2024 August Market Update
Equity markets rose again in August despite a spurt of elevated volatility and a steep pullback early in the month. This was the 4th consecutive winning month for the S&P 500 and marks nine up-months out of the last 10. Bond markets also continued to show signs of an ongoing recovery (and possible emergence from their longest bear market in 150 years) behind a sharp decline in Treasury yields. Weaker than expected labor market data has increased confidence that the Fed will begin cutting rates in September, and Fed Chair Powell effectively confirmed as much in his Jackson Hole address on 8/23.
The sell-off in stocks early in August was initially triggered by a cooler than expected July Employment Report, which fueled simmering investor fears of a looming recession. The modest selling pressure this caused intensified significantly due to technical factors such as crowded positioning in popular trades and poor liquidity from a rapid unwind in Japanese Yen carry trades. The resulting sharp 8% decline for the S&P 500 and 3rd largest spike in volatility on record was immediately followed by an equally acute “V-shaped” recovery in equities that saw indices recover their losses within a mere 7 trading days. An investor focused on summer recreation and travel may not have noticed much change at all!
The sell-off and rapid recovery serve as humble reminders that markets move faster and are more susceptible to technical factors today than ever before. Beyond any specific catalysts for the August surge in volatility, markets are generally vulnerable to a variety of shocks when complacency runs high and bullish sentiment sits at extreme levels. While the temptation might be to “do something” and become more active with portfolio trading and repositioning, investors are generally better served avoiding rash decisions when volatility has already begun to spike.
Similarly, investors should avoid trying to time or predict recessions. A quick look at large swings in interest rate forecasts so far this year shows how quickly narratives can oscillate from one extreme to another. Neither economists as a group, the Federal Reserve or even the markets themselves have proven to be dependable recession forecasters historically. Even if one could reliably predict a recession, markets don’t always move in sync with the economy and have responded differently from one instance to the next. Sometimes stocks front run economic downturns well in advance, in other periods they are caught off guard – the same holds true on the way out of recessions.We strive to maintain our focus on corporate fundamentals rather than reading macroeconomic “tea leaves.” Reported 2nd quarter earnings are on track to grow roughly +11% compared to the same period in 2023, modestly higher than the +9% expected back in April. So far, corporate earnings have outperformed modest growth in the underlying economy behind rising profit margins. Margins were widely expected to face pressure from rising rates and overall financing costs. However, companies are now benefitting as supply chain and input cost headwinds moderate while the pricing gains captured over the past few years stay in place. We remain laser focused on whether (and where) this can continue.
Interestingly, specific references to “recession” and “layoffs” were less frequent in company earnings calls during the recent reporting period compared to the past two quarters. Perversely, we have seen this play out right as media headlines mentioning these topics are becoming more frequent. As always, investors should remain wary of allowing macro headlines to distract from what they are seeing and hearing from individual companies.
Market performance and earnings growth have begun to broaden out beyond the so-called Magnificent 7 mega cap names in recent weeks. Broader markets tend to be healthier markets! The other 493 stocks in the S&P 500 have quietly outperformed the Magnificent 7 over the past three months, while 2nd quarter earnings showed the highest percentage of companies with sequentially improving earnings growth since late 2021.
Meanwhile, S&P 500 valuations remain elevated at north of 20x 2025 EPS estimates. Valuations are not reliable timing indicators but are highly correlated to future returns. Barring further multiple expansion, we might expect the major index returns will struggle to match the lofty performance realized over the last ~15 years.
The broadening earnings picture does lay bare the availability of relative bargains beneath the surface for those willing to look. Valuations excluding the Magnificent 7 remain much less demanding than multiples assigned to the world’s most popular companies. The spread between valuations for U.S. Growth stocks and Value stocks remains near the most extreme readings since 2000, while we have not seen Small-cap stocks trade at a wider discount to Large-cap stocks in over two decades!
With the Federal Reserve poised to begin cutting interest rates in September, note that some of the laggard sectors and asset classes of the past two years have also been the most sensitive to rates. For example, Small-cap stocks tend to rely more heavily on floating rate debt. Lower rates should provide a significant tailwind in the form of lower financing costs, which is likely why Small-caps historically fare better than Mid- and Large-cap peers following Fed rate cuts. Sectors like Utilities and Consumer Staples are also highly impacted by changing interest rates, and feature more defensive properties should a less rosy economic outcome unfold.
There is some nuance across different types of bonds with respect to the credit outlook, but for the most part fixed-income performance is directly tied to prevailing interest rates. Any diversified investor knows how much this part of their portfolio has underperformed stocks for several years – we suspect many would be surprised to learn that major bond indexes have posted better returns than stocks so far in the 3rd quarter of 2024. Following an extended period of positive correlation (seen most visibly in 2022 when both suffered losses), bonds finally began to provide more of a hedge when stocks wobbled earlier this month. History has shown bonds to be a more effective diversifier when inflation is below 3%, a threshold that we just crossed in July data readings.
While the prevailing backdrop is no doubt increasing in complexity and challenge, we continue to believe opportunities are there for patient and selective investors with an appropriate time horizon. Balance and discipline within portfolios are paramount for proper risk management and will likely be more crucial to producing decent returns going forward than in recent years. As always, we are here to help make sure your portfolio is properly aligned and in keeping with your long-term financial plans, goals and objectives. Let us use the “back-to-school” season to connect and discuss!
The information contained in this book does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. Expressions of opinion are as of the initial book publishing date and are subject to change without notice.
