We hope you had a relaxing 4th of July, and that summer is off to a nice start. We’re now officially past the halfway point of 2024. Following a strong first quarter, the market continued to advance as most domestic indices hit fresh all-time highs. The S&P 500 crossed 5500 for the first time ever and added 4%, lifting its year-to-date return to 15.3%.[1] However, market breadth (i.e., underlying stock participation) weakened, with much of last quarter’s gains attributable to just a few stocks.
Given that we’re at the halfway point in the year, we’d like to give you the lay of the land and what we think may be in store for the second half. In the spirit of the upcoming Olympic Games, the
stock market Gold Medal goes to Nvidia stock, with the silver going to the remaining six in the “Magnificent 7.”[2] If you haven’t heard of Nvidia, it’s the leader in sophisticated computing and the dominant supplier of artificial intelligence (AI) hardware and software.[3] With Nvidia stock up roughly 150%[4] this year and it being one of the largest companies in the world, it has been an enormous contributor to the S&P 500’s strong start to the year. As seen in the chart, if you take Nvidia out of the S&P 500, the index is up around 10% for the year. If you take out the entire Magnificent 7, the index is up 4%.[5]
We’ve written about weak market breadth or a “narrow market” frequently in the past as a risk to the overall index. While we believe it warrants an orange caution light, narrow leadership has broadened out this year. As of this writing, 10 of the 11 S&P sectors are in positive territory for the year. At this time last year, only three sectors contributed to the markets gains, each being the technology sector or technology adjacent.[6] If the market can broaden out, beyond just a handful of big stocks, a diversified portfolio should benefit in the second half of the year.
As for the economy, the conventional narrative at the beginning of the year was the Federal Reserve would begin cutting rates with ultimately 6-7 rate cuts being priced in by the market in 2024[7]. Right now, there have been zero rate cuts due to a stronger than expected economy. Taking a sampling of data, such as services surveys, retail sales, durable goods and payrolls, we see an economy with solid growth momentum during the first half of the year.
While better than expected economic growth has been positive for financial markets, it has given the Fed little reason to cut rates. With unemployment just now ticking above 4% for the first time since November 2021[8], and some softening of manufacturing and services data[9], we’re seeing early signs that economic growth is gently slowing. While many pundits in the media will start calling for recession, we don’t see it in the cards this year. However, we do see that the Fed will have enough evidence that the economy is slowing (from a high bar) to cut rates 1-2 times this year, with our base case being the first cut beginning in September.
What happens to stocks around the first rate cut? For illustration purposes, in the chart below we show 12-month forward returns for the S&P 500 around the start of a Fed rate cut cycle. The strength (or weakness) in stocks were largely dependent on 1) Why the Fed cut rates and 2) If a recession was avoided.
In both 1995 and 1998, 1-year forward returns were strong, as the Fed managed to avoid an initial recession (until the Tech Bubble burst.)
In both 2001 and 2007, 1-year forward returns were weak, as the Fed began cutting rates in response to the Tech Bubble and Global Financial Crisis.
In 2019, the Fed initially cut rates in response to slowing growth. Forward returns were strong despite the depths of the Covid pandemic occurring within a year of that initial rate cut.[10]
The Fed has acknowledged the risks to inflation in cutting too early. With inflation on its continued trend to the Fed’s target of 2%, we believe that the greater risk to the economy is the Fed waiting too long to cut. Going forward, we will be monitoring key indicators in the labor market and economic growth. Within the labor market, we think monthly jobless claims (people filing for unemployment) nearing 300,000 would signal a slowdown. In our opinion, with the unemployment rate at 4.1% the Fed will need to watch this closely, as their year-end forecast is 4%.[11] For growth, we believe second quarter Gross Domestic Product (GDP) estimates below 1.5% would be concerning, as original estimates were roughly 4%. The Atlanta Fed GDPNow Model, which is updated frequently based on incoming data, currently suggests 1.5% GDP growth for the second quarter.
Again, we are not calling for a recession in 2024. Instead, we believe the lagged effects of higher rates will slow the economy and give the Fed enough confidence to move ahead with cutting rates. In our view, this economic backdrop calls for consistency, stability and diversification, without excessive risk taking. We believe that opportunities exist in parts of the market that haven’t fully participated in this rally, and we’ll rely on our process to continue to identify those opportunities.
To close, we’re beyond grateful for you, our clients, and your continued trust, partnership and support. As always, we’re here to answer any questions you may have. In the meantime, we wish you and your family a relaxing and peaceful summer season.
Jack Piper
Founding Partner & Portfolio Manager
[1] Dorsey Wright July 8, 2024
[2] Magnificent 7 stocks are: Apple, Microsoft, Google, Amazon, Nvidia, Meta and Tesla
[3] BBC Business https://www.bbc.com/news/business-65675027 May 30, 2023
[4] Y-Charts July 11, 2024
[5] Chart – Dynasty Financial Partners July 11, 2024
[6] Blackrock July 11, 2024
[7] Goldman Sachs January 15, 2024
[8] Bureau of Labor Statistics July 11, 2024
[9] Natixis July 11, 2024
[10] Chart – Dynasty Financial Partners July 11, 2024
[11] Dynasty Financial Partners July 11, 2024
Disclosures
Great Diamond Partners, LLC is an investment adviser in Portland, Maine. Great Diamond Partners, LLC is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Great Diamond Partners, LLC only transacts business in states in which it is properly registered or is excluded or exempted from registration. Great Diamond Partners, LLC’s current written disclosure brochure filed with the SEC which discusses among other things, Great Diamond Partners, LLC business practices, services, and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov.
This information should not be considered investment advice. Opinions expressed reflect the judgment of the authors and are current opinions as of the date appearing in this material only. While every effort has been made to verify the information contained herein, we make no representation as to its accuracy and it should be regarded as a complete analysis of the subjects discussed. All investing involves risk, including the loss of some or all of your investment.
Past performance does not predict future results.
Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and do not reflect the impact of advisory fees. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular fund.
Certain information contained herein constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events, results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Nothing contained herein may be relied upon as a guarantee, promise, assurance or a representation as to the future.