Q2 2024 Rose Capital AdvisorsMarket Commentary & OutlookThe Rose TeamJuly 16, 2024
What We Got Right and Wrong in Q2
What we Got Right:
“Recent Divergence in Magnificent 7 will Continue”
Entering 2024 we expected divergence in Big Tech as investor focus on AI turned from “hype” to “results.” Winners in Q2 include Nvidia (+36%) and Apple (+23%), while Meta (+4%) underperformed.
“Still Upside Risk to Yields”
We continued to believe longer-term Treasury yields would rise due to stickier inflation and the Fed pushing out rate cuts. The 10-year Treasury yield peaked at over 4.7% in the second quarter.
“Strong Q1 Returns Historically Bullish for Rest of Year”
The S&P 500 rose 10+% in the first quarter for just the 10th time since 1970. In the previous nine years, the S&P 500 had a median return of 3.3% in the second quarter. The S&P 500 followed this trend, finishing Q2 up 4.3%
“US Large Caps Outperform During a Fed Pause”
A Fed pause has historically led to outperformance of Large Caps. This trend continued in Q2, as Small Caps (Russell 2000 Index) finished the quarter down -3.3%.
What we Got Wrong:
“Core Bonds Outperform During a Fed Pause”
We still expect core bonds to rally as the Fed nears cutting, but stickier inflation and rising yields led to underperformance versus Cash in Q2. The Bloomberg US Agg Bond Index was flat in the second quarter (+0.1%).
Peak Indexing? Concentration Near Historic Levels
A decade ago, the ten largest companies in the S&P 500 accounted for less than 15% of the index. Today the top ten is over 35% and consists mostly of Big Tech – raising valuation concerns. Companies trading near their highest valuations in the past 5 years include Apple (32x) and Microsoft (34x). Although Nvidia (41x) is less expensive versus prior years, it will face pressure to continue growing to justify its $3.1 Trillion market cap.
Stock Performance in Presidential Election Years
US stock performance has historically been strong in Presidential Election years. In fact, the stock market has only experienced two negative calendar years in a Presidential Election year, dating back to 1948. Those two negative years were in 2000 when the Tech Bubble burst and in 2008 during the Global Financial Crisis.
Bond Market Rout Continues
Negative calendar year performance for US Bonds are rare but have become more common in recent years. The Fed’s fight against inflation, which peaked at 9.1% in June 2022, resulted in the worst bond market year on record. The hope is the next Fed easing cycle will boost bond returns going forward.
Narrow Market Leadership Continues
Big Tech’s strong earnings and dominance in AI has led the market higher. Without the major Big Tech stocks shown to the right, the S&P 500 would only be up roughly 6% YTD. Nvidia alone accounted for 30% of the S&P 500’s returns.
Below we highlight new products or features that will allow these companies to capitalize on AI:
Nvidia: New GPU Chips: Blackwell (2024) & Rubin (2026)
Apple: New “Apple Intelligence” features in future iPhones
Microsoft: “Copilot” AI; partnership with OpenAI (Chat GPT)
Alphabet: “Gemini”; AI-driven responses in Search
Meta: AI generative assistant tool in social media apps
Amazon: AI Features for cloud (AWS) and shopping
Echoes of the Tech Bubble? Not so Fast
The buzz around Artificial Intelligence has garnered comparisons to the Tech Bubble in the late-1990s. The most obvious comparison is Cisco’s rise in the late-1990s versus Nvidia today. Cisco’s networking equipment was vital to powering the internet, while Nvidia’s GPU chips are key to powering AI applications. Both companies also became the most valuable company in the world at one point.
An important distinction, however, is the level of euphoria back in the late-1990s. Many Tech companies outside of Cisco experienced high returns despite having little-to-no profit or earnings. To help illustrate, we highlight the recent rally in the Nasdaq 100 (off the lows in late-2022) versus the rally off the lows in late-1998 (in leadup to the Tech bubble). Despite a recent rally of roughly 85% since late-2022, the Nasdaq 100 surged over 300% before the Tech Bubble burst.
Historically How Long Until the Fed Cuts?
The market remains focused on when the Fed will begin cutting interest rates. In looking back over the past 30 years, the Fed has averaged roughly 10 months between the last hike and first cut. It’s important to note the Fed has historically cut as early as 5 months after the last hike, and as late as 18 months (dating back to 1995). Given stickier inflation and a resilient labor market, it’s more likely the Fed waits until late-Summer to begin cutting rates.
