In the second quarter of 2024, global equity markets delivered mixed returns: U.S. large companies and emerging markets produced strong returns, while U.S. small companies and developed markets outside of the U.S. generated losses. The S&P 500 index performance was driven by strong corporate earnings in the technology and communication services sectors, fueled by enthusiasm for artificial intelligence (AI). Large-cap growth stocks—the largest tech companies, in particular—outperformed the broad market. The U.S. economy showed strength, with solid consumer spending and capital investment by corporations. Despite adjusted expectations for fewer interest rate cuts and ongoing inflation concerns, investors remained cautiously optimistic about corporate earnings and the potential for modest economic growth over the near term.

Equity Performance for Periods Ending on June 30, 2024

Total Return Index Market Sector Quarter YTD 1-year 3-year 5-year 10-year
S&P 500 Large U.S. Companies 4.3% 15.3% 24.6% 10.0% 15.0% 12.9%
Russell 2000 Small U.S. Companies -3.3% 1.7% 10.1% -2.6% 6.9% 7.0%
MSCI EAFE Developed Int’l Markets -0.4% 5.3% 11.5% 2.9% 6.5% 4.3%
MSCI EM Emerging Int’l Markets 5.0% 7.5% 12.6% -5.1% 3.1% 2.8%
BB US Agg Bond US Investment Grd Bonds 0.1% -0.7% 2.6% -3.0% -0.2% 1.3%

For the past two years, the Federal Reserve has been attempting to achieve a “soft landing” for the economy. It began increasing rates in March 2022 to slow the economy and reduce inflation, and it has since been carefully monitoring economic data to avoid driving the economy into a recession. So far, the Fed’s actions have been successful: the U.S. economy continues to grow at a modest pace, while inflation has declined. The Consumer Price Index showed no change from April to May, and increased just 3.4% from a year ago, its lowest year-over-year rise since August 2021. Despite expectations of a slowdown, job growth continued to surpass forecasts, as evidenced by June’s surprisingly robust nonfarm payrolls report. The Conference Board Leading Economic Index (LEI) for the U.S. continued to decline in May, which forecasted slowing growth, but fell short of indicating a recession. In the first quarter of 2024, real GDP for the nation grew at an annual rate of 1.4%. The Federal Reserve is currently predicting that the U.S. economy will grow by 2.1% for 2024, which is consistent with most other forecasts. Forecasters generally expect the global economy to grow by more than 3% in 2024, led by strong growth in emerging markets.

According to FactSet Research, earnings for S&P 500 Index companies are forecasted by analysts to grow by 11.3% and 14.4% for 2024 and 2025, respectively. In addition to strong earnings growth, the case for economic optimism includes a continuing decline in inflation, the anticipation of Federal Reserve rate cuts, persistent AI enthusiasm, and growth from increased productivity. Conversely, concerns include a possible market correction in the technology sector, a policy mistake by the Fed (e.g. holding rates too high for too long), uncertainty related to the presidential election, geopolitical tensions, and the systemic risk of a highly concentrated stock market in which just a few companies can impact market performance tremendously.

Our most significant concern for the stock market relates to overvaluation. The value of some companies in the S&P 500 are at historically high levels, especially those generally related to AI and the technology sector. The following graph shows the price-to-sales ratio for the companies in the S&P 500 Tech sector. The valuation of tech companies within the S&P 500 has reached unprecedented levels, with their stock prices now trading at 9.8 times total sales. This lofty valuation surpasses two notorious tech bubbles in recent history. During the dot-com frenzy of 2000, tech stocks reached a price-to-sales ratio of 7.5. And in the pandemic-induced “work from home” boom of 2021, this ratio climbed to 8.2. The current price-to-sales ratio is more than three times the average of 3.2 since 1990. This metric raises significant concerns about the sustainability of such elevated valuations in the tech sector.

Large Cap Tech Stocks Price-to-Sales

The concentration of value within the S&P 500 has reached record levels, driven largely by the soaring valuations of a few notable technology companies. Currently, the index’s top three constituents - Microsoft, Nvidia, and Apple - account for an astounding 21% of the total index value. This level of concentration far surpasses historical norms, including the dot-com era peak when the top three companies represented only 12% of the index. The trend extends beyond just the top three, with the ten largest companies now comprising 37% of the S&P 500’s total value. This remarkable concentration highlights the outsized influence of a small number of tech giants on overall market performance and raises questions about market diversification and the risks associated with investors overly crowded into such a small number of companies.

The impact of the upcoming presidential election on the U.S. economy and stock market remains difficult to quantify. However, one trend appears likely to persist regardless of the outcome: the continued growth of the federal debt. Both Trump and Biden have overseen substantial budget deficits during their tenures, contributing significantly to the expansion of the national debt. Since the beginning of 2019, the U.S. national debt has surged from $20.0 trillion to $34.7 trillion and now equals approximately 125% of U.S. GDP. In the first quarter of 2024, interest payments on the debt hit a record seasonally adjusted annual rate of $1.06 trillion, nearly doubling from $535 billion just three years ago. The U.S. Treasury reports that interest payments on the national debt currently consume 16% of federal spending in 2024. The rising levels of federal debt and the associated interest payments could potentially impede long-term economic growth.

In June, the Federal Reserve maintained the federal funds rate between 5.25%-5.50% for the seventh consecutive meeting, citing continued economic expansion and strong job gains despite elevated inflation. The Fed stated that rate cuts would not be appropriate until inflation moves sustainably toward 2%, indicating it intends to remain vigilant on inflation while continuing to assess risks to employment. The Fed now projects one rate cut this year and four in 2025. Most market observers are also forecasting one rate cut by year end.

During the second quarter of 2024, the yield on the 10-year Treasury note increased from 4.21% to 4.34%, causing a decline in longer-term bond values that largely offset interest income. The slight increase in interest rates resulted in a modest 0.1% return for the Bloomberg Aggregate Bond Index, which measures the performance of all investment-grade taxable U.S. bonds and has an average maturity of 8.5 years. Shorter-term bonds demonstrated better performance due to their reduced sensitivity to interest rate fluctuations. Considering our outlook and the current environment, we have maintained a relatively short average maturity for fixed income investments in managed portfolios, aiming to mitigate interest rate risk and capitalize on the attractive yields offered by shorter-term securities.

While we have highlighted concerns about valuation risks in specific sectors of the stock market, our analysis suggests that most companies are currently priced at reasonable levels. We maintain confidence that a well-diversified portfolio has the potential to generate attractive, long-term returns, even in the event of a correction within specific overheated market segments. Although anticipated interest rate cuts have been postponed by economic performance that exceeded the Fed’s expectations, we believe that modest rate cuts are still forthcoming. Interest rate cuts tend to provide benefits to broad sectors of the market. Consumers planning major purchases, particularly in the housing market, should find more favorable financing conditions. Businesses reliant on debt are likely to experience reduced borrowing costs, stimulating investment and growth. And the federal government could benefit from lower interest rates as it manages its budget deficit and debt obligations, easing some of its fiscal pressures.

John D. Frankola, CFA      Lawrence E. Eakin, Jr.       Matthew J. Viverette       Dylan C. T. Dunlop

Vista Investment Management, LLC is a Registered Investment Advisory firm. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide information and analysis regarding investments and is not a solicitation of any kind. References to historical market data are intended for informational purposes; past performance cannot be considered a guarantee of future performance. Neither the author nor Vista Investment Management, LLC has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.