Executive Summary
- Bifurcated returns amongst major equity benchmarks in Q2, led by large cap Growth
- The hawkish repricing of rates may have ended in early May
- Rates peaked in early Q2 and have since been in a trend of lower highs and lower lows
- A divided Fed lowered their projected rate cuts to one from three by YE 2024
- Economic data is softening, with employment appearing to be at an inflection point
The 1H of 2024 is in the books and while the major equity benchmarks are widely positive, the broad participation seen throughout the first quarter narrowed considerably in Q2. Q1 could best be described with the “rising tide lifts all boats” mantra as all the majors finished firmly in the green supported by robust breadth including new all-time highs for the S&P Midcap 400 and S&P 500 equal weight indices. Conversely, “a tale of two tapes” best describes Q2, which was characterized by poor market breadth and negative performance for most indices, yet a small group of large-cap growth stocks with outsized index weightings had robust gains. Accordingly, the Nasdaq-100 and S&P 500 indices had strong, double-digit returns in the 1H of 2024 and meaningfully outperformed Value, as well as mid- and small-cap benchmarks.
All but one of the major U.S. equity benchmarks (Russell Microcap Index) were in positive territory in the 1H of 2024, led by the Nasdaq Composite (+18.6%), the Nasdaq 100 (+17.5%) and the S&P 500 (+15.3%) indices. From there index performance drops off meaningfully with the S&P Midcap 400, the NDX and S&P 500 equal weights, and the Dow Jones Industrials each returning a relatively modest 5% to 6%. The small-cap Russell 2000 waffled around the breakeven level throughout most of the year before late strength over the final two weeks of June lifted it to a gain of 1.3%. The Russell Microcap Index closed out the 1H down 0.9%.
As the S&P 500 and Nasdaq-100 indices pushed to new all-time highs late into Q2, fewer stocks reached new highs across near (3M), intermediate (6M), and longer term (12M) time frames. The percentage of members in the S&P 500 making 12M highs peaked in March, while the percentage making 3M and 6M highs peaked six months ago in December, per below.
Amongst the majors, only the Nasdaq Composite (+8.5%), the Nasdaq-100 (+8%), and the S&P 500 (+4.3%) finished in the green in Q2. The Nasdaq-100 equal weight declined 0.2% in Q2 and underperformed its cap-weighted benchmark by 8.2 percentage points, while the S&P 500 equal weight declined 2.6% and underperformed its cap-weighted benchmark by 6.9 percentage points. The 6.9 percentage point spread between the S&P 500 and its equal weight index is the third widest since the inception of the equal weight index in 1989. The prior two wider spreads took place in Q4 1999 (8%) and Q1 2020 (7.1%). The 8.3% spread between the Nasdaq-100 and its equal weight index is the second widest on record since the inception of the NDX equal weight in 1985 — only Q2 2023 (+9%) was wider.
The performance bifurcation can be seen when comparing both large versus small caps, or growth versus value, and is largely attributable to the robust gains by select mega-cap stocks, which have the largest weightings in their respective indices. Currently, three companies have a market cap above $3T and combined comprise more than a 20% weighting in the S&P 500. At the height of the dotcom era in 1999, the top three members of the S&P 500 had less than a 10% weighting. The top 25 members of the S&P 500 currently have roughly the same market cap as the rest of the index combined. The top 10 have a combined index weighting of ~35% versus a high of ~27% in the dotcom era. The below chart illustrates the wide performance gap in 1H 2024, with the Magnificent Seven +37%, the S&P 100 +19.1%, the S&P 500 Equal Weight Index +5.1% and the Russell 2000 +1.7%.
Growth vs. Value
Large-cap growth gained a robust 8.2% in Q2, whereas the other three buckets (small-cap Growth and large- and small-cap Value) were all in the red. For 1H 2024, large-cap Growth has a total return of 20.7%, which alone is a phenomenal return marking its sixth best 1H gain since inception in 1978. It is even more impressive considering it followed 2023, which was both its best annual total return (42.7%) and 1H (29.1%) performance on record.
Sector Performance
Ten of the eleven large cap sectors were higher in 1H 2024, driven by outsized gains in Technology (28.2%) and Communications (26.7%). However, six of 11 sectors were lower in Q2 versus just one in Q1.
At the small-cap level, six of eleven sectors were higher in 1H 2024 while just three were in the green in Q2 versus eight in Q1. In general, smaller-cap companies are more sensitive to interest rates, which was a headwind for much of 2024 during the hawkish repricing of the yield curve.
Rates
Rates shifted higher across most of the curve in 2024, with the 2yr yield +50bps to 4.75% and the 10yr yield +52bps to 4.40%. The 10s, 2s spread has been inverted since July 2022, which is its longest inversion on record. While an inverted curve has historically been an early warning signal of an oncoming recession, a recession has not yet materialized in this cycle and U.S. economic activity continues to surprise to the upside. Prior economic cycles are often driven by credit whereas the current cycle is widely described as being driven by increasing incomes and fiscal spending.
