Change almost always represents an opportunity. People tend to be resistant to change, but it is a building block to personal and professional growth. Whether circumstances beyond our control force change upon us, or we intentionally force ourselves out of our comfort zones, both discomfort and evolution soon follow. This discomfort can be a catalyst for growth.
The markets are undergoing change as I type this. Volatility has significantly increased over the past week in reaction to a string of softer economic data points, the most important of which was last Friday’s (8/2/24) jobs report. Even though the report showed the economy added 114,000 jobs, expectations were to add 179,000. The unemployment rate was also reported at 4.3%, the highest rate since October 2021.
Some see the recent, rapid rise in the unemployment rate as a potential harbinger of an oncoming recession. We think that is still too early to call, but it has significantly changed the market’s expectations on interest rates as the Federal Open Market Committee recently indicated they are moving closer to cutting the overnight lending rate at the September meeting. This change in stance marks a full circle of changing expectations for Fed rate cuts. At the beginning of the year, expectations were for as many as seven rate cuts in 2024. These expectations declined during the first half of the year all the way to zero cuts in the face of persistent levels of inflation. With recent inflation levels moderating and rising unemployment, it again appears likely the Fed will begin reducing rates from the current level of 5.50%. Market pricing of futures contracts indicates an 85% probability of a 50-basis point cut in September, and an 84% probability of rates being between 4.25% and 4.5% by the year’s end. Such a path of rate cuts would likely be stimulative to economic activity and, potentially, equity returns.
We have written and spoken extensively about the disconcerting performance concentration within the US equity markets over the past several years; specifically, the “Magnificent 7” driving the S&P 500 and Nasdaq indices higher. We are finally beginning to see a broadening out of stock performance and declining prices of the Magnificent 7 securities, with other stocks declining less in comparison. As of the July 26 close, the stocks comprising the Magnificent 7 had collectively declined 13% from the July 10 peak. Concurrently the Russell 2000 Small Capitalization Index rose 10%.
Source: Goldman Sachs
Fundamental reasons behind this rotational change include a tempering of Artificial Intelligence expenditures versus returns analysis, broad based positive earnings announcements, and improving expectations of a Fed rate cut in 2024. This represents a very healthy change within the underlying drivers of equity market returns.
Also on the positive side, the unfolding 2Q 2024 earnings season is revealing change as well, with the S&P 500 reporting higher earnings for the second quarter today relative to the end of the quarter, countering fears of a recession slowdown. The current blended (actual and estimated) earnings growth rate of the S&P 500 for 2Q 2024 is 9.8% compared to an earnings growth rate of 8.9% at the end of the first quarter. Should this growth rate hold, it would mark the highest growth rate since 4Q 2021 and would mark the fourth consecutive quarter of year over year earnings growth. Eight of the eleven sectors are reporting year-over-year earnings growth, with four of those reporting double-digit growth.
The data that drives capital market returns is ever changing and evolving. The changes discussed above – increased volatility on weaker economic data, change in Fed posture on interest rates, improved market breadth, and positive revenue and earnings revisions – are all areas we are keenly focused on as active equity managers. The push and pull of these data points can create uncertainty – which the market dislikes – leading to market pullbacks. But these market pullbacks happen with regularity. On average, there has been a 10% market correction every 18 months since 1980. In spite of this, the market has been up in 33 of the past 44 years and is up over 4,800% in total since then. In accordance with each client’s long-term financial plan, change creates opportunities in the market to both deploy capital and position into companies that offer long-term value. Change should be embraced, not feared.
“Change is the only constant in life” – Heraclitus, 535 BC
Investment Commentary: Change is an Opportunity
By Andrew R. Duncan, CFA®
Change almost always represents an opportunity. People tend to be resistant to change, but it is a building block to personal and professional growth. Whether circumstances beyond our control force change upon us, or we intentionally force ourselves out of our comfort zones, both discomfort and evolution soon follow. This discomfort can be a catalyst for growth.
The markets are undergoing change as I type this. Volatility has significantly increased over the past week in reaction to a string of softer economic data points, the most important of which was last Friday’s (8/2/24) jobs report. Even though the report showed the economy added 114,000 jobs, expectations were to add 179,000. The unemployment rate was also reported at 4.3%, the highest rate since October 2021.
Some see the recent, rapid rise in the unemployment rate as a potential harbinger of an oncoming recession. We think that is still too early to call, but it has significantly changed the market’s expectations on interest rates as the Federal Open Market Committee recently indicated they are moving closer to cutting the overnight lending rate at the September meeting. This change in stance marks a full circle of changing expectations for Fed rate cuts. At the beginning of the year, expectations were for as many as seven rate cuts in 2024. These expectations declined during the first half of the year all the way to zero cuts in the face of persistent levels of inflation. With recent inflation levels moderating and rising unemployment, it again appears likely the Fed will begin reducing rates from the current level of 5.50%. Market pricing of futures contracts indicates an 85% probability of a 50-basis point cut in September, and an 84% probability of rates being between 4.25% and 4.5% by the year’s end. Such a path of rate cuts would likely be stimulative to economic activity and, potentially, equity returns.
We have written and spoken extensively about the disconcerting performance concentration within the US equity markets over the past several years; specifically, the “Magnificent 7” driving the S&P 500 and Nasdaq indices higher. We are finally beginning to see a broadening out of stock performance and declining prices of the Magnificent 7 securities, with other stocks declining less in comparison. As of the July 26 close, the stocks comprising the Magnificent 7 had collectively declined 13% from the July 10 peak. Concurrently the Russell 2000 Small Capitalization Index rose 10%.
Fundamental reasons behind this rotational change include a tempering of Artificial Intelligence expenditures versus returns analysis, broad based positive earnings announcements, and improving expectations of a Fed rate cut in 2024. This represents a very healthy change within the underlying drivers of equity market returns.
Also on the positive side, the unfolding 2Q 2024 earnings season is revealing change as well, with the S&P 500 reporting higher earnings for the second quarter today relative to the end of the quarter, countering fears of a recession slowdown. The current blended (actual and estimated) earnings growth rate of the S&P 500 for 2Q 2024 is 9.8% compared to an earnings growth rate of 8.9% at the end of the first quarter. Should this growth rate hold, it would mark the highest growth rate since 4Q 2021 and would mark the fourth consecutive quarter of year over year earnings growth. Eight of the eleven sectors are reporting year-over-year earnings growth, with four of those reporting double-digit growth.
The data that drives capital market returns is ever changing and evolving. The changes discussed above – increased volatility on weaker economic data, change in Fed posture on interest rates, improved market breadth, and positive revenue and earnings revisions – are all areas we are keenly focused on as active equity managers. The push and pull of these data points can create uncertainty – which the market dislikes – leading to market pullbacks. But these market pullbacks happen with regularity. On average, there has been a 10% market correction every 18 months since 1980. In spite of this, the market has been up in 33 of the past 44 years and is up over 4,800% in total since then. In accordance with each client’s long-term financial plan, change creates opportunities in the market to both deploy capital and position into companies that offer long-term value. Change should be embraced, not feared.
“Change is the only constant in life” – Heraclitus, 535 BC
Shannon DermodyTEST