Q2 2024: Surging tech stocks help to close out a strong first half for the market

The month at a glance

After a weak start to the quarter, equity markets rallied in May and June to close out an especially strong second quarter and first half of the year. Concerns of resurging inflation that had spooked investors in April eased in May and June while most measures of economic activity remained strong. The May core Personal Consumption Expenditure index (PCE) — the Fed’s preferred price gauge, which excludes food and energy — that was released at the end of June, rose 0.1% from the prior month, the lowest monthly increase so far in 2024.¹ The core PCE index now stands 2.6% above levels from a year earlier. As progress on bringing inflation down to the Fed’s 2% target remains slow, investors have reduced their expectations for how soon the Fed will begin cutting interest rates.

The change in interest rate expectations could have easily brought down stock returns, but the solid economic conditions and excitement around companies involved with AI that continued in the second quarter bolstered investor’s sentiment. Job gains remained high and the unemployment rate rose to just 4% after starting the quarter at 3.8%.² U.S. consumption continued to steadily grow, with Personal Consumption Expenditures up just over 5% in May from a year earlier, the rate it has hovered around since October 2023.³ Corporate earnings also showed continued growth, with S&P 500 trailing 12-month operating earnings in Q1 up almost 8% from a year earlier and forecasted to end the year up 12.63%.⁴ Technology companies in particular reported robust earnings growth, led by especially strong results from market leader and artificial intelligence poster company NVIDIA.⁵

• Equity markets gains were strong overall in Q2, but market leadership remains concentrated.⁶
• Technology stocks dominated the markets while small cap and value stocks continued to lag.⁷
• Nvidia alone has accounted for a third of the S&P 500’s first half gains.⁸
• Fixed income returns were generally positive in Q2 as longer-term rates fell modestly.^{9 10}
• Inflation came in cooler in April and May than in March for both the CPI and PCE indices.^{11 12}

Strong earnings and AI excitement boost stocks

Progress on inflation, continued strength in the economy and solid first quarter earnings combined to boost equity returns in the second quarter.

• The S&P 500 rose 4.28% for the quarter and is now up 15.29% in 2024.¹³
• US large cap growth stocks have dominated the market, with the S&P 500 Growth index up 9.59% for the quarter and 23.56 for the first half of the year.¹⁴
• Small cap and value stocks continued to lag in the second quarter and show negative returns so far this year.¹⁵
• Emerging market stocks rallied in Q2, outpacing developed International markets.¹⁶
• Market leadership has been markedly concentrated:
  • Technology and communication services stocks are up almost 3 times more than the next highest returning sector in the first half of 2024.¹⁷
  • More than half of the S&P 500 equity sectors reported negative returns for the quarter.¹⁸
    

Slight pull back in interest rates boosts fixed income

Longer term interest rates continued to move down in June, with the 10-year rate falling 22 basis points after a 33bp decline in May.²² The shorter end of the yield curve remained unchanged over Q2.²³

• The “barbelled” fixed income leadership persisted in Q2, with high yield and ultra short duration bonds showing the highest returns for the quarter and the first half of the year.²⁴
• Broader bond indices showed muted returns for the quarter and are generally negative for the year so far.²⁵
• Global government treasury bonds outside the U.S. delivered negative returns for both the quarter and year.²⁶
• Preferred stocks, which tend to move with equities, had a weak quarter, but remain the strongest category so far this year.²⁷

Mixed results in private markets

Cliffwater’s most recent alternative investments report released in late June with data through April 2024 shows a similar pattern to earlier months.²⁸ So far this year, private credit funds, which have seen substantial growth in assets, reported the highest average return of the three categories. With interest rates remaining higher for longer, demand for alternative sources of credit could stay strong. Private real asset funds, which contain a large number of real estate focussed strategies, have fared poorly, falling 5.37% on average in the past year.²⁹ Private equity fund returns cooled a bit from the prior two years as funding and valuation have come down, but could see increased opportunities from distressed situations if the Fed is successful at slowing the economy.

Can stocks keep it up in the second half?  

Despite the Fed’s efforts to cool the economy over the past 2 years, activity in the U.S. remains strong. Robust consumer demand and high government spending is likely to offset the lagged effects of higher interest rates. Add to this stimulus, solid corporate earnings and consumer balance sheets that are in good shape as well as the reinforcing “wealth effect” from rising asset prices, and you find a consumer that has continued to spend.³¹ The chart below shows that while consumer spending has indeed come down from the expansionary monetary and fiscal policy driven pandemic rebound, consumption has continued to grow at around a 5% year-over-year rate.³²

Election year tailwind 

In addition to the boost from expansionary fiscal policy and strong consumer finances fueling consumption growth, the “prime the pump” behavior of the government during election years may also provide a boost to the economy and a tailwind to stocks. Indeed there has been a relatively large amount of liquidity injected into the market in the past couple of years.

