Quarter 2 2024- Market Update
Global Perspective:
The U.S. stock market finished the first half of 2024 on a positive note, with a rally in some of the world’s largest technology companies propelling major stock indexes to multiple all-time highs. Quarter 1 could best be described with the “rising tide lifts all boats” mantra as major global indices finished firmly in the green supported by robust breadth. Conversely, “A Tale of Two Tapes” best describes Quarter 2, which was characterized by poor market breadth and negative performance for most indices, yet a small group of large-cap growth stocks with outsized index weightings had robust gains. Accordingly, The Nasdaq Composite gained 8.5% (USD) while the S&P 500 gained 4.3% (USD) in Quarter two. The Nasdaq-100 equal weight declined 0.2% (USD) in Quarter 2 and underperformed its cap-weighted benchmark by 8.2% (USD) percentage points, while the S&P 500 equal weight declined 2.6% (USD) and underperformed its cap-weighted benchmark by 6.9% (USD) percentage points. The 6.9% (USD) percentage point spread between the S&P 500 and its equal weight index is the third widest since the inception of the equal weight index in 1989. Currently, three companies (Nvidia/Microsoft/Apple) have a market cap above $3Trillion and combined comprise more than a 20% weighting in the S&P 500. At the height of the dotcom era in 1999, the top three members of the S&P 500 had less than a 10% weighting. The top 25 members of the S&P 500 currently have roughly the same market cap as the rest of the index combined.
The influence of major tech companies on global equity market returns remains substantial, with the “Magnificent 7” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) contributing to half of the MSCI World’s performance year-to-date and over 90% of June’s return. Among these, Nvidia has stood out, delivering a quarter of global equity market returns in June and year-to-date with a 13% return in June and a 150% increase year-to-date, despite a 16% three-day drop in its share price during the month. In June, Nvidia became the world’s most valuable company, commanding an estimated 70% to 95% share of the AI chip market. Over the latest quarter, Nvidia’s revenue surged threefold compared to the previous year due to high chip demand. Additionally, major tech companies such as Meta, Amazon, and Microsoft contributed approximately 45% of Nvidia’s data-center revenue.
This graphic shows the top 10 S&P 500 stocks driving stock market returns in 2024, based on data from Goldman Sachs:
The challenges of shifting rate cut expectations, political uncertainty in the UK and Europe, and a slowing US economy saw a mixed month for major global markets. The MSCI World gained 2.1% (USD) for the month and has gained 2.8% (USD) in the second quarter. However, while some global markets stuttered, others, including the US, Japan, and SA, recorded buoyant June performances. While the latest US economic data, indicating slowing inflation (a positive sign) and better-than-expected consumer sentiment, played a role, the timing and the pace of US monetary policy easing remains uncertain.
The economic momentum observed in the first quarter of 2024 carried into the second quarter, resulting in another positive period for equity markets over the last three months. Initially, investors reduced their expectations for central bank rate cuts significantly due to concerns of economic overheating in the US, which led to strong April data being negatively received by markets. However, as the quarter went on, these concerns eased and hopes for a soft landing revived. In Europe, economic momentum also remained strong as the impact of the cost-of-living crisis continued to diminish. Sustained economic growth has come with persistent inflation. While end-of-first-quarter concerns were somewhat exaggerated, services inflation has remained stubbornly high, above levels that central banks aim for. Consequently, the market now anticipates fewer rate cuts by Western central banks compared to earlier in the year.
Chinese equity markets received a boost from government efforts to support the real estate sector. This, coupled with strong performance in Taiwan’s AI-exposed stock market, helped Asia ex-Japan equities achieve a robust 7.3% (CNY) return for the quarter. The significant presence of Asian markets in the broader emerging market index meant that, despite mediocre returns in Latin America, emerging market equities outperformed their developed market counterparts, delivering a 5.1% return for the quarter.
In Europe, the outcome of the European parliamentary elections led President Macron to call for a snap election in France, causing market concerns and introducing significant volatility. The French equity market dropped by -6.4% (EUR) in June, impacting broader European returns, which were a modest 0.6% (EUR) for the quarter. In the UK, an improving economic situation helped the FTSE All-Share achieve a 3.7% (GBP) return.
US:
In June, all three major US indices posted gains. The Dow Jones Industrial Average (Dow) was the underperformer for the month and the second quarter, rising by 1.1% (USD) in June but recording a 1.7% (USD) decline in Q2 2024. Despite this, the Dow is up 3.8% (USD) year-to-date. The S&P 500 ended June with a 3.5% (USD) increase, up 14.5% (USD) year-to-date and 3.9% (USD) in Q2 2024. The Nasdaq, driven by AI optimism and a significant rise in Nvidia’s share price which rallied 6.0% (USD) in June. Both the S&P 500 and the Nasdaq remain close to their all-time highs.
