Q2 2024: A Deeper Dive

The primary drivers of both the equity and bond markets in the second quarter were strong Q1 corporate earnings reports, inflation and employment news, and the Federal Reserve policy stance. A series of stronger-than-expected inflation readings sent the equity and bond markets lower in April as investors reduced their expectations for rate cuts and determined the Federal Reserve would be forced to keep interest rates higher for longer than previously expected. May data, however, showed more favorable inflation numbers, and there were continued indications the labor markets were coming back into balance. These data points, as well as strong Q1 earnings reports, sent stocks higher and bonds higher.

The domestic large cap equity market, as measured by the S&P 500, was up 15.3% for the six months ending June 30 and up 4.3% for the second quarter. However, the quarterly performance numbers do not tell the whole story. There are six trillion-dollar companies in the S&P 500 that now make up approximately 31% of the index. These six companies (Nvidia, Apple, Alphabet, Amazon, Microsoft, and Meta) returned 16.8% in the quarter, while the remainder of the companies in the index returned -0.8%. The performance of these six companies helped to propel the index to multiple new all-time highs during the quarter. Despite the weak Q2 performance for the remaining companies in the S&P 500, their lower valuations and expectations for broadening earnings growth should lead to greater participation in the second half of the year.

It is clear from the names of the six companies which sector(s) led the market during the quarter, as only four of the 11 sectors were positive, led by Technology (+13.8%) and Communication Services (+9.4%). Utilities also recorded a positive quarter up 4.7% on the premise of increased electricity needs associated with the anticipated new data centers fueled by AI (artificial intelligence). The worst performing sectors in the quarter were Materials (-4.5%), Industrials (-2.9%), and Energy (-2.4%).

Domestic large cap stocks outperformed international stocks with the MSCI EAFE rising just 1.3%. The NASDAQ was the big winner for the quarter (also recording multiple all-time highs) returning 8.5%, while small cap stocks continued to struggle, declining 3.3%. Small cap stocks, which tend to carry more debt, continue to be affected by higher interest rates.

US Treasury yields increased along the majority of the yield curve, continuing the trend that began in the first quarter of 2024. During Q2, the yield on 2-year Treasuries rose 9.7 basis points to 4.7%, while the yield on the 10-year rose 17 basis points to 4.4% and the 30-year rose 19.6 basis points to 4.5%. On average, 2-year to 30-year yields rose 49 basis points during the first half of the year. The Bloomberg US Aggregate Index, which tracks investment grade bonds in the United States, was up 0.7% during the quarter but is down 0.7% for the first half of 2024.

Inflation readings continue to be a big driver of investor sentiment. After upticks in headline CPI in February and March, lower readings were recorded during the second quarter. On a year-over-year basis, June 2024 CPI came in below 3% for the first time at 2.9%, down from 3.5% in March. Core CPI (ex-food and energy) came in at 3.3%, down from 3.8% in March. Both were below market expectations and below the prior months’ levels.

The labor market has come into better balance as the number of job openings as measured by JOLTs data has continued its decline. The unemployment rate ticked up to 4.1% in June, the first time the rate has been above 4.0% in 30 months. However, at 4.1%, it remains well below the 50-year average of 6.2%. Monthly job gains came in at 206k in June, a bit lower than the six-month average of 222k. Over the last three months, however, the United States has been averaging 177k new jobs per month, an indication the labor markets may be easing a bit. Another sign of the labor market may be moderating is the uptick in the number of individuals filing unemployment claims each week, as well as the number of continuing claims filed.

The Federal Reserve continues to watch the data as it comes in to help guide them to the correct interest rate path. In June, the Fed revised its outlook for interest rates and, on average, are forecasting just one rate cut by the end of 2024. This is a change from their previous forecast of three cuts during the year they gave at their March meeting. Chairman Jerome Powell has consistently stated that the committee wants to see several months of improving inflation data to confirm that inflation is coming down in a sustainable way to meet their 2.0% target. More recent data should be providing them with that information.  Currently, the markets are betting there is a 75% chance of a rate cut at the committee’s September 18 meeting, an 86% chance at the November meeting, and 97% chance at the December meeting.

Moving forward, we expect broader participation of companies within the S&P 500. Additionally, we expect a resilient consumer, fueled by a favorable labor market and increases in real wages, to continue to propel the economy. We also expect inflation metrics to continue to decelerate throughout the remainder of 2024 and prompt the Federal Reserve to initiate rate cuts as it works its way back to a neutral stance and achieves the sought-after soft landing. With that in mind, it is important to note there remain several risks, including the upcoming presidential election, geo-political tensions, and elevated interest rates that could cause disruption to our domestic economy.

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