By: Darren W. King | Wealth Management
Equity markets continued pushing through all-time highs in the second quarter, as economic growth remained resilient and financial markets began to anticipate the Fed cutting rates in 2024 and beyond. The S&P 500 gained 4.28% in the 2nd quarter, and 15.29% for the year. Markets moved higher, despite some signs of higher-for-longer rates slowing economic activity. The Technology-heavy NASDAQ was up 18.57% ytd., while the DOW Jones Industrial Average was up only 4.79%. The Russell 2000 Small Cap Index finished the first half of the year up 1.73% over the same period. International developed market equities, as measured by the Morgan Stanley Capital International Europe, Australasia, and Far East Index (MSCI EAFE), closed the first half up 5.78% in US dollar terms and up 11.05% in local currency. The MSCI Emerging Markets Share Price Index closed 2Q 2024 up 7.60% in US dollar terms.
The second quarter witnessed the same technology names regain leadership, with artificial intelligence-levered sectors outperforming the S&P 500. S&P 500 sector results through 6/30/24: Technology 28.24%, Communication Services 26.68%, S&P 500 15.29%, Energy 10.93%, Financials 10.16%, Utilities 9.44%, Consumer Staples 8.98%, Health Care 7.81%, Industrials 7.75%, Consumer Discretionary 5.66%, Materials 4.05% and Real Estate -2.45%. Amazon, Meta Platforms, Microsoft, Alphabet, Broadcom and Nvidia accounted for 64% of the S&P 500 six month return of 15.29%. The remaining 494 S&P 500 constituents contributed 5.23% of the first half’s 15.29% return. Value, defensive, and interest-rate sensitive stocks posted less impressive returns and have struggled to reach new highs. Equity markets continue treading water, when discounting a select group of technology mega-caps, that have continued their performance dominance.
Based on current consensus earnings forecasts, the forward 12-month P/E ratio for the S&P 500 is 21.1X, more expensive than the five-year average P/E of about 19.6X. Currently, the market is estimating 11% earnings growth on 5% revenue growth in 2024. Average equity strategists’ bottom-up price targets for the S&P 500 in 2024 are at 5589, 2% higher than current trading levels. We are expecting a more normalized return environment for equities for the remainder of 2024 with valuations needing to also normalize after the strong rally over the past 3 quarters. However, we do see a continued broadening of equity returns out of technology and into other areas of the market that have not participated as dramatically in the equity rally. Part of the first half rally in stocks can be attributed to earnings estimates for 2024 moving higher since the end of last year. The level of interest rates will continue to be the main determinate of equity returns in 2024. Risk still remains that the Fed could trigger an economic slowdown, the longer they hold rates at restrictive levels in their effort to move inflation back to their 2% targets.
During their June 2024 meeting, the Federal Reserve kept interest rates steady, and set the table for only one cut in 2024 and four in 2025. However, market expectations at the end of 2023, for 150 basis points of interest rate cuts in 2024, have quickly moved closer to Fed guidance for 25 to 50 basis points of interest rate reduction. Through June, the Federal reserve have initiated eleven interest rate hikes, as the fed funds rate now sits at 5.25%-5.50%, the highest level since 2007. Latest economic projections show an economy that is growing at much higher levels than late 2023 projections, but with slightly higher inflation remaining. GDP is estimated by the Fed to be 2.1% in 2024, revised up from 1.4% GDP growth estimates assumed in December. As measured by the Fed’s preferred inflation gauge, the Core Personal Consumption Expenditures Index, inflation is estimated to end 2024 at 2.6%, slightly higher than earlier projections at 2.4%. As of July 2, the fixed income markets place a first rate cut by the Fed in September at around 66% odds; a drastic move from late 2023 when many saw the Fed reducing interest rates as early as March of this year. While equity markets rallied in the second quarter on signs of improving economic and earnings growth, the bond market sent interest rates higher on signs the economy is strong enough for higher interest rates for longer. As of July 5, 10-year treasuries now yield 4.28%, up from 3.88% at the end of 2023.
The 10-year treasury staged a significant correction through June of 2024, starting the year at 3.88% and ending the quarter at 4.40%. Longest duration bonds underperformed shorter duration issues as yields rose over the course of 2024. 20+ year treasuries were down 5.90% in the first half of the year, while intermediate treasuries were up .21%. In a risk-off trade, higher credit quality outperformed the lowest credit quality issues. Aaa rated bonds within the Barclays U.S. Aggregate Index were up .55% in the first half of 2024, while Baa rated bonds lost .15% during the same period.