Aptus Capital Advisors analyzed a report from Strategas that looked at how the S&P 500 has behaved in election years when an incumbent president is in the race (a “re-election” year)³⁴. The chart below from that report shows that historically the S&P 500 has increased in every presidential re-election year since 1944, with an average rise of roughly 16 percent. The S&P 500 has not fallen in a re-election year since 1940. Since that time there have been 3 election years where the S&P has fallen, but those were in elections with no incumbent running (1960, 2000, 2008). This year so far has been the second-best S&P 500 return in a presidential re-election year since 1964.

S&P 500 Returns in Presidential “Re-Election” Years

Narrow market leadership is a concern 

Even with a continued strong economy and a possible tailwind from election year stimulus policies, there is a worry that the increasing concentration of the gains in the stock market in the largest US technology companies presents a risk. That concentration has indeed gotten extreme. The chart below from Apollo Global Management’s Chief Economist shows the issue. Currently, the top 10 companies in the S&P 500 make up 35% of the market’s capitalization but only 23% of the market’s total earnings.³⁶ This gap between prices and earnings has never been bigger and underscores the extreme bullish sentiment for the future earnings of the top companies.

S&P 500: Earnings and Market Cap Share of top 10 Companies

Ultimately, the price of a stock is connected to the earnings that company generates. When prices rise so much for a small group of companies, the expectations for vastly superior earnings growth is built in. As the Apollo economist says, “the problem for the S&P 500 today is not only the high concentration but also the record-high bullishness on future earnings from a small group of companies.”³⁸ The risk is that any challenge to that bullishness for the leading companies will likely force a swift change in prices that, given how these leading companies have driven the majority of market gains, could bring down the whole market. The best protection in this situation is to remain well diversified in one’s equity holdings despite the temptation to concentrate in the admittedly compelling winners.

[1] https://www.bea.gov/news/2024/personal-income-and-outlays-may-2024
[2] https://www.bls.gov/news.release/empsit.nr0.htm
[3] https://www.bea.gov/news/2024/personal-income-and-outlays-may-2024
[4] https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
[5] https://www.thestreet.com/investing/stocks/nvidia-earnings-seal-big-tech-stock-dominance
[6] https://www.spglobal.com/spdji/en/index-family/equity/
[7] https://www.spglobal.com/spdji/en/index-family/equity/
[8] https://fortune.com/2024/06/15/nvidia-stock-valuation-nvda-sp500-returns-market-capitalization-risk-investors/
[9] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[10] https://fred.stlouisfed.org/series/DGS10
[11] https://www.bls.gov/news.release/cpi.nr0.htm
[12] https://www.bea.gov/news/2024/personal-income-and-outlays-may-2024
[13] https://www.spglobal.com/spdji/en/index-family/equity/
[14] https://www.spglobal.com/spdji/en/index-family/equity/
[15] https://www.spglobal.com/spdji/en/index-family/equity/
[16] https://www.msci.com/end-of-day-data-search
[17] https://www.spglobal.com/spdji/en/index-family/equity/
[18] https://www.spglobal.com/spdji/en/index-family/equity/us-equity/sp-sectors/#indices
[19] https://www.spglobal.com/spdji/en/index-family/equity/
[20] https://www.nasdaq.com/market-activity/index/comp/historical
[21] https://www.spglobal.com/spdji/en/index-family/equity/
[22] https://fred.stlouisfed.org/series/DGS10
[23] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[24] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[25] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[26] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[27] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[28] Cliffwater, Alternative Investments Report, June 2024
[29] Cliffwater, Alternative Investments Report, June 2024
[30] Cliffwater, Alternative Investments Report, June 2024
[31] https://www.apolloacademy.com/the-daily-spark/
[32] https://fred.stlouisfed.org/series/PCE#0
[33] https://fred.stlouisfed.org/series/PCE#0
[34] https://aptuscapitaladvisors.com/aptus-musings-enter-stage-left-the-u-s-presidential-election/
[35] https://aptuscapitaladvisors.com/aptus-musings-enter-stage-left-the-u-s-presidential-election/
[36] https://www.apolloacademy.com/the-daily-spark/
[37] https://www.apolloacademy.com/the-daily-spark/
[38] https://www.apolloacademy.com/the-daily-spark/

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