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2024 07 The Iceberg
All LettersThe Iceberg
I hope that your summer is going well. It's a genuine pleasure to provide you with this quarterly update. I hope that we had a chance to meet with you in the first half of the year for a more in-depth review. We will hold our second cadence meeting set in October and November.
I am starting this letter by sharing some enduring truths about building and protecting wealth. From there, we can proceed to some more current observations.
General principles that drive our investment philosophy:
- We are goal-focused, plan-driven, long-term investors. Our portfolios are derived from and driven by your most cherished lifetime financial goals, not from a short-term view of the economy, the markets, or the day's politics.
- We do not believe the economy can be consistently forecast, nor can the markets be consistently timed. We do not believe it is possible to gain any advantage by going in and out of the markets, regardless of current economic conditions.
- We therefore believe that the most efficient method of capturing the total compound return is by remaining fully invested all the time
- We are thus prepared to ride out the equity market's frequent, often significant but historically temporary declines.
Fed Rate Watch: Day 836
The Fed announced the first post-Covid interest rate hike on March 16, 2022. As measured to the end of Q2 2024, that was 836 days ago. The Fed has repeatedly said they are looking for inflation to show signs of returning to the target rate of 2%. While the numbers trend in that direction, we are not there yet. In recent comments, Fed chairman Powell intentionally steered clear of providing guidance on when a rate cut might happen while admitting he was balancing concerns about the negative impact of keeping rates high for too long.
As a reminder, CPI (Consumer Price Index) is a widely used measure that tracks household expenditures to measure inflation. Core PCE measures much the same information but also includes spending made on households' behalf. One example would be the contribution towards health care that employers make on behalf of employees, which is included in Core PCE but excluded from CPI. Core PCE is the preferred measure of the Federal Reserve. Both are typically measured "year over year," even though markets often react to "month over month" changes.
Market Review
Broad market indices continued to rip in Q4. The S&P 500 was up 4.3% in the quarter and 15.3% on the year.
Key Index Returns | |||||
Index Name | As of Jun 30, 2024 | Q2 2024 Change | 2024 YTD Change | Trailing 1 Year Change | 2023 |
S&P 500 | 5,460 | 4.3% | 15.3% | 24.6% | 26.29% |
Nasdaq Composite | 17,733 | 8.5% | 18.6% | 29.6% | 44.64% |
Dow Jones Composite Average | 12,473 | -1.6% | 2.9% | 10.1% | 14.17% |
Russell 2000 | 2,048 | -3.3% | 1.7% | 10.1% | 16.93% |
MSCI World Ex USA | 2,329 | -0.4% | 5.4% | 11.8% | 18.60% |
MSCI Emerging Markets | 1,086 | 5.1% | 7.7% | 13.0% | 10.27% |
Bloomberg US Aggregate (Bonds) | 2,147 | 0.1% | -0.7% | 2.6% | 5.53% |
Effective Federal Funds Rate | 5.33% | 0 bps | 0 bps | 25 bps | 25 bps |
10 Year Treasury Rate | 4.36% | 3 bps | 48 bps | 55 bps |
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Source: YCharts. All values represent Total Return, which includes dividend reinvestment. The data series end date is Jun 30, 2024. Data was accessed and calculated on Jul 15, 2024. Note: you cannot invest directly in an index. |
AI and The Iceberg
It has been said that only 10% of an iceberg is visible, while the remaining 90% is submerged under the water. Is that what we're seeing in today's market?
What's driving this? The AI revolution is powering significant gains in technology shares and the S&P 500. Look no further than chipmaker Nvidia (NVDA), a leading provider of very specialized chips used in AI. Last month, Nvidia was briefly the largest publicly traded company in the world. According to a Wall Street Journal report on June 21, 2024, Nvidia accounted for an astonishing 44% of the rise in the S&P 500 since the end of 2021.
Why? The S&P 500 Index is a market capitalization-weighted index. The top three stocks are valued at over $9 trillion, comprising a significant portion of the index's value of about $46 trillion.
We've established that the largest publicly traded companies are, on average, performing admirably. That said, have investors shunned many equities that make up the S&P 500 Index in favor of a few large companies?
There is a saying in the technology world that people overestimate the impact of new technologies in the short term and underestimate their impact in the long run. The upbeat case for AI argues that technology and AI will drive productivity, fueling economic growth as millennials enter their prime spending years. We have only begun to see some of the productivity gains promised by AI, and only time will tell if AI is the game changer the market is currently pricing in.
Is the S&P 500 Equal Weight Index a potential warning sign?
As the name implies, every stock in the index equally contributes to its performance. It is made up of the same 500 stocks as the S&P 500 index but de-emphasizes large stocks and, therefore, gives more emphasis to small and medium-sized stocks. The equal-weight index is up a respectable but modest 5.1% this year. Notably, the equal-weighted index was off 2.6% in Q2 versus an advance of over 4% for the S&P 500 market-cap-weighted index.
What might this mean?
Some market technicians have fretted over the lack of breadth in today's market. "This Rally Is All About a Few Star Stocks-and Some Investors Are Worried," the Wall Street Journal wrote on June 6, 2024.
One possibility is that the expectation of rate cuts by the Fed has been driving market returns. If this is true, it would imply that we have essentially pulled some future market gains forward to today, which would, in turn, imply lower expected short-term returns.
What does this mean for you?
We can't see around corners or into the future, so we'd never dismiss the possibility of a market pullback. However, the market's long-term track record provides a compelling reason for including stocks in a comprehensive financial plan.
I trust you have found this review to be informative. If you have any inquiries or wish to discuss other matters, please don't hesitate to contact me or any team member.
As always, thank you for choosing us as your financial advisor. We are honored and humbled by your trust.
Chris Duke
July 16, 2024
DISCLOSURES
This is being provided for informational purposes only and should not be construed as a recommendation to buy or sell any specific securities. Past performance is no guarantee of future results, and all investing involves risk. Index returns shown are not reflective of actual performance nor reflect fees and expenses applicable to investing. One cannot invest directly in an index. The views expressed are those of Chris Duke and do not necessarily reflect the views of Mutual Advisors, LLC, or any of its affiliates
Investment advisory services are offered through Mutual Advisors, LLC, DBA Context Wealth, an SEC-registered investment adviser.