Market Commentary | Q2 2024
Heat waves have been a consistent theme in recent weeks, with the planet having the hottest June on record, which also marks the 13th consecutive month that a global heat record was set.[1] Beyond the uncomfortable temperatures many of our clients have experienced in the Bay Area, new all-time record temperatures were set in a multitude of cities including Las Vegas (120°F) and Palm Springs (124°F). At the same time, the U.S. stock market also soared higher, with both the S&P 500 and the Nasdaq Index touching all-time highs.
As the recent heat wave moved to the Central Valley and inland states, it pulled in the marine layer that brings fog and cooler weather to the Bay Area and coastal regions. This cyclical variation in temperatures mirrors what we’re seeing in financial markets, with a set of factors that cause some sectors to heat up, while others experience a cooling trend, and the balance is continuously shifting.
The second quarter of 2024 was marked by strong growth in financial markets, cooling inflation, and surprise political outcomes. While there are questions about the sustainability of both current temperatures and market valuation levels, we have confidence that the market will navigate any near-term volatility and continue delivering growth for long-term investors.
What’s Been Heating Up?
We have seen an upward trajectory in a few key areas during the second quarter, and particularly over the past few weeks, that are being closely watched by investors.
Market Prices: The big story so far in 2024 is how top-heavy the returns of the S&P 500 have been, with the blended index up +15.3% through the end of June, fueled in part by AI optimism. The following comparison helps illustrate our point: +33% for the “Magnificent 7” (Apple, Microsoft, Google, Amazon, Tesla, Nvidia, Meta) versus a meager +5% return for the other 493 companies in the S&P 500. Despite the imbalance, both the S&P 500 and the Nasdaq Index have set new all-time highs in recent weeks, and the U.S. large cap funds in our client portfolios have captured those index returns.
While we are glad to have participated in some of the growth of large companies like Nvidia, we also acknowledge that other segments of the global stock market, such as international stocks and U.S. small cap stocks, appear attractive based on current valuations and long-term investment potential. International stocks grew by +5.3% through the end of the second quarter, with emerging markets stocks adding +7.5% through the midpoint of the year.
Lastly, the bond side of portfolios provided income and stability, but prices were hampered by the Fed’s reluctance to lower interest rates on the timeline that investors were anticipating. Bond prices jumped meaningfully last December, but in the first six months of 2024, the total return from bond funds was effectively flat, returning only +0.1% in Q2. We continue to see bonds as a source of stability and diversification, especially for clients taking distributions from their portfolios, but we expect the majority of future growth to come from our long-term allocation to stocks.
Political Tensions: In recent weeks, election tensions have been heating up and have provided some surprising outcomes that are still being digested by the global financial markets. U.S. voters witnessed a presidential debate that is causing ripple effects that may influence the outcome of the November election. The UK elections saw the Labour Party sweep the Conservatives out of leadership, and France’s decision to call a snap election ended up with a split government that is led by a left-wing coalition, but still saw significant gains by a surging National Party of Marine Le Pen.
Exposure to social media and the 24-hour news cycle can create a lot of stress during election years for investors, who often worry that politics will have a negative impact on their portfolio. The good news is that financial markets generally don’t share the public’s fascination with elections.
Regardless of which party controls the presidency, policy outcomes often show up on a lag and come with unintended consequences. History clearly shows that the most profitable path for investors is to stay invested and stick to a long-term plan. Since its inception in 1957, the S&P 500 has grown by an average of +9.8% per year under Democratic administrations and an average of +6% per year under Republican administrations.[2] Markets have increased under both Republicans and Democrats, and speculative attempts to time the market rarely work as expected.
For our North Berkeley clients, we do not anticipate making any significant allocation changes based on the outcomes of the U.S. election. Instead, we’ll maintain our long-term diversified portfolios and will take advantage of rebalancing opportunities that may present themselves if market volatility increases.
What is Cooling Down?
While increases in prices, temperatures, and political headlines have been quite noticeable, we have also been monitoring areas of the market and economy that have been on a cooling trend over recent weeks and months.
Inflation: Overall inflation was 3% in June on an annualized basis, down from 3.3% in May, and slightly lower than what economists had been forecasting.[3] While still higher than the Fed’s official 2% target, the recent inflation report was markedly cooler than the 2022 peak of 9.1%. Digging further into the recent report, we saw housing costs growing at a slower pace, certain services like airfare and hotels declining in price, and the overall price of goods (excluding food and energy) remaining flat or falling in recent months. This should provide a small boost to U.S. households that have been squeezed by inflating prices.
Now that inflation has come down as far as it has, Fed officials are focused on not overdoing their effort to cool the economy. They want to fully stamp out inflation, but they do not want to cause a recession in the process.
Interest Rates: Fed officials are currently forecasting one rate cut later this year. Despite this clarity from the Fed, the bond market is still pricing in an expectation of two quarter point cuts in 2024. There is virtually no chance the Fed will ease policy at the end of July, but action at the September meeting is looking increasingly likely based on recent data.
The November FOMC meeting falls just two days after the presidential election. Fed officials will likely try to avoid the political fracas and opt to make no changes. That only leaves December for a second rate cut. Based on the Fed’s record over the past two years, the market would be wise to trust what the Fed is saying about a single rate cut and adjust its expectations accordingly. If rates do come down, it has the potential to provide a slight boost to bond prices, spur some capital investment, and help the housing sector if it translates to lower mortgage rates.
Looking Ahead
The economic transformation that is underway from the current AI boom, coupled with slowing inflation, will likely follow a cyclical trajectory of periodic heating and cooling. So far, investors have chosen to bid up AI-related portions of the stock market to dramatic highs. Going forward, some investors may feel tempted to sit on the sidelines and await clarity – especially given the attractive returns from holding cash in today’s interest rate environment. Yet history indicates that staying invested and embracing the current risks while remaining diversified can lead to higher long-term rewards, and we remain optimistic about the future for stock prices as well as the resiliency of our shared economy.
Our team at North Berkeley is grateful for the trust that our clients place in us, and we welcome conversations about markets and portfolios, as well as financial planning discussions that often help create clarity and tangible benefits that go beyond portfolio composition. In a world full of uncertainty, with some areas heating up while others begin to cool, an approach of diversification, regular rebalancing, and thoughtful long-term planning is more valuable than ever.
Resources
[1] June 2024 Extended Earth’s Stretch Of Record-Hot Months To Over A Year Weather.com
[2] Average Stock Market Return Under Democratic and Republican Presidents Motley Fool
[3] Inflation Cooled Further in June NYTimes
