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Market Overview and Strategy
As we move into the second half of 2024 our bullish outlook remains strong. The fundamentals behind our trades last quarter remain unchanged, and we are maintaining our optimistic stance. We’ve strategically leaned into earnings strengths and moved away from the narrative of no rate cuts. We continue to prefer stocks over bonds, U.S. markets over international, mega-cap over small-cap, and growth over value.
Market Conditions and Economic Factors
Both U.S. and developed non-U.S. markets have shown resilience despite challenges like interest rate volatility, Fed discussions, election uncertainties, and escalating conflicts in the Middle East. The earnings power of mega-cap tech and growth giants continues to exceed even the highest analyst expectations. We anticipate that the impact of AI on spending and economic productivity will provide a long-term structural boost to the U.S. economy, reinforcing its position as a global growth leader.
The tech sector, particularly companies involved in AI applications, has seen remarkable growth. Nvidia’s data center revenue, which includes GPU production for AI, rose by 427% from the same quarter last year, valued at $22.6 billion. Overall, growth stocks have outperformed value stocks by over 9% this year, and large caps have outperformed small caps by 12%. Our investment signals from March predicted this widening gap between leaders and laggards, which has indeed materialized.
There has been much commentary suggesting that small-cap stocks are undervalued or that value stocks are the way to go. However, those who bet on these narratives have not fared well. For instance, Tesla experienced significant drops earlier this year, and even Apple has lagged. In contrast, the “Mag 7” stocks have outperformed the equal-weighted S&P 500 by over 20% this year, with Nvidia playing a crucial role. Following Nvidia’s impressive earnings release on May 22, the stock rallied by 20% while the broader S&P 500 index fell by 1%.
We have closed our underweight position in emerging market equities and are now more selective in credit, given the current tight spread levels. As inflation pressures ease, we expect the inflation figures from spring to weaken, potentially surprising on the downside in late summer or early fall. This scenario could prompt the Fed to proceed with the projected rate cuts before year-end. Consequently, we are starting to adjust our strategy, with a stronger focus on growth stocks and sectors like semiconductors and large-cap tech, particularly Nvidia.
Looking ahead, the key question for economists and portfolio managers is whether, when, and by how much the Fed will cut interest rates in 2024. At the start of the year, there was an expectation of up to seven rate cuts. However, this consensus has shifted significantly, with only an 11% probability of three rate cuts and a 40% probability of just one cut, even suggesting a 16% chance that no cuts will occur until next year. This shift is due to persistent inflation, which has led to more hawkish Fed discussions.
We believe that focusing solely on headline inflation can be misleading due to the noise and complexities involved in its calculation. Primary contributors to inflation have been rents and vehicle insurance, which have significantly impacted core inflation. Present-day real-time measures suggest that actual rent inflation is closer to 2%, below pre-pandemic levels. Adjusting the Fed’s preferred inflation measure using real-time data indicates that inflation may already be near the Fed’s target, providing a different perspective from headline data.
Historically, election years present significant uncertainty for investors. However, we tend to observe stronger performance in the second half of the year, particularly in Q3 and Q4. The direction of economic and inflation trends will have a greater impact on returns, but observing these seasonal trends supports a continued risk appetite.
Portfolio Positioning, Adjustments and Performance
In your portfolio, you will notice that instead of a general investment in the S&P 500 index, we have differentiated between S&P growth and S&P value. Currently, we are tilted towards growth, which has proven to be a favorable decision. Our broad asset allocation has resulted in a 4% overweight in stocks, which have rallied significantly since this adjustment, while bonds have experienced slight sell-offs. This overweight is consistent with the current drifted portfolio positions.
Beyond our focus on tech and growth stocks, we are also increasing our exposure to emerging markets. Historically, emerging markets perform well during U.S. rate-cutting cycles, delivering strong positive returns. This year, we have seen an uptick in growth expectations for emerging markets, supported by improved global growth and dovish central bank policies. Emerging market stocks are currently trading at attractive valuations, prompting us to close our underweight position.
On the fixed income side, we are making small adjustments to better align with the current macroeconomic environment. With high starting yields and low defaults, carrying credit can still be considered attractive.. However, tight spreads necessitate a focus on quality, and we prefer active fixed income managers who can screen for high-quality and avoid the riskiest borrowers.
To summarize, EWA is maintaining a 4% overweight in stocks and leaning into growth, which has shown strong earnings across both U.S. and developed markets. We are also preparing for potential shifts in Fed policy in 2024 and beyond. We welcome any questions you have and look forward to our next financial planning review to ensure your financial plan continues to support your goals.
– The EWA Team
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Important Disclosures:
Securities and advisory services offered through EWA LLC dba Equilibrium Wealth Advisors (a SEC Registered Investment Advisor).
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
* All indexes referenced are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
* Gold represents the afternoon gold price as reported by the London Bullion Market Association. The gold price is set twice daily by the London Gold Fixing Company at 10:30 and 15:00 and is expressed in U.S. dollars per fine troy ounce.
* The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* The Dow Jones Industrial Average (DJIA), commonly known as “The Dow,” is an index representing 30 stock of companies maintained and reviewed by the editors of The Wall Street Journal.
* The NASDAQ Composite is an unmanaged index of securities traded on the NASDAQ system.
* International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage is often obtainable in commodity trading and can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
* There is no guarantee a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
* Asset allocation does not ensure a profit or protect against a loss.
* Consult your financial professional before making any investment decision.
In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.
EWA, LLC dba Equilibrium Wealth Advisors, is an SEC-registered investment advisory firm providing investment advisory and financial planning services to clients.
Investments in securities and insurance products are not insured by any state or federal agency.
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In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.