Economic activity in 2024 has been stronger than anticipated at the start of the year, but recent Quarter 2 data has fallen below expectations. Notably, the unemployment rate increased to 4% in May, slightly above the forecasted 3.9%. Inflation data showed the headline PCE (May) at 2.6% year-over-year, matching forecasts and down from 2.7% in April. Core-PCE also came in at 2.6%, in line with forecasts and down from 2.8% in April. The first estimate of Q2 GDP, to be published on July 25, is expected to show a 2% year-over-year growth, up from 1.4% in Quarter 1. While the Fed is unlikely to cut rates at the next FOMC meeting on July 31, its messaging could become more dovish. The continued disinflation trend and the increasingly below-consensus economic data, including softening employment data, may provide the Fed with the justification to signal a rate cut at the FOMC meeting in September. Markets are now pricing a 63% probability of a rate cut in September.
US equities reached 31 new all-time highs in the first half of 2024, a notable achievement given the absence of new highs between December 2021 and December 2023. The S&P 500 delivered a total return of 14.50% (USD) year-to-date, surprising many given the persistently high interest rates and bond yields. While increased valuations have contributed to this performance, the primary driver has been earnings growth, especially from companies involved in AI development. This performance has been driven by a relatively small group of mega-cap tech leaders, raising some concerns about market concentration.
UK:
The FTSE 100’s returns have not been as robust compared to global peers, but a total return of nearly 8% (GBP) is still commendable, especially given the UK stock market lacks global technology leaders. A significant portion of the market’s return has come from dividend income, with an annual dividend yield of about 4%. Notably, approximately a quarter of the index’s gains have been driven by the pharmaceutical company AstraZeneca (+18%), a leading company in its industry despite not being involved in the popular appetite-suppressing drugs.
The concentration of the FTSE 100’s returns is often overlooked. Remarkably, 99% of the 430 points accumulated this year can be attributed to just six companies: AstraZeneca, Shell, HSBC, Unilever, Rolls Royce, and RELX. Among these, only RELX benefits from the AI trend due to its extensive proprietary data, particularly in the legal profession. This list showcases far less industry concentration risk compared to others.
On a smaller scale, there has been a positive recovery in smaller companies, with the FTSE Small Cap Index (excluding Investment Trusts) achieving a total return slightly above 8% (GBP). Increased merger and acquisition activity, along with growing optimism about a more stable political environment, has highlighted the value in this segment, especially if Labour wins the upcoming election as expected.
Europe:
Equity markets outside the United States have made progress this year but still lag behind larger US companies. Europe’s equity market performance was particularly disappointing, with French equities down 6.6% (EUR) month-over-month. French President Emmanuel Macron surprised investors by announcing snap elections after his political alliance suffered a defeat to Marine Le Pen’s far-right National Rally party in the European elections.
European indices performed slightly better than the UK in local currency terms but worse when measured in sterling. Most gains were in the first three months of the year, but mixed economic recovery and delayed interest rate cut expectations stalled progress. Recent political developments have also caused concerns. Macron’s decision to call a snap parliamentary election undermined confidence, and fears of a fiscally irresponsible government led to a rise in French government bond yields. This situation highlighted France’s long-standing fiscal challenges and the limitations of European monetary policy controlled by the ECB.
It remains uncertain whether the National Rally, likely to win the second round, will form a government, but there is some hope they would be constrained by the realities of governance, as seen in Greece and Italy.
Emerging Markets:
Emerging markets (EMs) had a strong month, with the MSCI EM Index rising 4% (USD) month-over-month. Taiwanese chipmaker TSMC, which gained 18% (TWD), accounted for about 40% of June’s EM Index performance. Indian stocks also contributed significantly, rising 7% (INR) as Prime Minister Narendra Modi secured crucial backing from coalition allies, allowing him to form a government and extend his decade in power.
There was some volatility around elections in India, Mexico, and South Africa, but markets have since settled. Indian shares rallied to new highs despite initial disappointment over Modi’s less-than-resounding victory. In Mexico, the market awaits the October inauguration of new President Claudia Sheinbaum to see if she will be as market friendly as her predecessor.
Emerging market indices continue to look to China for leadership, which has yet to materialize. Hopes for further economic stimulus remain unmet, and the collapse of China’s real estate sector casts a shadow over its economy. Tensions over China’s claims on Taiwan and the South China Sea also weigh on sentiment. The upcoming third Communist Party Plenum of the current Presidential cycle in July may provide a chance for positive news, as this event typically outlines long-term growth plans. However, what emerging markets would really benefit from are US interest rate cuts and a weaker dollar, which may take time.
