Markets and Events
The market had a good second quarter with the S&P 500 rising 4.4%. After rising 10%+ through the end of March, the market hit an air pocket and declined 5.5% by April 19. This drop was driven by recalibration of rate cut expectations for 2024. March inflation numbers come in higher than expected which reduced probably of rate cut before late 2024 thus driving stock prices down. Then from the low on April 19, we had an unbroken run up of 10% into June 30 as the market adjusted to the idea of “higher for longer” interest rates. We had a return of meme stock mania when “Roaring Kitty” resurfaced with a big position in GameStop. On the higher quality side, Dow Jones Industrial Average topped 40,000 level for the first time. Nvidia continued its remarkable run by first hitting $3 trillion dollar mark and then surpassing Microsoft on June 17 to become the most valuable company in the world. It has since pulled back somewhat but Nvidia, Microsoft and Apple each remain above $3 trillion in market value. After stagnating for several months, Apple perked up upon making some big AI (Artificial Intelligence) announcements at its developer conference in June.
There were also a lot of development in U.S. politics. In April, Congress passed Ukraine and Israel aid packages after months of in-fighting. Then in May, former President Trump was found guilty on 34 counts in the hush money case becoming first President to be convicted of a felony. The Supreme Court had a very busy summer session issuing a raft of important rulings largely favoring conservative priorities. In late June, first of two presidential debates didn’t go well for Biden leading to a major panic in the Democratic party.
Outside of the U.S., there have been no shortage of big developments either. Iran launched a major air attack on Israel in a retaliatory move, although almost all of the 300 projectiles were shut down without serious damage. This still sets a troubling precedent. Then a month later Iranian president died in a helicopter crash (it was an accident), creating further uncertainty in the region. Meanwhile, the war in Gaza continued to rack up death toll and Israeli politics remain in flux. Russia opened new front in the Kharkiv region of Ukraine, but it petered out after some initial success. That conflict remains largely frozen along existing lines of contact. Then in May there was a slew of elections in important countries. Claudia Sheinbaum was elected as Mexico’s first female president. In India, Modi won re-election but suffered a stunning setback as his party unexpectedly lost its majority. In France, Macron called snap election after the EU vote favored a far-right party and early results show poor performance by his centrist party. In the U.K., Rishi Sunak called election for July 4th (hey, that’s OUR holiday!).
Asset Classes
Most of the major asset classes had a decent quarter (Exhibit 1). U.S. stocks did well with Nasdaq leading and small caps lagging once again. Gold and U.S. dollar did pretty well too indicating search for stability. On the international stock side, emerging markets did better than developed. This was led by good results in Turkey, Taiwan and India, as well as some recovery in the Chinese market. Mexico, Brazil and Philippines were the big laggards last quarter. European stocks in France, Italy, and Germany, as well as Japan were detractors on the developed markets side. Bonds were largely flat, with longer dated and riskier ones performing the worst. Bitcoin had a bad quarter after the big run into mid-March.
Sectors and Stocks
Let’s take a look at which types of stocks drove the market in the last quarter (Exhibit 2). Semiconductors continued to lead the index higher still riding the AI wave. Larger technology and communication sectors also retained their leading position. On the bottom of the table, we have homebuilders, which had a big reversal in their prior outperformance (mortgage rates). Also underperforming were various commodity groups, transports, retail, industrials and financials. Looking at the laggards gives us a pause as they are all economically sensitive groups, possibly foreshadowing slowing growth.
Digging a little deeper, Exhibit 3 shows the best and worst performing stocks in the S&P 500 during the quarter. The left section features top/bottom 5 names by dollar change in market value (and thus largest actual impact on the cap-weighted S&P 500 index). Nvidia, Apple, Google, Microsoft, and Amazon (all tech companies) collectively gained $2.1 trillion in market value, which accounts for 117% of the total index return. That means that the remaining 495 companies in the S&P 500 had a negative collective return, and the index was only bailed out by these five super-stars. While the narrow market leadership can be a concern, it doesn’t necessarily portend trouble ahead. The bottom five companies headlined by Intel and Disney subtracted $220 billion from the index market cap.
The right section normalizes for the sheer company size and shows best/worst performers by percentage change in market value (as opposed to dollar change). Nvidia and Apple show up here too, while the other three companies are different. On the losing side of that ledger, there are five smaller companies losing 30%+ in Q2.
Economy and Rates
Interest rates on 3-month, 2-year and 10-year Treasuries finished the quarter almost exactly where they started. There was, however, a fair amount of movement there during the three months. Rates ran up into late April as strong inflation numbers dampened rate cut hopes, but then declined in May/June as softer economic indicators and milder inflation reignited expectations of reduced policy rates. The job market remains very strong if not so unnaturally tight as it was in 2021/22. Inflation is coming down (albeit slower than expected) and Fed’s preferred measure hit 2.6% in May, which is the lowest since April 2021. The one part of the economy that remains unhealthy is the housing market with still high mortgage rates (6.9% for 30 years) and low inventory leading to very high prices and paucity of homes to buy.
Another aspect of Federal Reserve policy that is not talked about as much is the size of its balance sheet. It ballooned from $3.8 trillion pre-pandemic to a massive $8.5 trillion in May 2022, but has been slowly declining since then. Currently it stands at $6.7 trillion, down 20% in the last two years. I think that normalizing rates and reducing Fed assets are healthy developments for our economy.
So overall the economy remains robust, unless you listen to politicians running in this year’s elections.