The topic of interest rate cuts continues to dominate the financial markets. Investors are focused on when the Federal Reserve will lower rates, while also keeping a close eye on corporate earnings. Economists are analyzing inflation and labor market data to determine their impact on the probability and timing of rate cuts. Comments from several Fed Board members and minutes of recent Fed meetings have been in focus as investors search for clues about the central bank’s next steps.
While the Federal Reserve waits for more confirmation that domestic inflation will return to its target of two percent, the trend among global central banks has shifted away from tightening. Central banks around the world are starting to cut interest rates as inflation slows. More than 10 central banks have cut rates, including Canada, Switzerland, and the ECB. The monetary policy environment is shifting from rate hikes to rate cuts, and investors expect this trend to strengthen in the coming quarters. This easing cycle is likely to be more staggered than previous cycles, with central banks cutting interest rates at varying speeds based on their unique inflation and economic growth conditions.
During the second quarter, there has been an increase in the number of negative economic surprises, relative to estimates, as the U.S. economy underperformed expectations. Job growth slowed in April, and the unemployment rate rose to 4% in May. Retail sales declined in April, raising concerns about an increasing level of stress for lower-income households. May manufacturing survey data signaled a slowdown, while the Department of Commerce reported the economy grew more slowly in the first quarter than initially estimated. Market participants will continue to debate what these recent negative surprises indicate. As we progress into the third quarter, we may finally get an answer as to whether the Fed can achieve its elusive “soft landing”.
Performance
During the quarter, the equity market experienced a little bit of everything. In April, stocks traded lower, reversing some gains from the previous quarter. In May, stocks rebounded, and the S&P 500 finished the quarter by setting multiple new highs. Five S&P 500 sectors traded higher during the quarter, while the remaining six traded lower. Technology led with a gain of 13.8%, communication services followed with a gain of 9.4% and utilities rounded out the top three with a gain of 4.7%. At the opposite end of the spectrum, materials trailed all other sectors with a decline of 4.5%, followed by industrials (- 2.9%) and energy (-2.4%).
S&P 500 Sector Performance (ETF)
One notable theme in the stock market this year has been the outperformance of the largest companies. The S&P 500 Index gained +4.3% in the second quarter, increasing its YTD return to 15.3%. In contrast, the Russell 2000 Index of small cap companies fell by -3.3%, lowering its YTD return to +1.7%. Likewise, mid-cap equities fell 3.4% during the quarter which resulted in a YTD gain of 5.0%.
The group of companies known as the “Magnificent Seven”, (Apple, Amazon, Google, Meta Platform, Microsoft, Nvidia, and Tesla) has returned +34.9% this year. Expanding to the top 50 S&P 500 stocks reduces the return to +21.8%. Including the remaining S&P 500 companies, which are smaller in market-cap, reduces the S&P 500’s return to +15.3%. An equal-weighted S&P 500, where companies are weighted equally rather than by market cap, lowers the return to +5.0%. Investors appear to favor larger companies as they await clarity on Fed policy and the economy.
International
International stocks underperformed U.S. stocks in Q2, but performance was mixed. The MSCI Emerging Market Index gained +5.0%, slightly higher than the S&P 500’s return and has gained 7.5% for the first half. However, the MSCI EAFE Index of developed market stocks returned -0.4% over the quarter yet remains positive through the first two quarters with a gain of 5.3%. The two main international stock market indices have underperformed U.S. stocks by almost -10% this year, despite mid-single-digit gains. The difference in returns continues to be a lack of exposure to companies in the artificial intelligence industry outside the U.S.
Commodities
The commodity market remained a mixed bag in June with the Bloomberg Commodity Index declining 1.9% and the S&P GSCI, which is more heavily weighted toward energy sectors, climbed 1.0%. The monthly performance reversed the overall trend of the second quarter, with the BCOM rising 1.5% and S&P GSCI down 0.7%.
Industrial metals (+6.8%) was the best performing sector for the quarter led by zinc (+18.4%). Precious metals were boosted by silver (+16.2%) and gold (+3.5%). Brent and WTI crude were both slightly negative. Agricultural were down 6.9% with cotton (-21.8%) leading that decline and coffee (+21.0%) being the best performer in that sector.