Asia:
In Japan, the benchmark Nikkei ended June 2.8% (JPY) higher and has risen by 18.3% (JPY) year-to-date, though it is down 1.9% (JPY) for the second quarter of 2024. On the economic front, May’s headline CPI increased to 2.8% year-over-year, up from April’s 2.5%. However, Japan’s core inflation, which the Bank of Japan (BoJ) considers when formulating monetary policy and excludes fresh food and energy prices, was lower at 2.1% in May, down from April’s 2.4%, moving closer to the BoJ’s target rate of 2%
South Africa:
In South Africa, the JSE gained momentum in June following the 2024 National and Provincial Elections, which introduced a new era of coalition politics. The formation of a government of national unity, initially partnering the ANC with its biggest political opponent, the DA, was one of the more market-friendly outcomes. The rand strengthened significantly, dropping below R18/US$1 earlier in June and closing the month about 3.3% firmer against the dollar, up 0.9% year-to-date and 3.8% in the second quarter of 2024. Despite some volatility due to uncertainty surrounding the government of national unity amid prolonged negotiations, particularly between the ANC and the DA, the FTSE JSE All Share Index broke through the key 81,000 level, hitting a record high on June 19 before retreating to end the month at 79,707.1. The index posted a 3.9% (ZAR) gain month-over-month, up 3.7% (ZAR) year-to-date and 6.9% (ZAR) in the second quarter of 2024, while the Capped SWIX rose by 4.2% (ZAR) month-over-month, up 5.7% (ZAR) year-to-date and 8.2% (ZAR) in the second quarter of 2024.
In economic data, South Africa’s May headline CPI was 5.2% year-over-year, unchanged from April. Month-over-month, headline CPI slowed slightly to 0.2% in May from April’s 0.3%. Core inflation, excluding food, fuel, and electricity, also remained unchanged at 4.6% year-over-year. This indicates that underlying inflationary pressures stayed close to the 4.5% midpoint of the South African Reserve Bank’s target band of 3% to 6%, where it prefers to anchor expectations.
House View & Summary:
The saying “beauty is in the eye of the beholder” applies to the stock market as well. Many see the narrow market breadth as a cautionary signal, suggesting that major equity benchmarks may be at risk of a deep correction. While this is a potential risk, it is not the only scenario. The first half of 2023 also had narrow breadth, weak relative performance across many industries, and a banking crisis, yet by year-end, the major indices experienced above-average returns. There are plausible reasons to maintain a more optimistic outlook for the second half of 2024. As noted in prior reports, the constructive price action in Q4 2023 and Q1 2024 was historic in terms of breadth and magnitude, with past instances indicating strong future 12-month returns.
While we believe that value—and possibly small-cap—stocks may start to challenge the dominance of large-cap growth stocks, it is important to distinguish between a broadening of the market’s opportunities and a rotation between market styles, sectors, or capitalizations. We are not predicting the imminent decline of the “Magnificent Seven” but rather anticipating a continued broadening of opportunities to include more companies and sectors that have lagged in recent years.
Despite the sharp, hawkish repricing of rates in the first half of 2024, the underperforming Dow Jones Industrials, S&P Midcap 400, Russell 2000, and the equal weight S&P 500 and Nasdaq-100 indices have a combined average total return of 4.6%, which is on track to reach nearly 10% (USD) by year-end.
Regarding our house view, we continuously monitor macroeconomic and market factors to ensure that our portfolio construction is optimally positioned. Throughout the year, the Sierra Global Fund has maintained exposure to major AI companies such as NVIDIA, Microsoft, and Amazon. However, it is important to note that our asset allocation is forward-looking. We have recently allocated to small caps, as we believe that when the market broadens and the U.S. lowers interest rates, small caps will be the primary beneficiaries.
Additionally, we have an allocation to U.S. treasury bonds, which currently provide us with a high yield in USD and the potential for capital appreciation in the near future. Overall, the Sierra Global Fund is a balanced fund, positioned to capitalize on the current AI-driven rally while also being poised to seize future opportunities. Our investments in defensive quality companies enable us to protect our investors from downside risks.
As we enter a new earnings season, two key trends are emerging. Firstly, while earnings expectations remain high, they are gradually declining. According to FactSet Earnings Insight, year-on-year profit growth for Q2 is projected at 8.8%, down from 9.0% three months ago. Secondly, companies that fall short of investor expectations are facing severe repercussions.
Historically, July has been a favourable month for U.S. equities. Since 1928, July has averaged as the best month of the year for stock-market performance. During this period, the S&P 500 has averaged a 1.7% (USD) gain in July, finishing the month higher more than 60% of the time. If history is any guide, the positive momentum for U.S. equities may continue into July.
