Financial markets advanced again in the second quarter. Broad US stocks as measured by the Russell 3000 index gained 3.2% and the S&P 500 climbed 3.9%. Small US companies as measured by the Russell 2000 lagged, declining 3.6%, as did international developed markets, which fell 0.6%. Emerging markets were a bright spot, climbing 5%. Bond prices treaded water in the face of slow inflation declines, with the Bloomberg Barclays Aggregate rising 0.07%.
US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index [net div.]), Emerging Markets (MSCI Emerging Markets Index [net div.]), Global Real Estate (S&P Global REIT Index [net div.]), US Bond Market (Bloomberg Barclays US Aggregate Bond Index), and Global Bond Market ex US (Bloomberg Barclays Global Aggregate ex-USD Bond Index [hedged to USD])
The second quarter built on a strong Q1. In the first six months of 2024, the S&P has risen roughly 14.5%, and volatility has been mostly low. But as is often the case, peeking under the hood reveals a divergent tale of two markets. Much of the S&P gain has been driven by just a few stocks. The Wall Street Journal recently noted that for the second quarter, AI (artificial intelligence) themed stocks in the S&P 500 rose 14.7%, while the other stocks declined 1.2%. AI darling Nvidia has risen 149% since January, making up about 30% of the S&P 500 gain. Add in other tech names with AI growth hopes (Amazon, Meta, Alphabet, Microsoft), and that figure climbs to over 50%. If we look at a broader market measure—each stock in the S&P 500 is equally weighted—the comparable gain is barely 4%. In other words, AI hopes continue to be the main driver of gains.
Indices used for hypothetical portfolios returns are the MSCI ACWI for equities and the BBgBarc US Agg Bond for fixed income. All data derived from Morningstar Office. Past performance is no guarantee of future returns.
That said, as we head into mid-summer, the fairy tale of Goldilocks comes to mind. In Wall Street jargon, a Goldilocks scenario reflects an economy that is neither too hot nor too cold—it’s just right. At the beginning of 2024, this was the dominant theme: cooling inflation with moderate growth positioning the Federal Reserve for several interest rate reductions. That view was upended as inflation proved sticky, wage growth continued, and bond yields climbed. Yet now, six months later, a rosy view is again emerging. Inflation is cooling, wage growth and job switching have slowed, financial markets remain generally healthy, and hopes for rate cuts by the Fed in the fall are again on the table. In other words, Goldilocks appears alive and well, waiting for her porridge to cool.
Of course, whether that comes to fruition or not is an unknown. Some analysts fret over too much exuberance: meme stocks and the “Roaring Kitty”—the self-hyped trader who has made himself a star on social media—are again making headlines, and cryptocurrencies have stormed back. Yet that sentiment, frothy or not, has served to drive stock prices higher, and the expectation of lower rates to come positions bonds for future gains. Analysts at JP Morgan recently described the US economy as “mid-cycle,” indicating their belief that a period of cooling growth remains ahead. Importantly, they also noted that while the Fed initially raised rates to combat inflation, they have been kept at these levels because of growth: a critical and positive distinction that could bode well for broader participation in gains beyond a handful of mega-cap tech companies. We will discuss inflation more later, but for now, keep in mind that future rate cuts should thus be a mechanism to balance growth and inflation, not as a response to a recession. Goldilocks? This type of dynamic is music to Wall Street’s ears.
Inflation continues to be a key driver of future expectations both in the US and abroad. Through May, headline CPI grew at a rate of 3.3% over the last 12 months, a rate unchanged from the prior month and almost flat with the 3.4% reading in December 2023. Yet the PCE (Personal Consumption Expenditures), a broader inflation measure that incorporates consumer behavior such as switching brands when prices increase (the favored measure of the Fed), paints a more positive picture. The 12-month reading for May for PCE was 2.6%, the lowest annual rate since it broke 2% in March 2021. The Federal Open Market Committee met in May and June and held rates steady at a 23-year high of 5.25–5.5%, but the encouraging inflation data has led to positive comments from Fed members and hopes that second-half rate cuts may be in store. And to repeat, these cuts are likely to be because of an economy moving into a steadier state, not a recession. This encourages many analysts. Looking abroad, easing is already underway. The European Central Bank recently lowered its rates by 25 basis points, and cuts have also come from Canada, Sweden, and Switzerland.
Measures of economic growth continue to be mixed. The index of leading economic indicators (LEI) declined in May by 0.5% and is down 2% over the past 6 months. The release noted this was “… driven primarily by a decline in new orders, weak consumer sentiment about future business conditions, and lower building permits.” Yet while Consumer Sentiment did decline slightly from May to June, it remains up 6.2% over the past 12 months, a positive tailwind.
Services as measured by the ISM Services Index rebounded in May, with 13 of their 15 sectors showing growth. It is the 46th month out of the last 48 reflecting growth. Yet participants struck a cautious tone, noting concern about volatility ahead around elections, possible tariffs, and still-high rates impacting real estate. Manufacturing remains in the doldrums, having declined 20 times out of the last 21 months. Participants noted concerns over demand leading to increased inventories and decreasing sales backlogs.
The labor market continues to be solid, albeit, as with many of the above measures, showing signs of cooling. In June 206,000 new jobs were created, down from 272,000 in May. The unemployment rate has ticked up to 4.1%, with roughly 6.6 million unemployed. Over 12 million were unemployed at the pandemic highs, so the progress is unmistakable. From the cooling perspective, one year ago the unemployment rate was 3.7% with 6.1 million unemployed, so a slight slowing is apparent. Yet there is still room for workers: the May job openings report (JOLTS) noted 8.14 million jobs available. The ratio of openings to unemployed is now 1.22—almost exactly what it was in February of 2020, just before the pandemic burst onto the scene. It remains a good time to find work.
Gross Domestic Product (GDP) is bumpier than the trend of labor markets. Robust growth in the 4th quarter of last year slowed to an annual 1.4% pace in the first quarter of 2024. Forecasts are for a higher rate in Q2, with the slope easing back toward a sustainable 2% or so.
For the quarter, yield on the 10-year treasury declined by 14 basis points, ending the quarter at 4.34%. Oil prices declined slightly as Middle Eastern turmoil had a negligible impact on production. Further, the OPEC + group of countries agreed to extend production cuts into 2025 to counter weak demand. Oil finished the quarter at $81.51/barrel. Gold continued a strong year, rising 4.02% in the quarter to $2,335/oz.
Looking ahead there are, as always, many crosscurrents. A generally stable and healthy US economy, solid employment, and easing inflation should continue to provide support for stock prices. Yet clouds are gathering around a contentious November election, with a majority of voters wishing for other candidates, and data is clear that in the short run, angst over politics affects consumer sentiment. Overseas politics are also in play, with upheavals in the French government and a UK election that has resulted in a rout for the current governing party as voters expressed their frustration with a struggling economy and stagnant progress on social issues such as immigration and infrastructure. Clearly, change is in the air. Add in a growing chorus drawing attention to the US national debt, which will cost our government (according to CBO estimates) some $892 billion in interest payments this fiscal year. While there are many positives to note, there are equally as many concerns, meaning volatility remains likely.
However, it is worth bearing in mind that over the long run, financial markets absorb these events and distractions and consistently move on to new highs. It is important to maintain a long-term approach and balance assets between short-term needs and growth for meeting lifetime goals. If you are not sure where you stand, talk to your advisory team about this balance.
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