DSWM Quarterly: Q2 2024

Halfway through 2024 many investors would agree that the year has not unfolded how they expected, but for the most part that has not been a bad thing. In the U.S., 2023 finished with consistently falling inflation numbers, but weariness as to when the U.S. economy would buckle under the weight of the elevated rate environment and fall into a recession. There was good reason for concern in the U.S., since in late 2023 many other developed market economies were experiencing a recession or were on the cusp of one. The recession that many were worried about has not materialized in 2024, the U.S. economy has remined resilient in the higher rate environment, adding 2.8 million jobs over the past year and GDP expansion continues to maintain a positive level. The largest defiance of expectations this year would have to be the Federal Reserve’s interest rate policy. Early on in 2024 the market was pricing in 6 or even 7 rate cuts for the year, that very quickly changed as falling inflation numbers leveled off and Federal Reserve members shifted back to a more a hawkish tone, leaving market expectations at 1 to 2 rate cuts during the second half of the year.  

In the U.S. equity market, the Artificial Intelligence (AI) theme continued to dominate returns. Through the first half of the year the S&P 500® is up roughly 15%. If the returns of the “Magnificent 7” tech stocks (Amazon, Microsoft, Alphabet, Meta, Nvidia, Apple, and Tesla) are removed from the index, the S&P 500® would be up just over 7% for the year. That puts into perspective how much these 7 tech stocks have contributed through the first half of the year (it should be noted that Tesla is only up 0.50% for the year, so it is 6 stocks that are responsible for the six-month double digit return); it should be noted that the remaining 493 stocks are on pace for a 14% return for 2024, so the remainder of the large cap market clearly remains strong. A look at U.S. small cap equities shows a very different start to the year, the Russell 2000 finished the first half of 2024 nearly flat, after a bumpy 6 months of moving in and out of negative territory. The overwhelming market view on small caps since the beginning of this rate hiking cycle has been that smaller companies would be the first to show the stress of higher rates since smaller companies are generally more dependent on debt financing for growth. Thus far, those stresses have not materialized, and many analysts are pointing to a potential tail wind for small cap equities for the second half of 2024 as the U.S. gets closer to a more accommodative interest rate policy.

Thus far, there is not a better example of a market in 2024 where expectations going into the year have proven to be far from reality than the bond market. To start 2024, bond market investors were optimistic to say the least, inflation had been reigned in, the 6 to 7 rate cuts the market had priced in would be a boost to bond investments (yields down, prices up). That abruptly changed as data indicated stickier than expected inflation all while the economy and job market remained strong. This gave Fed officials good reason to wait on their first cut. The complete reversal from the expected path of rate cuts led to a volatile first quarter and beginning to the second quarter for bonds. The bond market has since calmed down and most fixed income asset classes managed to finish the second quarter in (slightly) positive territory.  

A look at international equities through the first half of the year reveals mixed results across developed markets, while emerging markets outperformed. In developed markets, European economies struggled which led the Swiss National Bank to be the first to cut rates and the European Central Bank (ECB) followed soon after. The expectation is that the Bank of England (BOE) will begin cutting rates early in the third quarter to stem off weakening economic conditions. The easing monetary policy across these European economies is giving many analysts optimistic views for the second half of the year. However, the war in Ukraine as well as major elections in many European countries do pose some risks for short-term volatility. Japanese equities continued to perform well but some returns are muted for investors outside Japan as the Yen depreciated against other major currencies. The Bank of Japan’s effort to push rates higher after ending their decades long negative interest policy should help stabilize the Yen against the U.S. dollar. Emerging markets, in general, got a boost from renewed optimism of a U.S. rate cut sooner rather than later, coupled with easing rate policies in many of the emerging market economies. The AI theme also extends to emerging markets, as both Taiwan and South Korea have outperformed due their role as manufacturing hubs for semiconductors and other hardware components necessary to power AI computing. China showed signs of improvement over the second quarter, but concerns remain due to a troubled property market, ineffective government remedies, and slowing growth prospects.

William Shakespeare wrote “Expectation is the root of all heartache.”   This year the market has not gone as expected, but at least from an investment standpoint we would hardly describe the results as leaving us with heartache. For the first half of the year, equities and bonds are both in positive territory, with some areas of the markets already up double digits for the year. However, it does not mean William Shakespeare’s insight does not ring true regarding investing, particularly for those that tried to time the markets based upon beginning of year expectations (as shown in the chart above, throughout the past 100 years there has been no shortage of expectation defying events which led to short-term market dislocations, the heartache comes if you change course as a result of the market pullback and miss all or part of the recovery). As we head into the heat of the summer and the hot political environment as we near election day, there will be surprises on all fronts – from weather to politics to the market.   We have no reason not to expect continued short-term market volatility, yet we plan on maintaining our investment philosophy of investing for the long-term which has served all of us well over the past almost 30 years.

 Droms Strauss Wealth Management

www.droms-strauss.com

(314) 862-9100

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