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Sweet summertime and all it brings…vacations, cookouts, pool parties, and there is no shortage of entertainment in the summer of 2024.
In the television department, the streaming services just dropped new seasons of The Boys, House of the Dragon, and The Bear and that’s just the appetizer, (Yes, Chef!), because as bingeworthy as that group is, it doesn’t even compare to the overload of excitement in global sports.
The Copa America and Euro Cup are nearing their finals. A few weeks ago, I went to Sofi Stadium in LA to watch Brazil play. It’s mindboggling that a country with 215 million people could tie 0-0 with Costa Rica who has a population of 5 million. My Brazilian in-laws were not happy, but I give credit to the underdog, Costa Rica. They have a soft spot in my heart as we honeymooned there. Pura Vida!
Wimbledon finals are fast approaching in one of the classiest sporting events of the year. I grew up watching the mesmerizing battles of Agassi versus Sampras and have been hooked ever since.
The last major tournament in golf, the British Open, takes place next week and yes Tiger Woods is in the field.
The Summer Olympics start in Paris in two weeks and televisions will be on all day.
However, even with vacation time, a sports overload and critically acclaimed T.V. shows, 50 million tuned in to watch the first presidential debate. It certainly didn’t feel very presidential. It almost felt like the candidates were playing themselves in a skit on Saturday Night Live, or bad reality T.V.
This election has huge implications and there is so much uncertainty despite who eventually wins. Markets hate uncertainty and that’s not the only headwind we face. There is also persistent inflation despite already tight monetary policy, limited room for fiscal policy, and increasing geopolitical tension.
And how are the equity markets doing? All-time highs!
The average investor might look at the S&P 500 and say that equity markets are doing exceptionally well, but the truth is there are huge dislocations, and the S&P 500 certainly does not tell the whole story.
Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia & Tesla have been deemed the “Magnificent 7,” making up about 30% of the S&P 500 and have accounted for 2/3rd of the S&P performance in 2024. Good news, as they are up 40%; However, the other 493 stocks are up just 5%!
This all translates to the S&P 500 up over 17% on the year but if you look at an equal weighted stocks equivalent, it’s up just over 5%. Given the stellar performance of the 7 names mentioned, US Large Cap Growth is outperforming Value by nearly 20% and US Large Cap is outperforming both US Small Cap and International equities by about 19% (EACH) on the year.
All investments carry the risk of loss, including the risk of loss of principal invested. Past performance does not indicate future results.
S&P 500 Equal Weight versus S&P 500 (Market Cap Weighted)
There’s no question regarding the importance of having exposure to the broad equity market, -including those “Magnificent 7”- but with how concentrated equity market performance has been, it’s important to know the risks involved and to build a truly diversified allocation that is tailored to your specific needs and goals.
The 20-year historical average Price to Earnings ratio of the US Large Cap Growth index is 19 and the current P/E is 30.5. This means the US Large Cap Growth index is 60% more expensive than 20-year historical averages; this is significant for many reasons. For one, the P/E is a proxy for value, overpaying on something – anything! – over 60% will reduce the return over time.
But valuation is not the only gauge to consider. “The Momentum Factor,” in layman’s terms, is the tendency of winning stocks to continue performing well in the near term. Some call the Momentum Factor the “Persistence Factor,” essentially allowing stocks to outperform even when deemed expensive. Currently, we find there has been tremendous overcrowding in the Momentum Factor and historically, when this has taken place, there is usually a sharp correction. Let’s not forget 2022 when the Magnificent 7 were down 40%. A surprise to many, even the stock market darling, NVDA was down 50% in 2022.
The old phrase “pigs get slaughtered” is a warning to not be excessively greedy; it’s important to not chase the trade due to FOMO.
So, what should investors do now that the S&P 500 is at all-time highs in the face of a collection of headwinds and rising uncertainty?
If your portfolio has been built properly, with your goals and risk tolerance in mind, you are likely well positioned. That said, all good athletes and teams make some in-game modifications, even when they are winning. In this case, even with a strong game plan and coming off a strong first half, there are certainly some halftime adjustments to make.
We’ve been vocal about our “higher for longer” view for some time and have argued that if the Fed were too quick to cut rates, we’d be in the same inflationary conundrum that we started in. Economists are now forecasting a 0.25% cut in both September and December.
A mentor once told me a story about 3 economists who went deer hunting together. A deer came into sight and one economist missed the deer to the left, the second took a shot and missed to the right. The third economists pumped his fist and proclaimed, “WE GOT HIM.”
There is more to this than academic conjecture. Jerome Powell recently spoke at a congressional hearing where he stated that unemployment is back to pre-pandemic levels, meaning the job market is strong but not “on fire” and inflation fell to 2.6% in May from 4% one year ago. His full statement showed confidence that rate cuts are a growing possibility, a distinct break from the cautionary messaging he has recently taken.
If we are near an inflection point in rates, then Fixed Income and Small Cap equities become more attractive.
Small Cap equities are trading at a huge discount to Large Caps and some of that can be attributed to higher interest rates. Small Cap companies are smaller (obviously) and growing, therefore they have less access to capital and end up with more debt funding. Like a young person out of college they are borrowing at higher rates, compressing their margins, affecting their valuation and creating this dislocation. Falling rates should benefit Small Cap companies. The ones that have attractive valuations and haven’t overextended themselves could outperform.
Infrastructure is another interesting opportunity as it has experienced more consistent cash flow with and attractively low downside capture. Within infrastructure, smart grid technology is an exciting space. This is an electricity network that uses advanced technology to transport and meet electricity demand. Sophisticated grid technology is needed to manage two-way power and data flow, which is becoming more important as electrical energy infrastructure adapts to growing demands from EV adoptions, A,I and crypto to name a few.
If you have a sound plan in motion that is tailored to your specific goals, don’t let emotions get the best of you but there could be some room for halftime adjustments. So when you take a break from the beach and all over these amazing sporting events, feel free to give us a call.
Disclosures:
The information contained in this presentation is provided for informational purposes only and should not be construed as investment advice or a recommendation to purchase or sell a security. Investing involves the risk of loss that clients must be prepared to bear. This document contains forward-looking statements of opinion, belief, and expectation about the future. Actual results could differ materially from such statements and our opinions are subject to change without notice. Connectus Wealth, LLC d/b/a Connectus Private is an SEC-registered investment adviser. Investment does not imply government endorsement or that the adviser has attained a level of skill or training.