Continued Highs

March 11, 2024

Summary

  • Despite the challenges faced in 2020, exercising patience and commitment to financial plans proved rewarding for investors, with February 2024 showing a departure from previous struggles as major U.S. and international stock indices surged to new highs.
  • The rise of the "Magnificent 7" tech giants, driven by excitement surrounding artificial intelligence, has significantly impacted market dynamics, pushing valuations close to 2021 levels and increasing market concentration.
  • While concerns about market concentration and inflation persist, recent earnings reports have exceeded expectations, contributing to continued optimism in the market despite potential challenges ahead.
  • With new highs come pullbacks. This is to be expected, especially since the spotlight has shifted back to the Federal Reserve and the presidential race.

February Recap

February 19th marked the top for the market in 2020. What came after was a chilling experience we all would prefer to forget. As COVID spread and shutdowns started to occur, the U.S. stock market tumbled precipitously, dropping the most in a single day outside of Black Monday in 1987. The market would go on to fall 34% from its February 2020 peak, rebounded later that year, and surged into the end of 2021 on the back of copious amounts of fiscal stimulus, only to suffer another 25% drop caused by high inflation and interest rates in 2022, marking its second bear market shortly thereafter.

Exercising patience, humility, and a steadfast commitment to one's plan through adversity has proven rewarding. Fortunately, February 2024 marked a departure from the challenges faced in 2020. Major U.S. stock indices surged to new highs despite pushback against rate cuts and an uptick in inflation figures. International equities also generated positive returns, while U.S. bonds experienced a second consecutive month of decline amid rising yields.

Source: Avantis Investors. Data as of 2/29/2024. See important disclosures at the end of this material.

All-time Highs

The Magnificent 7—Apple, Amazon, Alphabet (Google), Meta, Microsoft, Nvidia, and Tesla—were all the rage in 2023 and the start of 2024, and for good reason. They have helped push the S&P 500 Index to new highs, driven increasingly by investors’ excitement for artificial intelligence.

Hype surrounding artificial intelligence seems to have juiced animal spirits once again, driving discussions of increased productivity and sustained margins. As a result, valuations for U.S. stocks have been pushed close to 2021 levels, and concentration within the S&P 500 Index has only increased. This means that a small number of large companies are having a bigger impact on the index.

Marko Kolanovic and Dubravko Lakos-Bujas from JP Morgan speak to this concerning trend in a recent post, pointing out that market concentration has surged to its highest point since 1972.1  What's more, the top 10 stocks have distanced themselves from the rest—stocks #11 to #50—by an even wider margin than seen during the tech bubble of 2000-2001. Notably, historical data reveals that significant spikes in market concentration often anticipate or accompany economic downturns, a pattern vividly illustrated in the accompanying chart.

While this all sounds alarming, it is important to note that even though we are near extremes in terms of a few names, the rally has occurred for good reason.

According to Michael Cembalest, of the Magnificent 7’s 28% return since 2019, 21% can be chalked up to sales growth, 6% from margin expansion and just 1% from multiple expansion.2  So, unlike the dotcom bubble, this time around, fundamentals are a bigger part of the picture.

Furthermore, as we delved into the Q4 2023 earnings season, initial projections suggested a modest 1.18% growth in earnings per share for the S&P 500 Index. However, with reports in from 99% of companies, Bloomberg indicates a remarkable surge, with earnings soaring by 8.18%. This substantial upward revision in earnings is noteworthy, particularly as expectations for full-year 2024 earnings growth continue to surpass historical averages.

Moving On

As earnings reports have wrapped up, all eyes will be back on the trio of factors: inflation, interest rates, and the election.

U.S consumer prices in the U.S. surged more than anticipated at the beginning of the year, hindering progress and probably postponing any potential interest rate reductions. Bringing inflation down from 9% to 3% presents one challenge, but the transition from 3% to 2% is a different story altogether.

Nevertheless, this latest inflation report reinforces concerns that the trajectory of consumer prices may be longer and more turbulent than anticipated. As of now, the first rate cut is anticipated to occur in June, shifting expectations from an initial cut projected for March earlier in the year.3

A delay in rate cuts does have the potential to increase the odds of a recession. Labor strength, which is another concern for the Federal Reserve, has been wavering ever so slightly. The headline news was that unemployment increased from 3.7% to 3.9% in February and 275,000 jobs were added.4 However, upon closer examination, the data revealed the largest downward revision to monthly job growth since 2022.

As of 2/29/2024

Whether its inflation, Fed speak, or election rhetoric, it’s noteworthy that the S&P 500 Index will not keep producing a new all-time high each day, as exciting as that would be. Both here at home in the United States and abroad, markets will experience downside bouts of volatility. It’s impossible to tell whether it will be next week, next month, or next year. But, this should be of no surprise based on historical statistics which show markets endure at least three 5% declines and at least one 10% drop in any given calendar year.5

Market fluctuations are the necessary toll we endure to reap the greater rewards historically provided by stocks. Therefore, for the time being, new highs should be cherished rather than feared.

 

IMPORTANT DISCLAIMERS AND DISCLOSURES

  1. “Record Stock Concentration and Active Manager Performance”, Lakos-Bujas and Kolanovic, JP Morgan Global Markets Strategy, January 30, 2024
  2. P. Morgan Asset Management. "Eye on the Market: Medical Complications."
  3. Bloomberg.
  4. Bureau of Labor Statistics.
  5. Moneta Group. (2024, February 28). All-Time Highs: Is It All Downhill From Here? https://monetagroup.com/all-time-highs-is-it-all-downhill-from-here/

The S&P Global REIT Index measures the performance of publicly traded equity REITs listed in both developed and emerging markets. It is a member of the S&P Global Property Index Series.

The Bloomberg US Aggregate Bond TR Index measures the performance of investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The S&P 500 Index focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market.

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