ETF Prime Archive

Market Crosscurrents

Halfway through 2024, financial markets have continued to exhibit remarkable resilience despite a growing list of potential challenges moving forward.  Will the Federal Reserve finally win its inflation battle without tipping the economy into recession?  Can a handful of mega cap technology stocks – Microsoft, Apple, Nvidia, and its ilk – continue propelling the S&P 500 higher?  What about ongoing geopolitical tensions in Ukraine and the Middle East?  Oh, and you may be slightly aware there is an upcoming U.S. presidential election.  The markets have much to digest in the back half of the year.

That is not to say there aren’t plenty of reasons for optimism as well.  Inflation, while sticky, has been moving in the right general direction.  While that doesn’t reverse the massive price increases we have all experienced over the past several years, this is obviously a positive trend.  The economic backdrop remains healthy overall.  While jobs and wages have softened a bit recently, they haven’t rolled over to anywhere near recessionary-like levels.  The evolution of artificial intelligence – a key driver behind many of the stocks powering the S&P 500’s impressive year-to-date return – is clearly a game changer with the potential to transform companies, the economy, and society at large.  Volatility associated with elections and geopolitical issues tend to be short-lived from a market perspective, which should help minimize concerns for longer-term investors.

The point is that there are plenty of both challenges and opportunities.  If we were to ascribe a theme to the current market environment, it would be “crosscurrents”.  The definition of a crosscurrent is “a process or tendency that is in conflict with another”.  We think that describes the current situation well.  Let’s briefly dive into four broad crosscurrents that we are monitoring.

Inflation and the Federal Reserve

The Federal Reserve’s ongoing battle with inflation remains a focal point.  Despite a slight increase in unemployment and a deceleration in consumer spending, inflationary pressures persist.  The consumer price index came in at 3.3% in May, a slight uptick from earlier in the year.

Everyday expenses including groceries, utilities, and healthcare continue to strain household budgets.  While inflation has meaningfully come down over the past year-and-a-half, it is still nowhere near the Fed’s 2% target.  As a result, the Fed has been slow to cut interest rates – a posture that increases the risk of an economic slowdown.  While the overall economy continues to show resilience, the sustainability of consumer spending amid higher costs is a growing concern and one which we believe the Fed should consider getting in front of by reducing rates.

Stock Market Concentration and Corporate Earnings

Through the end of June, the top 10 holdings in the S&P 500 contributed a staggering 77% of the index’s total price return.  That is the second highest contribution in a positive performance year, behind only 2007 (we would also note that 2023 was the third highest year ever). 

_{Source:  Strategas’ Todd Sohn}

Nvidia alone contributed nearly 32% to the index’s return.  Extreme optimism around the potential impact of artificial intelligence has pushed stocks such as Nvidia, Microsoft, and Apple past $3 trillion in value.  Along with other stocks including Amazon, Meta, and Alphabet, the top ten holdings in the S&P 500 now comprise approximately 37% of the total index.  Notably, these companies only contribute about 24% of the earnings of the index – the widest such gap since the third quarter of 1990.

So, what does this mean?  Very simply, these companies will need to continue producing on the earnings side of the equation – if not exceeding earnings expectations.  Additionally, we would prefer to see market breadth widen out, with a larger number of stocks contributing to the market’s overall return.  That will also be predicated on earnings, which are expected to accelerate for the group of companies outside of the top 10 stocks.  However, corporate earnings are obviously heavily tied to the aforementioned consumer, who appears a bit strained.  The takeaway is that we will remain squarely focused on the health of the consumer and how quickly the Fed responds with a change in rates should that health start to deteriorate.

Geopolitical Climate

Geopolitical tensions, particularly the prolonged conflict in Ukraine and unrest in the Middle East, continue to influence global markets.  Commodity prices, especially oil, have seen fluctuations, adding to the inflationary pressures.  The summer driving season has pushed fuel prices slightly higher, further impacting consumer spending.  Consumers were paying an average of $3.20/gallon in January versus $3.60/gallon in May.

While historically, the longer-term market impact of geopolitical events tends to be minimal, their immediate effects can create shorter-term volatility.  We are currently not overly concerned about existing geopolitical tensions, but they are something we will continue keeping an eye on from a risk management standpoint.

The Upcoming Election

With the November election approaching, market anxieties are expected to rise.  As with geopolitical issues, it is important to remember that the political landscape has historically had minimal longer-term impact on market performance.  Once again, that is not to say the upcoming election can’t cause some shorter-term volatility.  However, we simply don’t view this as predictable or investable in any way.  We would reiterate our advice from last quarter:  “Don’t mix politics with portfolios”.  Market fundamentals are far more critical to investment success.

Staying the Course

Inflation and the Fed.  Stock market concentration and corporate earnings.  Geopolitical climate.  The upcoming election.  We see both challenges and opportunities among each of these four broad themes.  While the market crosscurrents are currently strong, we remain committed to staying informed about these developments, emphasizing global portfolio diversification, disciplined investment strategies, and maintaining a longer-term perspective.  As always, our team of advisors is here to support you in navigating these crosscurrents.