Crude Oil Prices – WTI
Fixed Income
Treasury yields experienced some volatility over the quarter as investors displayed their indecisiveness regarding the timing of possible rate cuts. On the surface, yields ended the quarter marginally higher, but it was a bumpy ride. The 10-year Treasury yield started the quarter at 4.20%, rose to 4.70% by late April, and dropped back to 4.37% by the end of June.
As a result of this volatility, bonds posted a barely positive return (0.1%) in the Bloomberg U.S. Aggregate Bond Index for the quarter and a negative YTD return of -0.7%. Corporate investment grade was also slightly positive for the quarter. High yield gained 1.1%, increasing its 2024 return to +2.6%. International markets are a different story. The Bloomberg Global Aggregate ex-U.S. was down 2.1% for the quarter and is now down 5.3% for the YTD period on a total return basis. One theme supporting bonds is their relatively high-income level compared to the past fifteen years. Treasury bills, which are a proxy for cash, can offer yields above 5%, but this yield is expected to decrease as the Fed cuts interest rates. Locking in today’s yields for a longer period requires buying longer 10-year Treasury bonds yielding closer to 4.4% or corporate investment grade yielding 5.5% depending on quality and duration.
Say what you will about the municipal bond market, but adjectives like “resiliency” and “tenacity” may be top of mind. New issues notably picked up this quarter, besting expectations and rivaling historical levels. Issuance in the first half of 2024 of $239 billion compares most closely with new issuance in 2015 and 2016, the first years that new issuance broke $400 billion for the year.
Fortunately, the new issuance supply met increasing demand. Not only are rates higher than the average of the past 10 years, it appears that taxes are more likely to go higher than lower as we grapple with rising federal government deficits. Municipal bonds are one significant way to try to reduce required tax payments to the IRS.
Inflation
The two most prominent measures of inflation have continued their positive trends toward the Fed’s stated goal of a 2% annual rate. The two measures are the Consumer Price Index (CPI; shown here), and the Personal Consumption Expenditure (PCE) Price Index. The CPI, which is compiled by the Department of Labor, generally makes front-page news as the more mainstream measure. Meanwhile, the PCE Index is part of the monthly Personal Income and Outlays report from the Bureau of Economic Analysis, which is usually put out about two weeks after the CPI report. Since the beginning of the year, the PCE rate of inflation has been lower than the CPI rate.
Consumer Price Index – YoY Change
The building blocks of the PCE and CPI inflation calculations are largely the same. Each index attempts to quantify changes in consumer prices by tracking changes in the prices of a specific basket of goods and services each month. Differences in the formulas, components, and weights of each index mean they can paint slightly different pictures of price pressures in the economy.
Differences between how components are weighted in the two indexes are often responsible for the differences between the two readings. That’s especially been the case in recent months. The most pertinent example is shelter prices, weighted roughly double in the CPI Index compared with the PCE Index.
Furthermore. the indexes are calculated using different mathematical processes. For example, the PCE formula adjusts its weights monthly, while the CPI does so yearly. When grocery shoppers switch to chicken after beef becomes more expensive, that change shows up in the PCE Index first. There are also differences in the scope of each index. The PCE report includes purchases made by urban and rural consumers, while the CPI report only tracks spending in urban areas.
Third Quarter Insights
Economic data has softened, raising the question of whether the economy is slowing or simply returning to normal. Investors started this year expecting the Federal Reserve to cut interest rates in March; however, they are still waiting for the first interest rate cut.
The second half of 2024 will be busy. Investors expect the Federal Reserve to start cutting interest rates before year-end with the first rate cut expected in September. The second-quarter earnings season began in mid-July, which will provide an opportunity to hear updated commentaries from companies. There is a renewed focus on economic data and the economy’s trajectory, and the presidential election will take place in November. We will continue to monitor financial markets and the economy, provide timely updates, and adjust portfolios as needed.
Brian T. Moore
July 2024
References
S&P 500 Sector Return Data Morningstar: Third Quarter 2023 total return of ETF proxies.
Crude Oil Prices – WTI – Federal Reserve Economic Data: Year to date, crude oil prices, West Texas Intermediate.
CPI – Year over Year Change – Federal Reserve Economic Data: Year over year percentage change September 2023.
