The good news and the bad as we return to normal The good news and the bad as we return to normal\images\insights\article\newspaper-glasses-desk-small.jpg July 9 2024 June 20 2024

The good news and the bad as we return to normal

Our optimistic market outlook has been right, but our 'broadening out' thesis has yet to work.

Published June 20 2024
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As we approach mid-year, I am tempted to take an early victory lap on our economic and market outlook call for 2024. We called the outlook “Boring” or, said differently, a return to normal. For sure, we got a lot right, starting with the conclusion for clients: stay overweight stocks, neutral money markets and underweight bonds. With the S&P 500's 15.5% total return so far up even more than our full year forecast of "high single digits," and bonds essentially flat, up 0.09%, that's worked out. Moreover, the economy has confounded the economists who confidently moved 2023's forecasted recession to 2024. Instead, the economy keeps chugging along as we'd anticipated. And we're even getting our "higher for longer" call on rates right, with consensus recently finally moving towards our idea of a single cut this year.

Yet, despite all this, I can't give us an "A." That's because, after a promising start, the "broadening out" of the market—so important to us stock pickers—has yet to kick in fully. The so-called Magnificent Seven continue to lead the market, especially following Nvdia's blowout April earnings report. Everything else we like—small caps, value, and international—are mostly higher, as well, but continue to lag. 

For sure, all the above have out-distanced bonds, which we are using in our balanced portfolios to fund the overweight to stocks. Importantly, though the indices for small caps, value and international have all lagged, the dispersion within these indices has picked up considerably—stock picking has mattered, even in large caps and the Mag 7 (just ask Tesla shareholders). Indeed, a real “winners and losers” game has emerged, and that game is focused on fundamentals. Good for fundamental stock picking approaches. Maybe call it a “return to normal.”

So, now what?

We expect that between now and year-end, the market advance gets choppier, and a "more normal" winners and losers game picks up steam. And yes, call me stubborn, but we'd also guess the long-promised market broadening gets a second wind following the first burst it saw earlier this year. Here's why:

  1. Simple math As terrific as the earnings growth numbers have been for an ever-narrowing group of stocks within the Mag 7, the math of year-over-year compares gets trickier and trickier as we enter the back half. The opposite is true of virtually everything else. By fourth quarter, many of the areas we like—financials, commodities, small caps and emerging markets—will begin to see double-digit earnings inflections that should get investors' attention.
  2. Discount rates Stocks are long duration assets, and the riskier elements of the markets that we like here are even longer duration than the large-cap market averages. So, discount rates matter! Though we've never been buyers of the idea that a dramatic decline in rates would happen in 2024, the news through the back half, looking into now 2025, should be good news for long-term assets. With the economy softening modestly, labor markets loosening somewhat, and inflation numbers likely to grind below what we would call the Federal Reserve's informal 3% target, markets should soon begin to focus less on “the number of cuts in 2024” to “the number of cuts this cycle.” We see fed funds dropping by 200 basis points this cycle, to 3.5%, or 50 to 100 basis points above where inflation seems stuck. And probably at least the first 75 basis points of these cuts are now within a 12-month horizon. That would help smaller cap and value stocks a lot.
  3. Valuations Valuations are a notoriously poor timing tool, but when they are grossly out of line with other fundamentals (like earnings and discount rates as noted), they do come into play. And valuation deltas right now are substantial. To pick a few: the Russell 1000 Growth Index is trading at 28.4x blended forward EPS (just a few points below pandemic highs) while the Russell 1000 Value Index is trading at just 15.7x. Similarly, the S&P 500 Index is at 21.2x blended forward EPS, while the S&P 500 Equal Weight Index stands at just 16.7x. If you look internationally, the MSCI EAFE Index is trading at just 14.2x, and the MSCI emerging markets index, which almost has as high a weight in technology-oriented stocks as the S&P, is trading at just 12.2x. That is some real value (no pun intended) in some of the areas of the market that we like.
  4. Politics Politics is a key reason we could see choppier markets near term, though trending higher within a more normal “winners and losers” environment longer term. With the markets in wait-and-see mode regarding the Fed and earnings until later this year, they are probably more vulnerable than usual to the other big source of news flow this summer: elections in the U.S., France and the U.K., along with the aftermath of recent elections for the European parliament and several big emerging markets. In most of these cases, a significant anti-incumbent wave appears to be forming, more so than a uniform shift right or left. Policy implications for the markets are not decisive either way, but will probably be viewed positively, particularly once we get through the pre-election rhetoric and into the post-election honeymoon period, whoever prevails. On the U.S. side, the rising odds of a Republican victory/sweep, which we highlighted in our recent piece (From here on the election will matter), is net-net a positive for a market broadening in the back half of the year. In Europe, while the pre-election rhetoric is market or at least Euro-negative, the reality is that at worse, policy gridlock ahead will largely support the status quo. That itself could be a relief.

So as we head forward with a B+ for now, we still aim for an A by year end. The summer could be rocky, but the fundamentals—even the politics—seem to be pointing to a re-broadening of the market as we approach year end. We’re already through our original 5,200 price-target for 2024, but 6,000 for 2025 is still 10% higher. We may yet get some of that upside as the storms of summer that may lie ahead blow over later this fall. We’re staying invested, and overweight stocks, in the meantime.

Tags Equity . Markets/Economy . Monetary Policy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Prices of emerging markets securities can be significantly more volatile than the prices of securities in developed countries and currency risk and political risks are accentuated in emerging markets.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

Small-cap companies may have less liquid stock, a more volatile share price, unproven track records, a limited product or service base and limited access to capital. The above factors could make small-cap companies more likely to fail than larger companies and increase the volatility of a fund’s portfolio, performance and share price. Suitable securities of small-cap companies also can have limited availability and cause capacity constraints on investment strategies for funds that invest in them.

Stocks are subject to risks and fluctuate in value.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

Magnificent Seven: Moniker for seven mega-cap tech-related stocks Amazon, Apple, Google-parent Alphabet, Meta, Microsoft, Nvidia and Tesla.

The MSCI EAFE Index is an equity index which captures large and mid-cap representation across Developed Markets countries around the world, excluding the US and Canada.  With 910 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

Russell 1000® Growth Index: Measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. Investments cannot be made directly in an index.

Russell 1000® Value Index: Measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. Investments cannot be made directly in an index.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.


Issued and approved by Federated Global Investment Management Corp.