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The Brave Report: Market Commentary for Q2 2024

How magnificent…. The markets marched higher this quarter continuing to be powered by the large tech names.  While market performance has been great, the rise of a few large highflyers has given us a false sense of overall market performance.  We continue to wait for more names and sectors to join the rally but so far participation has been muted.

Uncertainties over inflation, rates and the election still create an underlying sense of unrest for the markets but it hasn’t seemed to impact overall market volatility which remains at historically low levels.  The big question moving forward is will these tech names be able to continue to prop up the markets or do we need to see new leaders emerge for this rally to continue?

Market Overview

The markets continued their upward trend in the 2nd quarter.  The S&P 500 gained close to 4% while the NASDAQ jumped another 7.8%. The Dow Industrials were the only laggard during the quarter, dropping 1.7%.  This tech-led rally stalled slightly during the month of April only to surge higher during the later half of the quarter. The S&P 500 is now up close to 15% year to date and more than 32% since last October’s low.

On the fixed income side, we saw rates remain relatively stable throughout the quarter.  The yield on the 10-year treasury rose only slightly, rising from 4.2% to 4.32% to close out the quarter.  There was a small jump in yields in April only to see them drop back to around flat in June.  Inflation and uncertainty around the Fed’s next move continue to be the driving factor on this front.  However, even against this backdrop, rates have been pretty stable for the first half of this year.

While the markets have continued to rally this year, this rally has been a very top-heavy rally with a small number of companies being responsible for an outsized amount of the gains.  So far this year the S&P 500 is up around 15% but only around 25% of companies in the index are outperforming the index.  To put this into perspective, in 2021 when the index was up around 25% we saw 43% of companies outperforming the index meaning participation in the rally was much broader.

If we take this one step further and look only at the seven big tech names that have been driving the rally.  Referred to as the “Magnificent 7,” Alphabet, Amazon, Apple, Nvidia, Microsoft, Tesla and Meta, have been responsible for a majority of the market’s return year to date.  If we carve out these seven names from the S&P 500 they are up 48% year to date.  The remaining 493 stocks in the S&P 500 are only up 7.5%. Additionally, the small-cap Russell 2000 is actually slightly negative for the year. This type of top-heavy performance is typically not a great sign when it comes to the sustainability of a rally.  These names can only carry to the load for so long before other names or sectors need to start contributing.

I don’t want this to be taken as the rally is nearing its end and that some of these names still don’t have more room to run because the long-term story for these names is very intact. My contention is simply that the rally in these names is overshadowing the real performance of the underlying indices.  Most investors have been very happy with the market performance year to date but it is important to understand that the vast majority of the market is not performing as well as the indices would indicate. Furthermore, with the rally these large names have been on we could start to see some valuation concerns unless earnings continue to surprise to the upside.

Another interesting characteristic of the current rally is the lack of volatility in the markets.  It has been more than 385 days since the S&P 500 saw a down day of more than 2.05%.  This is the longest such streak since the financial crisis in 2008.  Apart from a small uptick in April, the VIX or Volatility index has remained historically low for the entire year.  This lack of volatility seems a bit strange considering the continued uncertainty around inflation, rates and the election.

With some names in the market continuing to soar, the upcoming earnings season will be an important one to watch.  We will be watching to see if earnings from these large tech names can justify the rapid rise these stocks have seen. Additionally, we will see if strong earnings from other companies and sectors will help add more participants to the rally and give it fuel for another leg higher.

I will also be looking to see how companies are assessing the current inflation and rate environment.  Inflation has remained stubborn and this has led to expectations of rate cuts to be pushed out even further into the future.  Going into the year, many expected up to four rate cuts, but most are now expecting one or none by year’s end.  While markets have handled this change in expectations well, we can learn from earnings releases how the current environment is actually impacting the economy and not just the stock market.

The other outlying uncertainty that the markets will need to factor in is the upcoming election in November.  I have never believed that the president has much direct impact on the economy in the short term, especially if Congress is split. However, over the next few months, we will start to get a more clear picture as to what if any policies could have a longer-term impact on the economy.  We are still in a wait-and-see mode right now but will get quite a bit more clarity in the next few months.

Strategy Commentary

I continue to remain patient when it comes to my overall equity allocation.  With markets continuing to push through all-time highs it has been difficult to find entry points for new money.  I have begun trimming a few of the high-flying names and sectors, trying to lock in some profits but have not gotten aggressive with any selling.  It has mostly been through adding trailing stops to highly appreciated names to avoid a large drawdown should market sentiment shift.  I am continuing to utilize short-term treasuries as a great place to park excess cash while we wait for new entry points.

Domestically I have not made any major changes, continuing to hold overweights to technology and communication services.  These have been winners for some time now and will look to lock in profits in these sectors if we see any negative shift in the markets.  Small-caps have underperformed throughout the recent rally but I still believe there will be a point where their valuation discount is too much to ignore.

Internationally, I am still quite cautious.  We have seen economic data lag in Europe and geopolitical uncertainty still creates a large overhang in both Europe and Asia.  I still maintain some international exposure but am not looking to add to an exposure at this time.

Short-duration fixed income, specifically treasuries continue to yield over 5% and provide a relatively risk-free place to park excess cash and other fixed income allocations.  I will continue to hold excess cash here while we wait for confirmation of a continued equity rally or we are provided with a more attractive entry point for equities.

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