By Tim Courtney, Chief Investment Officer

As we move into the third quarter of 2024, there are three critical factors we are watching that will shape the investment landscape: Gross Domestic Product (GDP) growth and broad economic data, market concentration and U.S. fiscal discipline. Each of these elements presents unique challenges and opportunities, influencing market behavior in significant ways. In this post, we delve into these factors to provide insights on what to monitor and why they matter in the months ahead:

GDP Growth & Economic Data: To-date in 2024, markets have been percolating around GDP growth and broad economic data such as employment numbers and manufacturing growth. We remain in a season where good news is bad news and bad news is good news because the market is cheering hard for interest rates. We've seen the market drop during weeks with strong economic numbers and rise when data is weaker than expected because the market is guessing how the Federal Reserve (Fed) will react.

This isn't the healthiest behavior for the market. Trading algorithms want rate cuts above all else, even good economic news. This has been a recurring theme for several years. Many investors and companies have become used to low rates and want back to that environment, despite the uncomfortable inflation those low rates caused.

So, we'll be watching GDP data closely to see if it's weak enough to justify cuts, but strong enough to support earnings, which is what long-term investors are focused on.

Market Concentration: Looking across asset classes so far in 2024, almost everything is positive, with commercial real estate being one of the few exceptions. Bonds are relatively flat, while cash is slightly positive. MLPs, commodities and gold are all showing gains.¹

Within the stock universe, every subclass of equities — large, mid, small, value, U.S., international, and emerging markets — is positive. However, the biggest gains by far have been generated by a handful of mega-cap tech stocks. Microsoft, Nvidia and Apple alone account for more than 20% of the value of the S&P 500.² The S&P 500 index has returned 15% year-to-date, but the seven largest companies in the index have generated a 25.3% return. If we exclude these names, the remaining 493 companies have only produced a 2.7% return.³ This indicates a significant concentration of market performance in a few key players.

In Q3 and beyond, we will be closely watching to see if the market starts to broaden. There are signs of this happening internationally, where markets have performed well, especially when factoring in the effect of the U.S. dollar on international investments.

Within the U.S., we’re also following small and mid-cap names, which have trailed large caps this year.⁴ Most U.S. companies fall into the small and mid-cap categories, with large caps being a small minority of publicly-traded stocks. Interest rate expectations have played a big role in small cap underperformance this year. As noted above, bad economic news released on certain days has led to small caps actually performing well as the market anticipates that rate cuts will disproportionately help small caps by lowering the cost of capital for these companies.

U.S. Fiscal Discipline: With the U.S. presidential election just months away, our primary focus is on the fiscal health of our country rather than the specific outcome of the election. For most Americans, the ongoing warnings of spending and debt are like the boy who cried wolf. Decades of warnings that the level of government spending is unsustainable, irresponsible and bound to have negative consequences have led to U.S. dollar strength and a market that continues to lend happily to the U.S.

But outside the U.S, we are seeing undisciplined countries being punished. Take China, for example. Despite being expected to overtake the U.S. GDP by 2020, China’s growth forecasts have been pushed back repeatedly, and now, very few expect China to surpass the U.S. economy.⁵ This shift is largely due to China's significant fiscal irresponsibility and one-man decision making.

Something that no investor currently imagines could certainly play out in the U.S. as we continue reckless spending and debts. There's always a cost to spending, and both Democrats and Republicans share the blame. Neither party has established a system for responsible fiscal management, and while we've avoided disaster so far, there's no guarantee we won't face consequences, which at a minimum are slower future growth and likely higher taxes. Last year, all three major credit rating agencies lowered the U.S. credit rating to double-A or a negative outlook.⁶

The second half of 2024 is uncertain as all quarters are, this time with a volatile presidential election, a concentrated market and all eyes trained on the Fed. As always, diversification remains key to successfully navigating whatever the upcoming quarter may bring. If you have any questions or concerns about your portfolio, please reach out to your Exencial advisor.

Sources

1. The Capital Spectator (5/31/24) - Major Asset Classes | May 2024 | Performance Review
2. MarketWatch (6/8/24) - Three stocks now account for 20% of the S&P 500’s value. That’s making some investors nervous.
3. Fortune (6/1/24) - Nvidia is carrying the S&P 500 like no company since possibly IBM four decades ago, expert says: ‘It’s unheard of’
4. MarketWatch (5/13/24) - The Russell 2000 will likely continue to lag — but pay attention to these small stocks
5. CNN Business (1/29/24) - The U.S. is pulling ahead in the economic race with China
6. CNBC.com (11/16/24) - US credit rating outlook lowered to “negative” by Moody’s — here’s why consumers should be worried

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