Quick Market Update

We’re in the final month of the quarter so let’s take a few minutes to review how markets have been performing and what’s been driving them.

The shifting sands of the inflation outlook and Fed policy continued to provide headwinds and tailwinds, depending on the day and sometimes the hour. Expectations have gone from multiple rate cuts this year to maybe one but probably none. The reasons why have been the same for months. Inflation has remained stubbornly high and overall economic activity has been chugging along nicely, which doesn’t provide any cover or impetus for the Fed to reduce interest rates.

However, a lot of these numbers are backward-looking. My research partners at Bespoke Investment Group regularly update a matrix of economic indicators and current numbers show momentum slowing down a bit. Maybe this matches up with inflation falling as well, only time will tell. If so, the Fed could lower rates later this year but then Election Day is coming up and the Fed has tended to hold firm on rates around general elections to stay out of politics. As of now the CME FedWatch Tool shows nobody expecting a rate change this Summer but this shifts to maybe 50/50 for the rest of the year. Investors expect the Fed will start cutting rates by early 2025, but not with much conviction.

This rate uncertainty has been moving stock prices and has helped cash to outperform bonds, which isn’t very fun for most investors. The Barclays Aggregate Bond Index (a good index for medium-term bonds) has been down almost a percent so far this quarter and about 1.6% this year. Longer-term bonds are down more. While there have been positive glimmers the situation with bonds doesn’t seem to be changing anytime soon, given the rate situation already mentioned. However, bond prices can turn quickly and that’s one of the reasons we still want to own bonds. On the positive side, money market funds are still paying good rates with no volatility and bank CDs offer about 5% for a year. However, money market rates aren’t guaranteed for any length of time as they are with CDs, so at least in theory those rates will change along with Fed policy.

The rise of AI and popular publicly traded companies in that space has also driven markets so far this quarter. And just like with the Fed, the AI boom has been with us for a while, often measured since the release of ChatGPT by OpenAI in late-2022. Nvidia Corp is definitely top of the popularity heap with year-to-date returns of over 120% and about 27% in the past month! Nvidia manufactures hardware and software used in AI infrastructure so the company being a proxy for the emerging industry makes sense. Distant (in terms of short-term performance) but popular seconds include Microsoft and Alphabet (Google’s parent company) with returns of about 11% and 23% this year and mid-single digits over the past month, respectively. These three companies are each worth around $3 trillion in market capitalization (share price X number of shares publicly available), with Microsoft leading at $3.2 trillion. That Nvidia is even close to that after such a short timeframe speaks to how aggressive the AI race has been.

This performance helped the tech-heavy NASDAQ index hit 17,000 for the first time this month and the Dow Joes Industrial Average briefly touch 40,000 in recent weeks. AI-driven performance has also helped the S&P 500, the typical stock benchmark, rise about 11% this year and about 1% this quarter, almost triple the Dow’s performance. This is due to the good luck of the S&P 500 in having more of these popular companies and bad luck for the Dow in having higher weightings to AI-related names like Intel, IBM, and Salesforce that have been getting trounced lately. I mention this because there’s a major dislocation in terms of where broad market performance is coming from. If you had picked the “wrong” individual stocks or were overly focused on the wrong part of the market this quarter and the past year or so, that could explain some underperformance.

Now, I’m not suggesting that you follow trends and fall prey to the so-called Greater Fool Theory. Instead, you should focus on being well diversified with the bulk of your investment dollars, especially what you have in your long-term retirement-oriented accounts. One could argue that certain stocks are overvalued but not that the whole market is overvalued. There’s lots of value out there if you know where to look. And diversification allows you to get some performance lift from the day’s popular stocks while limiting your exposure to being wrong.

Have questions? Ask us. We can help.