It has been an excellent six months for the stock market, with the S&P 500 up 15.23% through the end of June according to Morningstar. Returns have been steady with the only decline of note being a 5% pullback in April. However, not all has been as calm as it seems. Market expectations for rate cuts by the Federal Reserve have been greatly reduced. Unemployment has increased from 3.7% to 4.0%. Market pessimists are quick to point out that gains have been concentrated in large technology companies, particularly those exposed to artificial intelligence. In fact, about 1/3rd of the S&P 500’s returns this year have come from just one artificial-intelligence-focused company, according to UBS. The Dow Jones Industrial Average and the equally weighted S&P 500 are both only up about 4% for the year, with 40% of the stocks in the S&P 500 experiencing a negative first half return according to Bespoke. Further, many investors are spooked by the possibility for turmoil in the lead up to the Presidential elections in November.
Despite all the above, we have a more positive interpretation of the evidence. Lagging variables such as auto insurance rates and housing prices have kept inflation stubborn, but more than 50% of the CPI components are increasing at less than the Fed’s target of 2%. We are likely to see more progress on inflation and the long-anticipated rate cuts in the next several quarters, which should support stocks. The balance of economic data still suggests moderate growth. Credit markets, which are typically more economically sensitive than the stock market, remain strong. We also note that rate cuts can help blunt the impact of economic weakness, should it present itself, on the stock market.
While the technology sector has once again dominated market returns to date, the broad market has participated as well. The broadest measure of market breadth, the NYSE advance-decline line, made a new all-time high in early May. The equal-weighted S&P 500 made a new high in March after more than 2 years; an event that has historically led to further gains. Corporate earnings have been ahead of trend all year and are expected to grow 7.8% year-over-year this quarter. Earnings growth in non-technology companies are expected to accelerate, while those of technology companies are expected to decelerate based on difficult year-over-year comparisons. Meanwhile, valuations outside of the technology sector, particularly those in smaller stocks, are very compelling compared to history (all data from UBS). The evidence suggests that the rest of the market can pick up the slack if the technology sector stumbles.
Many investors are nervous about the presidential election and its potential impact on the stock market. We remind clients that they are invested in profit-making companies whose business models are largely unaffected by the party in charge of the Executive Branch of government. We have discussed several examples of this idea on our monthly market call and will continue to do so in the coming months. Eventual pullbacks are inevitable, but given the overall positive fundamental and technical backdrop, investors should stick with their plan and not be deterred. Remember, volatility is the emotional price investors pay for higher returns over the long run.
