a solid balance between the two extremes.

As Q3 began, we grew closer to tweaking our exposures within small caps to capture the unfolding opportunity better. More on that in a future update…

Risks and Outlook 

With businesses generally in good shape, there are three areas on our minds for the 2nd half of the year:

• Interest Rates 
• 2024 Election 
• Correlations 

For perspective on each, let’s look at some graphics:

Rates 

It appears the Federal Open Market Committee (FOMC) is finally ready to cut rates from their current target of 5.25-5.50%. It will not likely happen in July, but markets are forecasting a 0.25% cut in September, and they look pretty confident that a full 1% will be cut by March.

We’re not convinced this will change much of the math for longer-term bonds, as history shows your total return as a bond investor is pretty close to your coupon, absent credit considerations:

However, it reduces the appeal of holding short-term CDs and T-bills because of the prospect of reduced yields and the damaging long-term effects of inflation and government spending on purchasing power.

Election

We can’t ignore the obvious that there will be daily headlines about the November election. While there will certainly be sectors and constituents, who may see changes to the good or bad, as long-term investors, we know that the outcomes are generally minor noise in the overwhelming growth of our United States.

We’ll monitor events and consider their implications, but at this point, we are not expecting radical portfolio changes based on election results.

Correlations

We noted earlier that when you hold a cross-section of diversified assets, there will always be something that doesn’t work. In the past few years, that’s been anything not tied directly to the biggest of the S&P 500.

First in that discussion is fixed income. As you know, after COVID, we completely overhauled our defensive sleeve because the math on traditional fixed income just didn’t add up.

We didn’t like the return prospects, and equally important, we weren’t confident that bonds would continue to protect portfolios when equities entered a rough patch. 2022 turned out to be a terrible year for both stocks and bonds, and the correlation between the two remains dangerously high.

The other clear laggard has been anything outside of large technology companies, namely small caps and international stocks. We remain underweight but hold in the name of diversification and more reasonable valuations.

It was a dreadful first half for smaller stocks, but we think the long-term investment case for this area remains. The two charts below make the beginning case as to why.

Conclusion

We feel great about our growth and defensive sleeves and the balance between the two. We’ll continue to monitor the activities in Washington and across Corporate America and will loop you in on any changes to our thinking. As always, we appreciate your trust and welcome your feedback.

*The views expressed are those of the author as of the date noted, are subject to change based on market and other various conditions. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax or legal advice. Keep in mind that current and historical facts may not be indicative of future results.