It's hard to complain about the equity market performance for the first half of the year. When everyone was making their annual predictions, most had expected a year of single-digit rates of return for markets, as earnings growth would slow in the face of a broader economic slowdown. However, much of what those predictions were based on hasn’t come to pass. As in most cases, earnings have been stronger than expected, and valuations have continued to increase. The results at mid-year are double-digit returns for many markets that are at, or near, all-time highs.
Of course, there is more to this than just the headline numbers. So far, the story of the year has been the rapid adoption of AI and the stunning growth companies related to this theme are experiencing. The poster child for this has been Nvidia, as its dramatic move higher (149.50% YTD) briefly made it the most valuable company in the world on the back of surging demand for semiconductors to power AI.
The move higher in these megacap technology stocks has been powerful enough to skew returns and mask many underlying problems. To show this, one needs to only look at the difference year-to-date in performance between the market cap-weighted S&P 500 and the equal-weighted S&P 500: 15.29% vs. 5.07%, one of the largest divergences on record. It's also important to note the underperformance of many smaller companies, as the Russell 2000 is only up 1.73% on the year.
Much of this divergence has resulted from the move in bond yields this year. Interest rates were expected to be much lower by this point, as central banks would be well on their way to removing the rate hikes we’ve experienced over the last three years. That hasn’t happened. Inflation has proven harder to defeat, and by many measures, economic growth has been stronger. These higher yields continue to impact the performance of sectors that were supposed to benefit from lower interest rates and, until that occurs, will remain under pressure. The Bank of Canada and the ECB were finally able to institute the first rate cuts of the year in mid-June, much later than had been expected, as the strain of higher interest rates was hurting the economy, and inflation in those regions finally cooled. Will other central banks follow? That will be an important question for the balance of the year.
Unfortunately, the Canadian equity market hasn’t enjoyed the gains to the degree that other markets have. Lacking significant exposure to technology and the AI theme, a move higher in the cyclicals is required for the S&P/TSX to perform well. While the commodity markets have had a mixed to slightly positive performance for the year, the financials and utilities that comprise a large part of the market have struggled with higher interest rates. Added to that was our own self-inflicted selling as investors raced to trigger capital gains ahead of a tax hike to end June, leaving us to hope for a ‘January effect’ in July.
Where does that leave us for the balance of the year? As always, it will come down to the bond market. The benchmark US 10-year bond yield remains higher than many would like; a move lower from these levels would be very positive for the cyclicals. With recent measures of inflation ticking lower, more central banks should join the rate-cut party. The major one to watch remains the US FOMC, which is currently expected to begin cutting rates in September. By then, though, the world should be fully on US election watch. As markets tend to hate uncertainty, the election should overtake AI as the key theme for the remainder of the year. Any turmoil around this event could potentially affect both central bank policy and the all-important US dollar.
Regarding the US dollar, we are beginning to hear more noise around the end of ‘King Dollar.’ While major shifts to this extent don’t happen quickly, if this does begin to pick up more attention, it could ignite a massive move higher in commodities and other assets (Bitcoin?) that benefit when the dollar falls. As such, we remain positive on real assets for the balance of the year.
A shift to lower bond yields and a lower US dollar would help broaden the market rally. Lagging sectors could begin to act better, and any data points that cause investors to question if they had gotten ahead of themselves on the dream of riches from AI could cause a reversal of the flow of funds from technology toward cyclicals. The seven largest technology stocks pushed the S&P 500 to this record level, but it will take the other 493 companies to build on these gains.
The net result could be that the second half of 2024 will be much more challenging than the first. With many investors already experiencing higher-than-expected gains, it would only be natural for some to ‘tap the brakes’ and take off some risk. This doesn’t mean markets will fall; there remains a higher-than-normal amount of cash on the sidelines that is looking for any dip to buy and will act as a backstop. The global economy has been stronger than expected. This has delayed rates but is undoubtedly a positive for future earnings growth. For most markets, the path of least resistance will likely be higher, barring a geopolitical shock or issue around the US election. Still, any move to the upside will be made more likely and viewed more positively if a broader swathe of sectors and companies are invited to the party.
— Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
By the numbers displays total returns for the month of June 2024. The content of this document is for informational purposes only and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.
Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.