Disclaimer Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chesapeake Wealth Management), or any non-investment related content, made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Chesapeake Wealth Management. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his or her individual situation, he or she is encouraged to consult with the professional advisor of his or her choosing. Chesapeake Wealth Management is neither a law firm nor a Certified Public Accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Chesapeake Financial Group, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.
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Quarterly Commentary Q2 2024
Market Overview
The topic of interest rate cuts continues to dominate the financial markets. Investors are focused on when the Federal Reserve will lower rates, while also keeping a close eye on corporate earnings. Economists are analyzing inflation and labor market data to determine their impact on the probability and timing of rate cuts. Comments from several Fed Board members and minutes of recent Fed meetings have been in focus as investors search for clues about the central bank’s next steps.
While the Federal Reserve waits for more confirmation that domestic inflation will return to its target of two percent, the trend among global central banks has shifted away from tightening. Central banks around the world are starting to cut interest rates as inflation slows. More than 10 central banks have cut rates, including Canada, Switzerland, and the ECB. The monetary policy environment is shifting from rate hikes to rate cuts, and investors expect this trend to strengthen in the coming quarters. This easing cycle is likely to be more staggered than previous cycles, with central banks cutting interest rates at varying speeds based on their unique inflation and economic growth conditions.
During the second quarter, there has been an increase in the number of negative economic surprises, relative to estimates, as the U.S. economy underperformed expectations. Job growth slowed in April, and the unemployment rate rose to 4% in May. Retail sales declined in April, raising concerns about an increasing level of stress for lower-income households. May manufacturing survey data signaled a slowdown, while the Department of Commerce reported the economy grew more slowly in the first quarter than initially estimated. Market participants will continue to debate what these recent negative surprises indicate. As we progress into the third quarter, we may finally get an answer as to whether the Fed can achieve its elusive “soft landing”.
Performance
During the quarter, the equity market experienced a little bit of everything. In April, stocks traded lower, reversing some gains from the previous quarter. In May, stocks rebounded, and the S&P 500 finished the quarter by setting multiple new highs. Five S&P 500 sectors traded higher during the quarter, while the remaining six traded lower. Technology led with a gain of 13.8%, communication services followed with a gain of 9.4% and utilities rounded out the top three with a gain of 4.7%. At the opposite end of the spectrum, materials trailed all other sectors with a decline of 4.5%, followed by industrials (- 2.9%) and energy (-2.4%).
S&P 500 Sector Performance (ETF)
One notable theme in the stock market this year has been the outperformance of the largest companies. The S&P 500 Index gained +4.3% in the second quarter, increasing its YTD return to 15.3%. In contrast, the Russell 2000 Index of small cap companies fell by -3.3%, lowering its YTD return to +1.7%. Likewise, mid-cap equities fell 3.4% during the quarter which resulted in a YTD gain of 5.0%.
The group of companies known as the “Magnificent Seven”, (Apple, Amazon, Google, Meta Platform, Microsoft, Nvidia, and Tesla) has returned +34.9% this year. Expanding to the top 50 S&P 500 stocks reduces the return to +21.8%. Including the remaining S&P 500 companies, which are smaller in market-cap, reduces the S&P 500’s return to +15.3%. An equal-weighted S&P 500, where companies are weighted equally rather than by market cap, lowers the return to +5.0%. Investors appear to favor larger companies as they await clarity on Fed policy and the economy.
International
International stocks underperformed U.S. stocks in Q2, but performance was mixed. The MSCI Emerging Market Index gained +5.0%, slightly higher than the S&P 500’s return and has gained 7.5% for the first half. However, the MSCI EAFE Index of developed market stocks returned -0.4% over the quarter yet remains positive through the first two quarters with a gain of 5.3%. The two main international stock market indices have underperformed U.S. stocks by almost -10% this year, despite mid-single-digit gains. The difference in returns continues to be a lack of exposure to companies in the artificial intelligence industry outside the U.S.
Commodities
The commodity market remained a mixed bag in June with the Bloomberg Commodity Index declining 1.9% and the S&P GSCI, which is more heavily weighted toward energy sectors, climbed 1.0%. The monthly performance reversed the overall trend of the second quarter, with the BCOM rising 1.5% and S&P GSCI down 0.7%.
Industrial metals (+6.8%) was the best performing sector for the quarter led by zinc (+18.4%). Precious metals were boosted by silver (+16.2%) and gold (+3.5%). Brent and WTI crude were both slightly negative. Agricultural were down 6.9% with cotton (-21.8%) leading that decline and coffee (+21.0%) being the best performer in that sector.