Equity Performance Around the First Rate Cut
To the right we show 12-month forward returns for the S&P 500 around the start of a Fed cutting cycle. The strength or weakness in equities were largely dependent on 1) Why the Fed cut rates and 2) If a Recession was avoided.
In both 1995 and 1998, 1-year forward returns were strong as the Fed managed to avoid an initial Recession (until the Tech Bubble burst).
In both 2001 and 2007, 1-year forward returns were weak as the Fed began cutting rates in response to the Tech Bubble and Global Financial Crisis.
In 2019, the Fed initially cut rates in response to slowing growth. Forward returns were strong despite the Covid pandemic in 2020.
Risks in Waiting Too Long to Cut Rates
The Fed has acknowledged the risks to inflation in cutting too early. But it’s also worth noting the risk to the economy in waiting too long. The Fed has a “dual mandate” for both maximum employment and stable prices.
Going forward we will be monitoring key indicators around the 1) labor market, 2) growth and 3) inflation:
Key Levels to Watch:
Jobless Claims (people filing for unemployment insurance) nearing 300,000 would signal a slowdown.
A 4.1% Unemployment Rate is the highest since 2021. The Fed will watch this closely, as its year-end forecast is 4.0%.
Growth
Key Indicators & Current Levels:
Atlanta Fed GDPNow Model: 1.5%
Key Levels to Watch:
Second quarter GDP estimates below 1.5% would be concerning, as original estimates for Q2 were roughly 4.0%. The GDPNow model frequently updates its projections based on incoming data.
Inflation
Key Indicators & Current Levels:
CPI: 0.0% (MoM) and 3.3% (YoY)
Shelter: 5.4% (YoY)
Key Levels to Watch:
Monthly CPI remaining flat (0.0%) or barely positive (0.1-0.2%).
Shelter is a heavily weighted category of CPI (36%) and lags other categories. Rent prices, which remain high, reflect contracts signed months or a year ago.
Investment Implications
1. Our Base Case is the Fed Begins Cutting in September:
The Fed has seemed eager to cut since its “pivot” in late-2023 but has also acknowledged the risks of doing so too early. Stickier inflation and a resilient economy delayed the start of the Fed’s easing cycle. Going forward, we believe slowing inflation and softer economic data, along with an Unemployment Rate above 4.0%, is enough ammunition for the Fed to begin cutting at the September meeting. Current market odds seem to agree.
2. Expect Softer Economic Data:
We expect a catalyst for the Fed to begin cutting in September is softer economic data. This is not a call for a Recession in 2024. Instead, we believe the lagged effects of higher rates will slow the economy. Already we are seeing softer economic data. The Citi Economic Surprise Index measures if economic data has been coming in stronger or weaker than expected. A positive index means economic data is beating market expectations. This index recently turned negative and we expect similar results going forward.
3. Strong Q1 Returns (+10%) Historically Bullish for Rest of Year:
This is just the 10th time since 1970 the S&P 500 had 10+% returns in the first quarter to start a year. In the previous nine occurrences, the S&P 500 had a median return in the second quarter of 3.3%. The S&P 500 closely followed this trend, finishing the second quarter up 4.3%.
In looking at full year returns, the S&P 500 had median returns of roughly 28%. In fact, none of these years produced a single negative calendar year return. It is important to note that third quarter returns were more muted in these years, with a median return of just 1.9%.
4. Short/Intermediate Bonds > Cash Before Fed Cuts:
A Fed easing cycle is historically bullish for fixed income, as yields decline and prices rise. To take advantage of the beginning of a rate cutting cycle, investors should consider short/intermediate bonds over Cash before the Fed begins cutting rates. This allows investors to lock in some duration along with higher yields. As shown to the right, US Bonds forward 12-month returns are higher 3-months before the Fed begins cutting. We would avoid longer-term bonds due to risks of US deficits and increased Treasury issuance.
5. Yield Curve Disinverts:
We expect the yield curve to disinvert after two years of inversion, led by lower two-year yields. The two-year yield reflects market expectations of where the Fed Funds rate could be in a couple years. As of quarter-end the two-year yield was roughly 4.75%. We expect the two-year yield to decline as the Fed cuts earlier than expected and the market prices in additional cuts for 2025.
