Review & Outlook
July 9, 2024
During the quarter, the stock market continued its steady ascent led by a few Artificial Intelligence (“AI”)-related companies. While headline news likes to hype the vast stock market gains in the S&P 500 Market Cap Weighted Index (2nd Qtr. 4.3% and 15.3% Year to Date), after looking deeper into the Index, during the 2nd Quarter, there was negative breadth (199 issues up and 301 issues down) highlighting the magnitude of a very concentrated market. In fact, four stocks had contributed over half of the gains in the S&P 500 (Microsoft, Meta, Amazon, Nvidia) so far this year, a sign of a top-heavy, large capitalization Index that has not been witnessed in this magnitude since the 1998-2000 Technology “dotcom” bubble era.
Though a comparison to the Tech Bubble cycle 25 years ago is not perfect, we believe there are a couple of key parallels and conclusions to be drawn from that period. First, the Federal Reserve was in a similarly awkward position with a strong domestic economy (greater than 4% GDP growth) and roaring stock markets, while global markets were faltering in dramatic fashion. This led to multiple changes to interest rates (both down and up) as cycles changed; all preceding the 2008 market collapse. Today, Europe and China are facing similar economic malaise while US growth remains strong but slowing, and the Federal Reserve is primed to respond accordingly.
Second, many investors “felt good” during the 1998-2000 era being heavily invested in the Technology sector and eschewing diversification, only to achieve subpar results over the following decade. This highlights the risks of overconcentration on one theme and chasing the fad of the day. Through this and many other market cycles, Carderock has stuck to its discipline of owning an equity portfolio of higher quality, diversified and profitable companies that allows our clients to side-step heavy stock market declines that follow these types of theme cycles. And while we now find ourselves in a similar cycle where a quality portfolio of securities is not keeping pace on a relative measure, we believe in staying the course and remain confident in knowing this market cycle will eventually end.
From here to the end of the year, we see the following trends informing our investment process:
- Growth remains positive but will decelerate, as consumers cut back on discretionary items relative to staples.
- Labor markets will remain strong, providing a cushion under economic activity and making a recession unlikely.
- Interest-rate sensitive sectors will continue to be squeezed, as capital expenditure and homebuilding plans are delayed until rate cuts commence.
- The Artificial Intelligence investment theme and its narrow set of winners will continue to make strides, despite little to no revenue to show for the technology’s users so far.
In addition, our recent activity can be summarized as follows:
- Cash stock reserve targets stand at 10% of a fully invested Equity allocation.
- Our low cash targets reflect “bullishness” allowing us to rotate among new issues and sectors on our list.
- Buying continued to outpace selling, as we remained focused on cutting weaker names and keeping capital gains relatively low.
- We continued to buy Treasury bills to supplement cash reserves, as short-term rates remain high.
- Bond maturities across all accounts average roughly 2 years, and we expect to add exposure to longer-term bonds as short-term rates come down over the next few years.
We remain positive about the economy over the next 18 to 24 months as growth prospects remain attractive. And while a small cohort of issues have outpaced thus far, we believe the benefits of growth will broaden and extend to Quality Growth issues over time.
As always, feel free to call us to review your investment progress and to ask any questions you may have.
Warmest Regards,
Daniel A. Kane, CFA
President
Stephen F. Knapp, CFA
Director of Research