The Bloomberg Dollar Spot Index strengthened 4.67% in the first half of 2024, as global markets now see higher interest rates for longer for the US, as compared to our trading partners. Light crude oil futures rose 14% in 2024, with WTI oil futures rising to $81.54 from $71.65 at the end of 2023. 30-year mortgage rates rose from 6.99% at the end of 2023 to 7.26% by the end of the quarter, while 30-year treasuries rose 53 basis points from 4.03% at year-end 2023 to 4.56% at the end of the second quarter.
According to the Bureau of Labor Statistics, the June employment report showed 206K jobs gained during the month, with numbers for the prior two months revised down by 111,000 jobs. Most of the gains in employment came from government hiring. The private sector showed signs of slowing. Hiring remains elevated in the health care and government industries, while manufacturing hiring contracted, and business temporary help declined by the most in three years. The June jobs number reported unemployment at 4.1%, the highest unemployment rate since November 2021. The labor force participation rate in June was 62.6%, up from the pandemic trough of 60.2% in April of 2020. For June, average hourly earnings rose 3.9%, below the recent wage inflation numbers that were averaging greater than 5% for most of 2023. The latest jobs numbers indicate a slower trend in wage inflation and signs that the restrictive monetary policy is finally working its way through the economy. We see any further slowing in the jobs numbers over the summer triggering a first rate cut by the Fed at their September meeting. Further slowing in economic trends could play a major factor in the impending presidential election.
Retail sales in May increased .1% from the prior month, after an April reading that was down .2% from March, as consumers continue to wrestle with stubbornly higher levels of inflation and financing rates. Annualized retail sales were up 2.3% over the past year, compared to the consumer price index’s measure of inflation up 3.3%. Gasoline station sales were up 1.6% from the prior year as energy prices moved higher in 2024. Department store sales were down 1.6% from the prior year. Building materials and supplies were down 4.3%. E-commerce and mail-order houses ended the 12-month period with a 6.8% sales gain. Auto sales were up .9% from the prior year. Restaurant spending was up 3.8%, furniture store sales were down 6.8%, health care spending was down .7% and clothing and accessories were up 2.4%. On a positive note, food costs were only up 1.6% from the prior year, well below current year over year inflation numbers as supply chains are recovering from the pandemic. With consumer spending two-thirds of our economy, we are seeing consumption growth finally slowing, especially for big-ticket items related to housing. However, consumer spending on discretionary items remain resilient and better than most estimates coming into the year. With wage growth up 5.1% over the prior year and disposable income also up 3.7%; the income side of the equation is helping to defray some of the inflationary and higher financing pressures.
We are expecting a more normalized return environment for equities for the remainder of 2024 with valuations needing to also normalize after the strong rally over the past nine months. However, we do see a continued broadening of equity returns out of technology and AI themes and into other areas of the market that have not participated. We see the first Fed rate cut as the catalyst. Small capitalization and international equity valuations remain attractive compared to large capitalization peers. The level of interest rates will continue to be the main determinate of equity returns for the remainder of 2024. We do not see a Democrat or Republican win in the presidential election changing fiscal policy. Whether looser regulation, tariffs, ending green energy initiatives, continued direct entitlement spending, or continued infrastructure spending; we see a higher level of inflation and a free spending economy over the longer term. Equity markets believe economic growth is strong enough and inflation is falling fast enough for the Fed to rescue lofty equity valuations. An orderly return to a more normalized rate environment could prove to be a powerful catalyst for equities to avoid any major market correction in the near term.
Within the fixed income markets; interest rate, fed policy, and market traders are somewhere between one and two interest rate cuts this year, following weaker economic data over the past two months. Ten-year treasury rates are currently at 4.28%, up 10 basis points from the end of the first quarter, but down substantially from earlier this summer before softer data influenced markets. The corporate bond market is still offering yields north of 5%. We see rates moving lower over the intermediate term, and we see current interest rate levels as an opportune period to extend portfolio duration, invest excess cash in fixed income markets, or take some profits from equity portfolios to add to fixed income exposure.
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Data Sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Dept. of Commerce (GDP, retail sales, housing); Institute for Supply Management (manufacturing/services). Factset (S&P 500 statistics); Performance: based on data reported in Bloomberg (indexes, oil spot prices, foreign exchange); News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources, such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied upon as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.