Quarterly Update

The second quarter (Q2) of 2024 continued this year’s A Tale of Two Markets: AI Versus Everyone Else. Large indexes like the S&P 500 performed well but this was driven primarily by a handful of large companies. Otherwise, market breadth was mixed with performance growing worse as company size grew smaller. Bonds also continued their tale of woe while experiencing a couple of positive glimmers during the quarter.

Here’s a roundup of how major markets performed during Q2 and so far this year, respectively:

• US Large Cap Stocks: up 4.4%, up 15.2%
• US Small Cap Stocks: down 3.3%, up 1.6%
• US Core Bonds: about flat, down 0.7%
• Developed Foreign Markets: down 0.2%, up 5.8%
• Emerging Markets: up 4.4%, up 6.7%

As I just mentioned, major stock indexes in the US looked great on paper as average returns seemed to rise steadily throughout the quarter. The largest publicly-traded stocks related to artificial intelligence performed best. Microsoft, Apple, and Nvidia each ended Q2 with a $3+ trillion market capitalization and the worst performer of the bunch, Apple, was up 24% during the quarter. These and other popular Large Cap Growth names within the Technology and Communication Services sectors, like Google and Meta, now occupy such a large portion of the market that they massively impact index performance. Last quarter was positive because of this but performance could easily have gone the other way. This is plain when looking at benchmarks like the Russell 1000 that include the 500 largest stocks (similar to the S&P 500) and the next 500 smaller companies. According to my research partners at Bespoke Investment Group, this index rose by a respectable 3.3% during Q2. However, the top four stocks in the index added four percentage points of gain. Without them the remaining 996 stocks would have collectively averaged a small loss. Nvidia alone was worth almost 48% of the index’s gain. Besides the aforementioned sectors along with Consumer Staples and Utilities, up 1% and 4.6%, respectively, all other sectors in the US were negative during Q2. This is a reminder of how imbalances in the markets can be masked by average index performance and how this can promote investor complacency. Always look beyond the label – it’s what’s inside that matters.

This sort of imbalance isn’t unprecedented. Markets reflect the economy and substantial changes in market perspectives have coincided with every major development from the railroads to the creation of the internet. The rise of AI seems likely to be historically significant for the economy and markets, and maybe that’s a vast understatement. Only time will tell but we have to watch how these imbalances impact your portfolio in the meantime.

Beyond AI impacting the stock market, the bond market saw some positive moments during Q2 compared to recent quarters. Bond prices are highly sensitive to changes (anticipated or actual) in interest rates and rates were on the minds of investors again. As 2024 began investors expected the Federal Reserve to cut rates as much as half a dozen times during the year assuming inflation improved. However, inflation remained elevated and Fed officials indicated that rates could stay higher for longer. Investors quickly recalculated and the yield on the 10yr Treasury, an important benchmark, rose in April causing bond prices to fall. This reversed a bit in June as inflation and Fed policy forecasts seemed to improve. As Q2 ended the CME FedWatch website indicated investors were again expecting the Fed to reduce rates 3-4 times this year (and more into early-2025). These expectations could be overeager and have whipsawed quite a bit in recent weeks. This uncertainty will likely persist during the second half of this year.

So what to do about AI-driven imbalances in the stock market and the continued plight of core bonds. If you’re doing the “right” thing you’ll have diversification across asset classes (stocks, bonds, and cash), sectors (Technology, Healthcare, Financials, and so forth – there are eleven sectors in the US), and industries. Within bonds you’ll likely have exposure to those issued by the US Treasury, large corporations, and government agencies. You may also have bonds issued by states and smaller municipalities. You’ll have ready cash that pays essentially nothing in terms of interest, but you might also have some cash in a money market or CD at a decent rate. You have all these investment types so you’re not pinning your hopes on any one or two at a time. Sure, it would be nice to luck into having all of your money in Nvidia stock as it grows exponentially, but what if Nvidia got walloped or failed? I’m not suggesting this is likely. However, recall some of the many examples over time of massive growth followed by massive failure like Enron or maybe Pets.com. Those stories should stimulate a prudent desire to hedge your bets. Own it all in manageable and appropriate proportions. Then rebalance as needed based on a specific and repeatable process. You’ll get lift from AI-related stocks (or whatever else is popular at the time) while enjoying safety in numbers. You probably won’t beat the market on any given day but you’ll have a good chance of beating the system over the long run. And bonds are still helpful as a store of cash for the medium-term. You should continue to hold them in your portfolio along with complimentary instruments like short-term CDs and money market funds.

There’s uncertainty as we enter a new quarter, as always, but the economy is doing well and most of the stock market isn’t overvalued. I’m optimistic about returns for the rest of the year but I plan to stay disciplined and focused on long-term performance versus chasing what’s popular. I humbly suggest you do the same.

Have questions? Ask us. We can help.