Important Disclaimers and Disclosures
Rose Capital Advisors, LLC is registered as an investment adviser with Securities and Exchange Commission (“SEC”). Rose Capital Advisors, LLC only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. The use of the term “registered investment adviser” does not imply a certain level of skill or training. This report is a publication of Dynasty Financial Partners. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.
Information contained herein does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information. A professional adviser should be consulted before implementing any of the strategies or options presented. *Information is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), or product made reference to directly or indirectly, will be profitable or equal to past performance levels.
Rose Capital Advisors clients – please contact us at 305.534.7673 if there have been any changes in your financial situation or investment objectives, or if you want to implement reasonable restrictions and/or modify existing restrictions. As a reminder, all written business related inquiries regarding your accounts and/or investments should be submitted via email for compliance archiving purposes. Therefore, please do not text message any Rose Capital Advisor employee regarding any business related matters. All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
Dynasty Financial Partners is a U.S. registered trademark of Dynasty Financial Partners, LLC (“Dynasty”). Dynasty is a brand name, and functions through Dynasty’s wholly owned subsidiary, Dynasty Wealth Management, LLC, (“DWM”) a registered investment adviser with the Securities and Exchange Commission, when providing investment services. Any reference to the terms “registered investment adviser” or “registered” does not imply that Dynasty or any person associated with Dynasty has achieved a certain level of skill or training. A copy of DWM’s current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This message is intended for the exclusive use of members or prospective members considering joining the Dynasty Network of registered investment advisers. It should not be construed as an attempt to sell or solicit any products or services of Dynasty, DWM or any investment strategy, nor should it be construed as legal, accounting, tax or other professional advice.
This material is proprietary and may not be reproduced, transferred, modified or distributed in any form without prior written permission from Dynasty. Dynasty reserves the right, at any time and without notice, to amend, or cease publication of the information contained herein. Certain of the information contained herein has been obtained from third-party sources and has not been independently verified. It is made available on an “as is” basis without warranty. Any strategies or investment programs described in this presentation are provided for educational purposes only and are not necessarily indicative of securities offered for sale or private placement offerings available to any investor.
The views expressed in the referenced materials are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance; actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
Historical performance results for investment indices and/or product benchmarks have been provided for general comparison purposes only, and do not include the charges that might be incurred in an actual portfolio, such as transaction and/or custodial charges, investment management fees, or the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.
What We Got Right and Wrong in Q2
What we Got Right:
“Recent Divergence in Magnificent 7 will Continue”
Entering 2024 we expected divergence in Big Tech as investor focus on AI turned from “hype” to “results.” Winners in Q2 include Nvidia (+36%) and Apple (+23%), while Meta (+4%) underperformed.
“Still Upside Risk to Yields”
We continued to believe longer-term Treasury yields would rise due to stickier inflation and the Fed pushing out rate cuts. The 10-year Treasury yield peaked at over 4.7% in the second quarter.
“Strong Q1 Returns Historically Bullish for Rest of Year”
The S&P 500 rose 10+% in the first quarter for just the 10th time since 1970. In the previous nine years, the S&P 500 had a median return of 3.3% in the second quarter. The S&P 500 followed this trend, finishing Q2 up 4.3%
“US Large Caps Outperform During a Fed Pause”
A Fed pause has historically led to outperformance of Large Caps. This trend continued in Q2, as Small Caps (Russell 2000 Index) finished the quarter down -3.3%.
What we Got Wrong:
“Core Bonds Outperform During a Fed Pause”
We still expect core bonds to rally as the Fed nears cutting, but stickier inflation and rising yields led to underperformance versus Cash in Q2. The Bloomberg US Agg Bond Index was flat in the second quarter (+0.1%).
Peak Indexing? Concentration Near Historic Levels
A decade ago, the ten largest companies in the S&P 500 accounted for less than 15% of the index. Today the top ten is over 35% and consists mostly of Big Tech – raising valuation concerns. Companies trading near their highest valuations in the past 5 years include Apple (32x) and Microsoft (34x). Although Nvidia (41x) is less expensive versus prior years, it will face pressure to continue growing to justify its $3.1 Trillion market cap.
Stock Performance in Presidential Election Years
US stock performance has historically been strong in Presidential Election years. In fact, the stock market has only experienced two negative calendar years in a Presidential Election year, dating back to 1948. Those two negative years were in 2000 when the Tech Bubble burst and in 2008 during the Global Financial Crisis.
