2024 February Market Update

Equity markets pushed higher in February, rallying largely on “Artificial Intelligence” headlines to shake off a minor mid-month pullback. Mega Cap Technology companies continue to lead, buoyed by their resilient earnings growth. In aggregate, the “Magnificent 7” posted 58% year-over-year earnings growth compared with a 2% decline for the other 493 members of the S&P 500. While markets have ascended to all-time highs, participation in the gains remains relatively limited. We are, however, encouraged to see some relative outperformance from last year’s laggards, most notably in the Healthcare and Financials sectors.

At the index level, markets appear richly valued and near the top of their historical valuation ranges. However, it is important to note how top-heavy the indices have become, skewing these historical comparisons. The ten largest companies in the S&P 500, which all have forward Price-to-Earnings ratios higher than the ~20.5x Index average, account for over 30% of the Index. Meanwhile, the rest of the companies aggregate to an average valuation multiple that looks much more reasonable in historical context. Looking even more broadly at the S&P 1500 (which represents approximately 90% of the total US equity market), more than half of the constituents are trading lower than they were when the Fed began hiking rates nearly two years ago.

It’s important to note valuation multiples typically don’t serve as a useful market timing tool but can be more predictive of what types of returns to expect during the following year. Markets have historically posted more tepid forward returns when index valuation levels are this high. It would not be surprising to see weaker overall market performance given that the optimistic double-digit earnings growth estimates for both this year and 2025 demand almost perfect execution. Meanwhile, there remains considerable uncertainty on the forward trajectory of the potential economic slowdown even though many forecasters have already dialed down their odds of recession. As we frequently note, US stocks have averaged two 10% corrections a year over the past 100 years; pullbacks, over various time horizons and of varying severities, are the norm.

While always cognizant of these downside risks, investors should consider the real possibility of “upside” surprises as well. History suggests there are still ample gains available even as stocks touch all-time highs. Furthermore, the historical track record for the rest of the year following a positive January and February is equally encouraging. Market prognosticators, and even the Federal Reserve themselves, have been wildly off in their economic projections over the past several years. The domestic economy continues to show robust activity and resilience to headwinds even in the face of some of the most restrictive monetary policy in more than a decade. The historical lag between the beginning of a rate tightening cycle and effects on key economic measures (such as employment) can span at least two years, so data over the next few months will be telling.

The impact of “AI” also looks increasingly likely to be a permanent elevator of global labor productivity rather than merely a temporary tailwind. Certain semiconductor companies dominate “AI”-related headlines, but there are countless other companies in the technology infrastructure ecosystem – from equipment manufacturers to cloud computing providers to “AI” software enablers – that could potentially benefit. As has historically been the case with other “generational” innovations (such as cell phones and the internet), the companies that could benefit the most from “Artificial Intelligence” may not even exist yet!

Despite media headlines stoking a “fear of missing out,” we caution against losing portfolio discipline to chase momentum trades. Investors ought to be careful justifying today’s stock prices by extrapolating incredible growth rates out indefinitely without regards to future competition. At the same time, there remain significant value opportunities in “unloved” pockets of the market. Maintaining balance between resilient, defensible growth and timely value opportunities can potentially prove the necessary hedge to a variety of macroeconomic outcomes.

Fixed Income also continues to present attractive risk-adjusted return opportunities. Unlike stocks, despite elevated uncertainty on the forward interest rate trajectory, there always exists a high correlation between starting rates and future fixed income returns. This is, of course, because of the fixed coupon and maturity features of bonds relative to stocks. Investors holding bonds to maturity don’t need to be concerned about forward rate uncertainty. “Locking in” current rates by buying bonds with longer-dated maturities provides future cash flow and total returns visibility regardless of whether the Fed starts to cut rates later this year. Given the potentially gloomy message that elevated valuations could be sending about forward broad-market stock returns, bonds could prove quite competitive, especially on a risk-adjusted returns basis. A balanced portfolio of stocks, bonds, and cash alternatives, tailored to your financial goals and needs, will continue to be essential. To that end, we are always happy to discuss your portfolio’s allocation and look forward to further ‘catch-up’ talks soon!

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the Wise Investor Group and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Investments mentioned may not be suitable for all investors. The companies engaged in the communications and technology industries are subject to fierce competition and their products and services may be subject to rapid obsolescence. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. Holding bonds to term allows redemption at par value. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. There are special risks associated with investing with bonds such as interest rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment risk, and unique tax consequences. To learn more about these risks and the suitability of these bonds for you, please contact our office. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Past performance may not be indicative of future results.