Crude Oil Prices – WTI
Fixed Income
Treasury yields experienced some volatility over the quarter as investors displayed their indecisiveness regarding the timing of possible rate cuts. On the surface, yields ended the quarter marginally higher, but it was a bumpy ride. The 10-year Treasury yield started the quarter at 4.20%, rose to 4.70% by late April, and dropped back to 4.37% by the end of June.
As a result of this volatility, bonds posted a barely positive return (0.1%) in the Bloomberg U.S. Aggregate Bond Index for the quarter and a negative YTD return of -0.7%. Corporate investment grade was also slightly positive for the quarter. High yield gained 1.1%, increasing its 2024 return to +2.6%. International markets are a different story. The Bloomberg Global Aggregate ex-U.S. was down 2.1% for the quarter and is now down 5.3% for the YTD period on a total return basis. One theme supporting bonds is their relatively high-income level compared to the past fifteen years. Treasury bills, which are a proxy for cash, can offer yields above 5%, but this yield is expected to decrease as the Fed cuts interest rates. Locking in today’s yields for a longer period requires buying longer 10-year Treasury bonds yielding closer to 4.4% or corporate investment grade yielding 5.5% depending on quality and duration.
Say what you will about the municipal bond market, but adjectives like “resiliency” and “tenacity” may be top of mind. New issues notably picked up this quarter, besting expectations and rivaling historical levels. Issuance in the first half of 2024 of $239 billion compares most closely with new issuance in 2015 and 2016, the first years that new issuance broke $400 billion for the year.
Fortunately, the new issuance supply met increasing demand. Not only are rates higher than the average of the past 10 years, it appears that taxes are more likely to go higher than lower as we grapple with rising federal government deficits. Municipal bonds are one significant way to try to reduce required tax payments to the IRS.
Inflation
The two most prominent measures of inflation have continued their positive trends toward the Fed’s stated goal of a 2% annual rate. The two measures are the Consumer Price Index (CPI; shown here), and the Personal Consumption Expenditure (PCE) Price Index. The CPI, which is compiled by the Department of Labor, generally makes front-page news as the more mainstream measure. Meanwhile, the PCE Index is part of the monthly Personal Income and Outlays report from the Bureau of Economic Analysis, which is usually put out about two weeks after the CPI report. Since the beginning of the year, the PCE rate of inflation has been lower than the CPI rate.
Consumer Price Index – YoY Change
The building blocks of the PCE and CPI inflation calculations are largely the same. Each index attempts to quantify changes in consumer prices by tracking changes in the prices of a specific basket of goods and services each month. Differences in the formulas, components, and weights of each index mean they can paint slightly different pictures of price pressures in the economy.
Differences between how components are weighted in the two indexes are often responsible for the differences between the two readings. That’s especially been the case in recent months. The most pertinent example is shelter prices, weighted roughly double in the CPI Index compared with the PCE Index.
Furthermore. the indexes are calculated using different mathematical processes. For example, the PCE formula adjusts its weights monthly, while the CPI does so yearly. When grocery shoppers switch to chicken after beef becomes more expensive, that change shows up in the PCE Index first. There are also differences in the scope of each index. The PCE report includes purchases made by urban and rural consumers, while the CPI report only tracks spending in urban areas.
Third Quarter Insights
Economic data has softened, raising the question of whether the economy is slowing or simply returning to normal. Investors started this year expecting the Federal Reserve to cut interest rates in March; however, they are still waiting for the first interest rate cut.
The second half of 2024 will be busy. Investors expect the Federal Reserve to start cutting interest rates before year-end with the first rate cut expected in September. The second-quarter earnings season began in mid-July, which will provide an opportunity to hear updated commentaries from companies. There is a renewed focus on economic data and the economy’s trajectory, and the presidential election will take place in November. We will continue to monitor financial markets and the economy, provide timely updates, and adjust portfolios as needed.
Brian T. Moore
July 2024
References
Morningstar: Third Quarter 2023 total return of ETF proxies.
Federal Reserve Economic Data: Year to date, crude oil prices, West Texas Intermediate.
Federal Reserve Economic Data: Year over year percentage change September 2023.