The second quarter saw solid gains for equities, completing an impressive first half performance for the S&P 500. The information technology and communication services sectors continued to lead the market higher. These sectors were the two best performing sectors in the second quarter and through June 30th. They returned more than twenty-six percent through the first half of the year. Every other sector in the S&P 500 underperformed the index through June 30th. This was in large part due to the declines seen in six of the eleven sectors during the second quarter.
The Russell 2000 Index and the S&P Midcap 400 were down between three and four percent for the quarter and are up 1.02% and 5.34%, respectively, year-to-date. In the second quarter, investors gravitated to large-cap domestic stocks with artificial intelligence exposure. International stocks lagged the S&P 500. The MSCI EAFE Index fell 1.48% in the quarter while the MSCI Emerging Markets Indices returned a respectable 4.13%.
Intermediate investment grade bonds had a modest second quarter after being a drag in the first quarter. Treasury rates moved up about twenty basis points from the end of the first quarter for the five, ten and thirty-year Treasury securities. The rise in yields, which hurts returns, was offset by coupons which are very respectable now after the rise in yields. The Bloomberg Intermediate US Government/Credit Index was up 0.64% for the quarter and is now up 0.49% year-to-date. Longer bonds did not do as well. The Bloomberg Aggregate Index was up a mere 0.07% for the quarter and is down 0.71% through June 30th.
Gold continued to shine. The yellow metal returned 4.34% for the second quarter and is now up 12.79% year-to-date. Commodity price movements were range-bound in the second quarter after a strong first quarter. Oil prices were down 1.96% in the quarter while the CRB BLS commodity index edged up 0.55%. The dollar remained strong and was up 1.32% in the quarter, and 4.47% year-to-date.
AI Continues to Dominate Equity Markets
Artificial Intelligence (“AI”), and specifically NVIDIA remain in the headlines and helped power stocks higher. NVIDIA briefly dethroned Microsoft and Apple as the S&P 500’s largest company by market capitalization. It’s not just NVIDIA. Other hardware, software, or internet stocks that have exposure to AI are outperforming the market. The ascent is remarkable, but a pause or pull back should be expected. Several of these companies have seen their revenues and profits skyrocket. NVIDIA was in an unusual position in the second half of 2023. Its stock jumped while the company’s price to earnings ratio fell as earnings skyrocketed due to the growth in demand for its AI chips. Recently though, there has been multiple expansion that probably requires a follow through in earnings growth for the stock moves to be sustainable. It is possible, but there are likely to be hiccups. NPP has taken a small amount of money off the table during the market’s rise. We are not bears, but prudence dictates a little bit of caution. Nevertheless, we would not be surprised if the market for AI grows to be larger than the bulls are estimating in the long run. Investors often underestimate the long-term potential of transformative technologies, while being overly optimistic in the short-term.
Inflation Moderates, Yields Stabilize
Inflation data worried market watchers in the first quarter. There was a fear that inflation had bottomed out and was reaccelerating. Thankfully, the second quarter data was much better and indicates that the rate of inflation is resuming its downtrend. The first quarter inflation data has been seasonally strong recently. NPP and investors’ hope is that inflation will moderate further toward the Fed’s 2% target.
Bond yields followed inflation higher, and Treasury returns were negative during the first quarter. The second quarter saw Treasury yields rise before finishing a bit above where they started the quarter. If, and this is a big if, the annual inflation rate continues to fall, the Federal Reserve is likely to cut rates at least a couple times over the next twelve months. This will be a tailwind for bond investors should it occur. The increase in yields has led to weak returns, but bond investors have not been hit too badly this year because the coupons have offset the move up in yields on the intermediate part of the curve, while dampening the losses for long-term Treasury investors.
Economic Growth is Slowing
There are signs that the economy is slowing. The Bureau of Economic Analysis reported that real GDP grew 1.4% in the first quarter of 2024 after growing 2.5% in 2023. The Atlanta Fed GDPNow GDP Forecast currently sits at 2.25%. The job market, while still strong, is less strong as job openings, average hourly earnings, and monthly changes have moderated. Nominal consumer spending growth is back near its long-term trend.
The data is consistent with slower inflation growth. It also points to an economy that is getting closer to equilibrium. The change in economic data trends needs to be monitored. There have been several times in the past where a downshift in growth did not stop until a recession occurred. On the other hand, there were a few occasions in the post-GFC period and the nineties where growth slowed without causing recessions. NPP does not believe the growth slowdown is alarming yet. It is necessary to move inflation sustainably lower. There is a possibility it will be good for both stocks and bonds, and it may be part of the reason for the strong performance of equities in the second quarter.
Neutral on Equities
There are signs that economic growth is slowing. However, NPP does not expect a recession in the second half of the year, and we think the data is pointing to a slower growth environment. We believe the most likely direction for stocks is up, but we do feel it’s wise to rebalance among assets classes and reduce concentrated positions where warranted. Equities, and technology stocks specifically, have had a very good run. NPP does not foresee an imminent bear market or correction, but valuations are a little stretched. Valuations are not a great timing tool and momentum cannot be ignored. Absent a recession or an external event, the downside is likely contained. Nonetheless, now is the time to be prudent.