Stronger economic activity has driven the hawkish repricing of rates throughout the majority of 2024 whereby, in mid-January, Fed Funds Futures were pricing a peak of 168bps in rate cuts by year end 2024 to as little as 28bps at the start of May. The Federal Reserve’s most recent Summary of Economic Projections (SEP) released at the June FOMC shifted hawkishly to one rate cut this year rather than the three forecasted in the December 2023 and March 2024 SEP releases. The ECB cut rates ahead of the Federal Reserve and now half of the G10 central banks have cut rates. Investors are more dovish and are expecting two rate cuts (now 45bps) from the Federal Reserve by year-end.
While 2024 economic activity has been stronger than anticipated versus the start of the year, the more recent data in Q2 has been coming in below expectations. Maybe most importantly is the upward trend in unemployment. The monthly unemployment rate (May) came in at 4% versus forecasts for 3.9%. The unemployment rate bottomed in January 2023 at 3.4% and is already at the Fed’s year end projection. The four-week moving average of weekly jobless claims rose to its highest level since last September, while the three-month moving average of nonfarm payrolls fell to its lowest level since November 2023 and January 2021. On the inflation front, last week’s headline PCE (May) came in at 2.6% YoY, in-line with forecasts and down from 2.7% in April. Core-PCE came in at 2.6%, also in-line with forecasts, and down from 2.8% in April. The first estimate of Q2 GDP will be published on July 25, the week before the next FOMC, with consensus at 2% YoY vs. 1.4% in Q1.
While the Fed is unlikely to cut rates at the next FOMC on July 31, its messaging could be more dovish. Given the continued disinflation trend (2.6% headline and core PCE) and the increasingly below consensus economic data (see below declining Citigroup Economic Surprise Index,) including the softening employment data, the Fed may have cover to signal a rate cut at the ensuing FOMC in September.
Corporate Earnings
Q2 2024 earnings season is soon arriving. For Q2, the estimated S&P 500 EPS growth rate is +8.8% YoY, while estimated revenue growth is +4.6% YoY, according to FactSet. Eight of the 11 sectors are expected to report higher EPS growth in Q2. For CY 2024, analysts are projecting S&P 500 EPS growth of 11.3%, and revenue growth of 5%. For CY 2025, analysts are projecting S&P 500 EPS growth of 14.4%, and revenue growth of 6%. The S&P 500 has a 12M forward PE of 21.2x, which is a 16% premium to its 10-year average.
Looking Ahead
Beauty is in the eye of the beholder, and for the stock market, many are interpreting the narrow market breadth as a cautionary signal warning the major equity benchmarks are at risk of rolling over and entering a deep correction. While this is a potential risk, it is not the only possibility. The 1H of 2023 also had narrow breadth, weak relative performance amongst many industries, as well as a banking crisis, but by year end the major indices all experienced above average returns.
There are plausible reasons supporting a more constructive, “glass half full” bias for the 2H of 2024. As we have noted in prior reports, the constructive price action in Q4 2023 and Q1 2024 was historic in terms of breadth and magnitude where prior instances boded well for future 12M returns.
The strong breadth took place late in 2023 when a “Zweig Breadth Thrust” was triggered in the first week of November for only the 18th time in the prior 85 years. Breadth thrusts are technical measures capturing extreme bearish to bullish price action across a wide range of stocks by analyzing advancers to decliners. The prior 17 occurrences were all followed with positive 12M returns with average and median gains of 23.7% and 24.8%, respectively. Nearly seven months since the most recent breadth thrust was triggered on Nov. 3, the S&P 500 has since gained 26.5%.
More recently, the S&P 500 had double digit gains in Q4 2023 (11.2%) and Q1 2024 (10.2%). This is only the nineth time since 1940 (84 years!) where the S&P 500 had double-digit gains in consecutive quarters. The 12M future returns during the prior eight occasions were all positive with average and median gains of 14.9% and 13%, respectively. Also, during the five months from November into March 2024, the S&P 500 gained 25.3% for its 10th best 5M return since 1940. The 12M forward returns in the prior nine occasions were all positive with average and median returns of 19.6% and 22.6%. Currently, the S&P 500 is +4.6% since the end of March.
While many of the major equity benchmarks with less exposure to large cap growth are underperforming the Nasdaq-100, Nasdaq Composite, and S&P 500, they are not yet showing technical signs of breaking down. From a technical perspective one could argue they are simply in the midst of a constructive, sideways consolidation following prior steep uptrends during Q4 and Q1.
Despite the sharp, hawkish repricing of rates in the 1H of 2024, the underperforming Dow Jones Industrials, S&P Midcap 400, Russell 2000, and the equal weight S&P 500 and Nasdaq -100 indices have a combined average total return of 4.6%, which is on pace to come in just below 10% by year end. Those five benchmarks are on average down 3% from their 52-week highs, which is a very modest pullback. All the majors are trading above their rising 200-d simple moving averages, and all are in technical uptrends as defined by having a 50-d moving average greater than a 200-d moving average.
The critics may prove to be right and the major equity benchmarks could break down from their sideways consolidations for a much deeper correction, possibly even testing their respective moving averages. However, the below charts of the S&P 500 equal weight index and the S&P Midcap 400 Index show each benchmark with a similar consolidation of lower highs and higher lows following one of the most bullish five-month performances in the history of the markets. A bullish breakout from the Q2 ranges might require a dovish catalyst from the Fed at the next FOMC, or potentially sooner from upcoming economic data. Time will tell how this unfolds, but history could favor the optimists.
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