ISG Market Commentary July 2024

ISG

July 29, 2024

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Equity markets performed well once again in the second quarter with the S&P 500 gaining 4.3%.¹ US large cap growth stocks continued their outperformance over small caps, value stocks and international markets.

The focus on artificial intelligence and cybersecurity continued to dominate the investment community. The so called, “Magnificent 7”, a group of the largest seven tech companies, drove performance thus far this year and now make up an astounding 37% of the market cap of the S&P 500 and accounted for 77% of the Index’s returns through the first half of the year.² We have seen some signs of a broadening market with short periods of outperformance from value stocks and small cap stocks, but we’ve yet to see a sustainable trend.

At the midpoint of 2024, the economic landscape presents a mixed picture. Positive first-half trends like job growth, rising consumer spending, and strong gross domestic product (GDP) growth have raised hopes for a solid second half of the year. However, signs of a slowdown are starting to appear in cooling job and wage growth and waning consumer confidence. While this softening could help ease stubbornly high inflation, it also presents new challenges.

Despite the shifting conditions, financial markets continue to offer opportunities. The S&P 500 recently hit new highs and analysts are projecting strong earnings growth over the next 12 months. While fixed income investors navigated a turbulent first half as evolving interest rate expectations benefited lower-credit sectors, many bond asset classes now boast elevated yields compared to recent years, which may provide stability to portfolios. The upcoming election and numerous geopolitical tensions could spark volatility, but underlying fundamentals appear resilient.

The Economy

The economy has traversed a winding path so far this year. Many expected turbulent conditions brought on by persistently high inflation and interest rates, restrictive monetary policy, and slowing consumer and business spending. However, the first half defied expectations and carried the momentum from 2023.

Strength in hiring fueled consumer spending despite rising rates. Although GDP growth slowed to 1.3% in the first quarter (from 3.4% in the fourth quarter of 2023), it came in at 2.8% in Q2.³ Going forward, the economy looks less certain and one of the primary drivers of this uncertainty is inflation. After falling from a high of 9.1% in the summer 2022, year-over-year consumer inflation has cooled, landing at 3.0% in June.⁴ While this represents an improvement from recent highs, inflation remains well above the Federal Reserve’s (the Fed’s) 2% target, with the pace of improvement slowing. This may serve as the primary risk in the second half of the year for markets and the economy.

Consumer spending will be pivotal in determining which path the economy takes, as personal consumption growth accounts for about two-thirds of GDP.

In the first half, consumers remained ready to travel, and a robust job market fueled their willingness to spend. In fact, the economy added nearly 250,000 new jobs per month leading to strong wage growth on a historical basis.

As we look ahead, though, some signs may indicate bumpier terrain in sight. Hiring and annual wage growth cooled notably in April, and while these numbers unexpectedly popped again in May, the unemployment rate breached the 4% mark for the first time since January 2022, while the labor force participation rate declined. This uneven landscape has been paired with wavering consumer confidence so far this year—and confidence has historically been linked to consumer spending growth.

While signs show that we may be in for slower consumer spending growth in the third and fourth quarters, it’s crucial to note that slower growth is still growth.

Equities

2023 was all about the recession that never was and the end of the rate hiking cycle. As a result, corporate earnings growth exceeded expectations, and the S&P 500 saw a 26% return. This upward trajectory largely continued in the first half of 2024. Large-cap stocks have led the charge, with mid- and small-caps lagging behind. Value stocks have also underperformed growth stocks, with higher earnings growth for growth stocks keeping them in the lead.

Looking ahead, the tug-of-war between earnings growth and valuations will be a key theme for the second half of 2024. According to FactSet consensus estimates, S&P 500 earnings could rise over 10% this year. Fourth-quarter earnings (reported in 2025) will be a major factor in valuations, where the expectations call for 17% growth.⁵ Combined with expectations for 14% growth for 2025, this could support equity valuations despite their elevated level of more than 20x forward earnings projections.

High Expectations Pave the Way for Greater Market Balance

If, in fact, earnings align with expectations, we could see markets continue their march forward for the second half of 2024. However, the path upward is not without obstacles. Market concentration in both market capitalization and earnings sources has raised risks.