Bond Market Rout Continues
Negative calendar year performance for US Bonds are rare but have become more common in recent years. The Fed’s fight against inflation, which peaked at 9.1% in June 2022, resulted in the worst bond market year on record. The hope is the next Fed easing cycle will boost bond returns going forward.
Narrow Market Leadership Continues
Big Tech’s strong earnings and dominance in AI has led the market higher. Without the major Big Tech stocks shown to the right, the S&P 500 would only be up roughly 6% YTD. Nvidia alone accounted for 30% of the S&P 500’s returns.
Below we highlight new products or features that will allow these companies to capitalize on AI:
Echoes of the Tech Bubble? Not so Fast
The buzz around Artificial Intelligence has garnered comparisons to the Tech Bubble in the late-1990s. The most obvious comparison is Cisco’s rise in the late-1990s versus Nvidia today. Cisco’s networking equipment was vital to powering the internet, while Nvidia’s GPU chips are key to powering AI applications. Both companies also became the most valuable company in the world at one point.
An important distinction, however, is the level of euphoria back in the late-1990s. Many Tech companies outside of Cisco experienced high returns despite having little-to-no profit or earnings. To help illustrate, we highlight the recent rally in the Nasdaq 100 (off the lows in late-2022) versus the rally off the lows in late-1998 (in leadup to the Tech bubble). Despite a recent rally of roughly 85% since late-2022, the Nasdaq 100 surged over 300% before the Tech Bubble burst.
Historically How Long Until the Fed Cuts?
The market remains focused on when the Fed will begin cutting interest rates. In looking back over the past 30 years, the Fed has averaged roughly 10 months between the last hike and first cut. It’s important to note the Fed has historically cut as early as 5 months after the last hike, and as late as 18 months (dating back to 1995). Given stickier inflation and a resilient labor market, it’s more likely the Fed waits until late-Summer to begin cutting rates.
Equity Performance Around the First Rate Cut
To the right we show 12-month forward returns for the S&P 500 around the start of a Fed cutting cycle. The strength or weakness in equities were largely dependent on 1) Why the Fed cut rates and 2) If a Recession was avoided.
In both 1995 and 1998, 1-year forward returns were strong as the Fed managed to avoid an initial Recession (until the Tech Bubble burst).
In both 2001 and 2007, 1-year forward returns were weak as the Fed began cutting rates in response to the Tech Bubble and Global Financial Crisis.
In 2019, the Fed initially cut rates in response to slowing growth. Forward returns were strong despite the Covid pandemic in 2020.
Risks in Waiting Too Long to Cut Rates
The Fed has acknowledged the risks to inflation in cutting too early. But it’s also worth noting the risk to the economy in waiting too long. The Fed has a “dual mandate” for both maximum employment and stable prices.
Going forward we will be monitoring key indicators around the 1) labor market, 2) growth and 3) inflation:
Labor Market
Key Indicators & Current Levels:
Weekly Jobless Claims: 238,000 Unemployment Rate: 4.1%
Key Levels to Watch:
Jobless Claims (people filing for unemployment insurance) nearing 300,000 would signal a slowdown.
A 4.1% Unemployment Rate is the highest since 2021. The Fed will watch this closely, as its year-end forecast is 4.0%.
Growth
Key Indicators & Current Levels:
Atlanta Fed GDPNow Model: 1.5%
Key Levels to Watch:
Second quarter GDP estimates below 1.5% would be concerning, as original estimates for Q2 were roughly 4.0%. The GDPNow model frequently updates its projections based on incoming data.
Inflation
Key Indicators & Current Levels:
CPI: 0.0% (MoM) and 3.3% (YoY)
Shelter: 5.4% (YoY)
Key Levels to Watch:
Monthly CPI remaining flat (0.0%) or barely positive (0.1-0.2%).
Shelter is a heavily weighted category of CPI (36%) and lags other categories. Rent prices, which remain high, reflect contracts signed months or a year ago.
Investment Implications
1. Our Base Case is the Fed Begins Cutting in September:
The Fed has seemed eager to cut since its “pivot” in late-2023 but has also acknowledged the risks of doing so too early. Stickier inflation and a resilient economy delayed the start of the Fed’s easing cycle. Going forward, we believe slowing inflation and softer economic data, along with an Unemployment Rate above 4.0%, is enough ammunition for the Fed to begin cutting at the September meeting. Current market odds seem to agree.
