Stocks finished the first half of the year on a high note, marking its best start to an election year in the last century. Returns were driven primarily by the largest companies in the US, thanks to a surge in spending on Artificial Intelligence (AI). Smaller US companies and the global market experienced slight pullbacks. The quarter was relatively calm, with only one day when the market moved more than 1.5%, which is unusual. The Federal Reserve kept short-term interest rates steady. Inflation continued to cool but it remained above the 2.0% target. Bond markets were also stable, with rates ending the quarter about where they began.

The stock rally was narrowly focused, with 90% of the S&P 500’s returns coming from Nvidia, Apple, and Microsoft. These three companies comprise 21% of the large-cap space and benefited significantly from AI segments in their businesses. Overall, AI-related companies in the S&P 500 saw a 14% gain, while all others were down 1.2%. The top-performing sectors were Technology (+8.8%) and Communication Services (+5.6%), with Utilities also seeing a 4.6% increase due to the expected rise in power demand from new AI-driven data centers. AI truly drove the market this quarter!

Investment Strategy

Your portfolio is fully invested in line with your strategic investment allocation. Our stock holdings have the greatest exposure to the largest US companies, which have driven most of the returns this year. We favor this segment because it is where most of the earnings growth is happening and earnings growth is the largest driver of long-term returns. In this category we are using a blend of growth and value investments which is allowing us to participate in the market upside but limiting your portfolios exposure to some of the concentration in the S&P 500. International and smaller US companies continue to have a neutral weighting. We are monitoring US small caps for an opportunity to increase our exposure, possibly when rates decline.

We are optimistic about future returns in your bond portfolios. The yields you are earning from your bond funds are at levels not seen in over a decade. High starting yields are a strong predictor of future bond returns, and they currently look very attractive. Our yields in taxable bond funds are close to 7%, with tax-equivalent yields in municipal bond funds in a similar range.

Outlook

We remain positive about stocks, even after a strong first half. While valuations are rich, they are justified by several factors. Profit margins are near peak levels and expected to stay strong. Companies have healthy balance sheets, giving them the flexibility to focus on growth. Historically, real yields are still reasonable, which supports current valuations. These elements suggest that valuations don’t need to contract anytime soon.

We expect future price gains will come from earnings growth. For the rest of 2024, earnings are expected to grow in the high single digits. This year, there have been few target revisions, which is rare and a positive sign. All 11 sectors are expected to show earnings growth, potentially broadening the rally beyond just a few stocks. In 2025, earnings per share (EPS) should grow around 6%. Additionally, share buybacks will boost the market, with around $1 trillion set for buybacks for 2024. This is a 13% increase from last year. For these reasons, we remain constructive on stocks for the rest of the year but caution that returns may not be as strong as the first half.

The economy is performing well, maintaining healthy growth even as it slows slightly. A major factor behind this resilience is the strength of the US consumer. As long as consumers have jobs and continue to spend, economic growth will remain supported. Additionally, inflation is trending lower, which should enable the Federal Reserve to cut interest rates this fall. We expect one or two 0.25% rate cuts, which would provide a welcome boost to stocks. Overall, steady consumer spending and potential rate cuts paint a positive outlook for the economy.

While our outlook remains positive, we are monitoring a few factors closely. Unemployment has been ticking up and is now around 4%, higher than its low of 3.4% in April 2023. If this trend continues, it could affect consumer spending as people become more cautious about their job security. This would cause economic growth to slow at a faster pace.

The bond markets have been relatively stable this year, but with the upcoming election, projected increased spending from both parties would widen deficits. This might prompt the bond market to react, potentially leading to higher interest rates to compensate for additional risks. Higher rates would likely cause stocks to sell off as well. While these issues are not imminent, they are important things to consider. We remain optimistic but grounded, keeping these potential challenges in mind and closely monitoring their developments.

With the US election about four months away, it is not unusual for stocks to pull back slightly due to election uncertainty. Typically, once the election concludes and uncertainty is resolved markets tend to rise. This year, the biggest sell-off in the S&P 500 has been about 5.4%, which is below the usual intra-year sell-off of 14% or more. While the market has been relatively stable this year, the upcoming election might introduce some volatility. However, given the historical patterns of election years and normal market fluctuations, we are not planning to deviate from our strategy. Remember, it’s important to keep political views separate from investment decisions and stay focused on long-term goals.

Q2 2024 Market Review & Outlook