Mid-year Market Update: Stocks Maintain Momentum at Year’s Halfway Point

In today’s blog, I’m going to review detailed information on mid-year markets, as noted by Dimensional’s mid-year market update. But first, I’ll review three takeaways from the first half of 2024.

Key Mid-year Takeaways

Takeaway #1

U.S. stocks extended a bull market with the S&P reaching a series of record highs in the first half of the year, led by technology stocks.

Takeaway #2

Core inflation fell slightly, but it remained above 3 percent in the U. S. The Fed kept rates steady, while central banks in Europe and Canada cut the interest rates.

Takeaway #3

Small cap and value stocks lagged the market, while high profitability stocks outperformed, a reminder of the benefits of pursuing multiple premiums of higher expected return.

So, let’s dive into the details.

The beginning of 2024 started a lot like the end of 2023 with markets rising amid a talk of a potential decrease in U.S. inflation and interest rate cuts from the Federal Reserve that could follow.

But much like last year, those expectations remain unfulfilled as core inflation fell slightly but held above that 3 percent and the Fed stood pat on interest rates.

U.S. stocks, as measured by the S&P 500, rose to a series of record highs, as you might have noticed, in the first year’s half, and the benchmark 10-year U. S. Treasury bond yield approached 5 percent in the spring before retreating. The Fed held a key measure, the federal funds rate, steady through June at 5.25%, the highest level in more than two decades, with officials citing an effort to cool persistently high inflation.

Meanwhile, the European Central Bank cut rates for the first time since 2019, as did the Bank of Canada.

U.S. core inflation was 3.4 percent in May, a multi-year low, but still well above the Fed’s 2 percent target. However, it has moved in the direction policy makers have said they’d like to see it go, lower, though they indicated at their meeting in June that they expect just one rate cut before the end of the year. Against this backdrop, U. S. stocks extended the bull market that began late in 2022 with the S&P index gaining 14.6 percent through June 14th and notching new all-time highs.

Record levels may lead some investors to wonder whether it’s a good time to sell, but historical data could help allay such concerns.

Periodic record setting in the market should be expected for an asset class with positive expected returns.

As Exhibit 1 shows on the screen, the average return for weeks following these new highs was 26%, which is very close to the average return of 22 percent across all weeks.

As long as investors demand positive returns in exchange for holding those stocks, a new market high doesn’t mean that the market’s going to tumble.

The strong rally in the technology sector in 2023 continued into the new year.

The tech heavy NASDAQ, after gaining 44.6 percent last year, has risen 18.1 percent this year, versus the S& P’s 14.6 percent gain. NVIDIA remained the biggest driver of gains in the tech sector through the end of May, as demand remained strong for chips using two power cutting edge AI applications.

But, expecting NVIDIA and the rest of the so-called ‘Magnificent 7’ tech stocks to outperform the broader market is to bet on them further exceeding the market’s expectations. Simply meeting expectations may result in returns more in line with the market, consistent with the history of the top U.S. stocks.

Global markets reached multiyear highs with the MSCI All Country World Index rising 10.6 percent through mid-June.

Developed international stocks as represented by the MSCI World Ex USA Index added 4.4 percent and emerging market stocks as represented by the MSCI Emerging Markets Index were up 6.4%.

U.S. Treasuries were little changed for the year with the 10-year Treasury bond falling 1%. However, yields, which rise when prices fall, remain higher than they have been for most of the past decade. The 10-year treasury yield touched 4.7 percent in April, after nearly reaching 5 percent last October for the first time since 2007, before pulling back to 4.2%.

And if we try to put premiums in perspective, as the broader market gained value stocks and stocks of companies with smaller market capitalizations were just unable to keep up with their historical outperformance.

The MSCI All Country World Value Index rose 5.3%, about a third of the 15.7 percent increase for the MSCI All Country World Growth Index. Without help from the U. S. tech sector, the MSCI All Country World ex USA Growth Index only rose 6.4%, still ahead of the 3.5 percent increase for the MSCI All Country World ex USA Value Index.

Small cap companies underperformed large cap stocks globally

The MSCI All Country World Small Cap Index returned 1.3 percent versus 10.6 percent for the larger cap MSCI All Country World Index.

But history suggests giving up on small cap value underperformance in the past would have been a mistake. And premiums don’t always move in lockstep, as stocks of companies with high profitability have recently outperformed the stocks of companies with low profitability.

That has held true in both developed and emerging markets this year. The Fama/French Emerging Markets High Profitability Index rose 10.7 percent as of May 31st versus 6.8 percent for its low profitability counterpart.

The Fama French Emerging Markets High profitability index rose 5.4%, while its low profitability counterpart rose 0.7 percent as of May 31st. It’s a reminder that investors who pursue multiple premiums can increase their chances of long-term success.

So, the benefits of a flexible approach, pursuing historical premiums, is just one way of seeking to outperform benchmark returns. Implementation, including a portfolio’s design, daily management, and trading, is another.

Every June, an event helps put this into focus. That’s when the Russell U. S. Indices undergo their reconstitution, when the benchmarks add and drop stocks as time goes by. However, stock prices will change. What was once a small cap stock might become a large cap stock. Revising holdings annually means those stocks are stuck in the index regardless of their characteristics until the following June.

As Exhibit two shows, from December 2009 to May 2024, the small cap Russell 2000 Index had unsteady exposure to small caps. The percentage made up of large caps tended to rise throughout the year and peak before the index was reconstituted in June. That exposure to large caps came at the expense of a more consistent focus on small caps.

In other words, investors may not have been getting what they came for.  An investment process with flexibility to evaluate and adjust holdings daily can provide a more consistent focus over time, potentially capturing premiums more reliably.  Investors who diversify and focus on those premiums and embrace a flexible investing approach will continue to confront uncertainties in the year’s second half.

Uncertainty is unavoidable, and it accounts for the risk that can lead to positive returns over the long haul.

How long can this bull market endure, and which way is inflation going to go? Which way will interest rates go?  Will the surge for those AI associated companies continue? Will global hostilities in the Middle East and Ukraine ease or increase?

Will the U. S. election bring a big November stock swing?

Spoiler alert, it usually has not, so we’ll find out eventually, but by the time the answers are found, they’re also going to be incorporated into the market prices. And until then, 2024, like every year, is a good one to have a long-term plan and consider sticking with it.

At One Life Financial Group, we provide customized planning, a way to track your progress, and ongoing guidance. If you’re interested in learning more about how we can work together to develop a plan to help you maximize your wealth, minimize your lifetime tax bill, and protect your time and money so that you have more for what matters to you, schedule a no-cost, 90-minute consultation.

Source: https://www.dimensional.com/us-en/insights/midyear-review-stocks-maintain-momentum-at-years-halfway-point

Advisory services are offered through One Life Financial Group, Inc., an Investment Advisor in the State of Minnesota. All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions.