Second Quarter Review: Equity markets offered mixed performances in the second quarter as the markets’ narrow leadership became increasingly pronounced. The top-heavy Standard and Poor’s 500 Index gained 4.3%, the Russell 2000 Small Cap Index declined 3.3%, and the MSCI All World ex- U.S. Index rose 1%. With market interest rates rising across the yield curve, the Bloomberg Aggregate Bond Index was flat. Gold rallied 4.3% and the Bloomberg Commodity Index rose 2.9%.
Bifurcated Markets: Investor enthusiasm directed at the potential for artificial intelligence has seemingly created two markets; the handful of U.S. mega-cap technology related companies that are the core AI builders and the 5,000 other companies scattered across the globe. The resulting market and index distortions are quite notable. Thanks to global flows into these heavyweight companies, the U.S. market now comprises 72% of the MSCI World Index, up from 50% in 2010. Remarkably, Microsoft’s 4.5% weight in the global index is greater than the entire market capitalization of the United Kingdom. Looking at the U.S. market, the ten largest stocks in the S&P 500 make up a record 37% of the Index, and they contributed 77% of the performance in the first six months of the year. While the S&P 500 Index is up 15.3% year-to-date, the S&P 500 Equal Weight Index with the same 500 companies has returned only 5.1%. This is the largest six-month performance spread since the tech bubble in 2000. For the first time in history, Morningstar, using its traditional growth/value metrics, scores the S&P 500 Index as a growth portfolio instead of a blend. The S&P 500 increasingly becomes a poor fit as a representation of “the market”.
Our Process: The narrowness of market leadership serves as both a warning flag and an opportunity. First, this performance divergence is not sustainable, and one must wonder how investors will react when the leaders’ performance fades. Will the entire market collapse, particularly with the massive amount of assets in passive vehicles, or will buyers rotate into areas that have not participated in the strong rally? There are plenty of investable opportunities and relative values across markets. While the ten largest S&P 500 stocks carry a Price-to-Earnings ratio of 30, the remaining 490 companies in the S&P 500 offer a P/E of 17.6. Value indices are in line with historical forward PE’s and remain attractive relative to Growth. Looking outside of the U.S., the MSCI All Country World Index sports a P/E of 13.5. As your adviser and your advocate in the capital markets, it is our dual responsibility to grow your assets beyond the long-term inflation rate while also being cognizant of how your portfolio risk lines up with your time horizon and liquidity needs. We have always balanced these goals by focusing on diversification and relative value so our investment process is geared toward the current environment, though we recognize we must be patient in our decisions.
The Second Half: As we enter the second half of the year, inflation pressures appear to be receding and investors continue to hope for an economic soft landing. However, there are increasing indications that the consumer, and the U.S. economy, are losing momentum and the first cut in the Fed Funds target since 2020 is on the table before year end. We are already into a tumultuous presidential campaign and election season and the market will surely try to handicap winners and losers depending upon potential outcomes. Unfortunately, neither political party will likely place fiscal discipline at the top of their policy list as U.S. debt and debt service costs continue to explode to new records. We will continue our exploration for relative value, and we currently see a reasonable opportunity set of investments for the long term. Every decision in your portfolio will be made in the context of your specific profile and goals.
We thank you for your continued trust and assure you our seasoned team of investors is highly engaged in these very interesting times.