2. Expect Softer Economic Data:
We expect a catalyst for the Fed to begin cutting in September is softer economic data. This is not a call for a Recession in 2024. Instead, we believe the lagged effects of higher rates will slow the economy. Already we are seeing softer economic data. The Citi Economic Surprise Index measures if economic data has been coming in stronger or weaker than expected. A positive index means economic data is beating market expectations. This index recently turned negative and we expect similar results going forward.
3. Strong Q1 Returns (+10%) Historically
Bullish for Rest of Year:
This is just the 10th time since 1970 the S&P 500 had 10+% returns in the first quarter to start a year. In the previous nine occurrences, the S&P 500 had a median return in the second quarter of 3.3%. The S&P 500 closely followed this trend, finishing the second quarter up 4.3%.
In looking at full year returns, the S&P 500 had median returns of roughly 28%. In fact, none of these years produced a single negative calendar year return. It is important to note that third quarter returns were more muted in these years, with a median return of just 1.9%.
4. Short/Intermediate Bonds > Cash Before Fed Cuts:
A Fed easing cycle is historically bullish for fixed income, as yields decline and prices rise. To take advantage of the beginning of a rate cutting cycle, investors should consider short/intermediate bonds over Cash before the Fed begins cutting rates. This allows investors to lock in some duration along with higher yields. As shown to the right, US Bonds forward 12-month returns are higher 3-months before the Fed begins cutting. We would avoid longer-term bonds due to risks of US deficits and increased Treasury issuance.
5. Yield Curve Disinverts:
We expect the yield curve to disinvert after two years of inversion, led by lower two-year yields. The two-year yield reflects market expectations of where the Fed Funds rate could be in a couple years. As of quarter-end the two-year yield was roughly 4.75%. We expect the two-year yield to decline as the Fed cuts earlier than expected and the market prices in additional cuts for 2025.
Important Disclaimers and Disclosures
Rose Capital Advisors, LLC is registered as an investment adviser with Securities and Exchange Commission (“SEC”). Rose Capital Advisors, LLC only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. The use of the term “registered investment adviser” does not imply a certain level of skill or training. This report is a publication of Dynasty Financial Partners. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.
Information contained herein does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information. A professional adviser should be consulted before implementing any of the strategies or options presented. *Information is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), or product made reference to directly or indirectly, will be profitable or equal to past performance levels.
Rose Capital Advisors clients – please contact us at 305.534.7673 if there have been any changes in your financial situation or investment objectives, or if you want to implement reasonable restrictions and/or modify existing restrictions. As a reminder, all written business related inquiries regarding your accounts and/or investments should be submitted via email for compliance archiving purposes. Therefore, please do not text message any Rose Capital Advisor employee regarding any business related matters. All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
Dynasty Financial Partners is a U.S. registered trademark of Dynasty Financial Partners, LLC (“Dynasty”). Dynasty is a brand name, and functions through Dynasty’s wholly owned subsidiary, Dynasty Wealth Management, LLC, (“DWM”) a registered investment adviser with the Securities and Exchange Commission, when providing investment services. Any reference to the terms “registered investment adviser” or “registered” does not imply that Dynasty or any person associated with Dynasty has achieved a certain level of skill or training. A copy of DWM’s current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This message is intended for the exclusive use of members or prospective members considering joining the Dynasty Network of registered investment advisers. It should not be construed as an attempt to sell or solicit any products or services of Dynasty, DWM or any investment strategy, nor should it be construed as legal, accounting, tax or other professional advice.
This material is proprietary and may not be reproduced, transferred, modified or distributed in any form without prior written permission from Dynasty. Dynasty reserves the right, at any time and without notice, to amend, or cease publication of the information contained herein. Certain of the information contained herein has been obtained from third-party sources and has not been independently verified. It is made available on an “as is” basis without warranty. Any strategies or investment programs described in this presentation are provided for educational purposes only and are not necessarily indicative of securities offered for sale or private placement offerings available to any investor.
The views expressed in the referenced materials are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance; actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
Historical performance results for investment indices and/or product benchmarks have been provided for general comparison purposes only, and do not include the charges that might be incurred in an actual portfolio, such as transaction and/or custodial charges, investment management fees, or the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.
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