The Magnificent 7 tech giants have powered much of the S&P 500 earnings growth in recent years, benefiting from rising spending in artificial intelligence (AI). As this cycle of tech spending peaks, other areas of the market may see increased growth on the productivity gains that come with the investment in technology.

While the top 10 companies have achieved valuations far above their historical averages, the rest of the index is closer to average. Small- and mid-cap companies are also closer to long-term average valuations, despite higher long-term growth expectations. This is why our portfolios remain diversified across various equity types.

Fixed Income

Inflation remains the central topic in discussions about interest rates and fixed income. The most recent reports showed promising signs of easing inflation. The CPI and PCE reports moved closer to the Fed’s 2% target, although both still have some work to do.

The fixed income markets at the end of the quarter were fairly flat. High quality fixed income struggled a bit as long-term interest rates moved higher compared to the beginning of the year putting downward pressure on bond prices. High yield fixed income, however, was up 2.5% through the first half of the year as the higher yields offset the price volatility.⁶ Higher interest rates have been a double-edged sword for the fixed income markets. On the one hand, yields are generally 5% or higher delivering attractive current income to investors, but on the other, higher rates have put negative pressure on bond prices lowering total returns.

The direction of long-term interest rates will be the key to fixed income returns for the remainder of the year. Currently, the market is pricing in a very high probability that the Fed will begin cutting interest rates in September as the inflation and employment data have been softening. If this continues, and the Fed does begin its easing cycle, lower rates should be a tailwind for fixed income investments going forward.

Alternative Investments

Private credit investments continue to perform very well in the current market environment. High interest rates lead to high distribution rates which are currently over 10%. In addition, a healthy US economy has kept default rates low.

Private real estate, on the other hand, has not performed as well. Fundamentally, the largest segments of the commercial real estate market, multi-family apartments and industrial warehouses, have performed very well. Rents continue to rise and occupancy rates are very high, both contributing to attractive distribution yields for these investments. However, rising interest rates have put downward pressure on real estate valuations, and total returns thus far this year have been weak. Office buildings have struggled as employees continue to work from home and the demand for office space remains challenged. Office remains a very small component of our real estate exposure.

Going forward, falling interest rates and a resilient economy should be tailwinds for real estate valuations and overall performance. Real estate has provided valuable diversification for portfolios and we continue to believe in the asset class.

The Election

Through the first half of the year, November’s election has remained a background concern for markets. However, after a failed assassination attempt and the incumbent president dropping out of the race, political news has abruptly taken the headlines.

Recent history suggests the race will be tight, decided by a handful of swing states. Along the way, campaign rhetoric could spark short-term market volatility. Potential policy shifts under a new administration could also have market implications, but a lot can change before proposals become legislation.

Despite the uncertainty that is sure to come over the next six months, the election season tends to end well for investors. Today’s political environment in Washington makes it hard to pass wide-sweeping legislation, and investors don’t mind that. As shown in the chart below, stocks tend to go up no matter what the power-sharing agreement is in Washington. So, our advice is to remain calm, tune out all the noise, and vote in the booth, not in portfolios.

Historical Stock Market Performance Under Different Political Party Controls

Source: Truist IAG, Strategas (Commonwealth Midyear Outlook Report dated June 30, 2024)

As always, we recommend maintaining a long-term view, staying the course and sticking to your plan. We remain focused on the core tenets of our investment process – long-term risk adjusted returns and constructing durable diversified portfolios.

If you have any questions or would like to discuss anything in more detail, please do not hesitate to call your Advisor.

Sincerely,

Your Team at ISG

Sources:

S&P Dow Jones Indices, Index Dashboard June 28, 2024
Hightower Advisors Weekly Wisdom July 10, 2024
JP Morgan Guide to the Markets June 30, 2024
US Bureau of Labor Statistics
JP Morgan Guide to the Markets June 30, 2024
JP Morgan Weekly Market Recap July 1, 2024

Investment Security Group is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Security Group and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Security Group and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.