Summer Busting Out

Weekly Newsletter: June 17, 2024

“Two roads diverged in the wood, and I – I took the one less traveled by.” Robert Frost was not likely talking about the technology sector and the rest of the market more than a century ago. The divergence between the top five stocks in the market and the remaining 495 is rather stark. For the second week, more stocks declined than rose even as the SP500 and OTC markets rose. The “growth” portion of the SP500 is up over 6% in June, while every other market capitalized index is lower. The question for the markets (and investors) is whether this is a “blow-off” move by the top technology names. There have been plenty of references to the tech rally in late 1999 and we can now add the divergence between those top names and the “average” stock within the SP500. After the tech peak in early 2000, the average stock, small stocks, and even emerging markets held up very well as technology stocks declined by over 50% from those peaks. It will be some time to see if the road less traveled by makes all the difference in the performance of these indices.

Last week was loaded with information that should have pushed the overall (not just a few stocks) market higher. Inflation, as measured by both the consumer and producer price indices, came in below expectations. A welcome respite from the persistently higher inflation over the first half of the year. Chair Powell referenced the good news at his press conference following the Fed’s decision to leave rates unchanged. What was interesting in the decision was the expectations of the various governors. Called the “dot plots”, it indicates where each one thinks economic growth, inflation, and interest rates will be over the coming quarters. Unemployment is expected to be unchanged, inflation a bit lower and interest rates lower by roughly one-half of a percentage point. Just reading through the commentary, it indicates the Fed is still leaning toward keeping rates higher for longer and they still see good economic growth with aboveaverage inflation. The markets read the dots and Powell’s comments very differently and bond yields fell dramatically on the week.

Bond investors were very encouraged by the inflation data and yields fell on the week. Bond yields continue to be very volatile. The 20-year yields have moved from 4.2% at last Christmas to nearly 4.9% by early May and now below 4.5%. The weekly moves have averaged ten basis points in both directions since late December. This contrasts with the average weekly in the two years leading up to the beginning of Covid of merely five basis points. The coming weeks will have plenty of “Fedspeak” to discuss views of the economy and the direction of interest rates. They are expected to restate their desire to see more data before being more interested in cutting rates.

There are now three companies with a market capitalization of 3 trillion, each now as large as the entire small-cap index. Valuations have been a concern for some time as the SP500 now trades in the 88th percentile of historical valuations. This contrasts with small stocks, trading around the 20th percentile of historical valuations. At some point they will converge, but after 10 years of very different performance profiles, that “certainty” is getting questioned. Why diversify if the SP500 just beats everything? The same philosophy was in play during the late 1990s, ahead of the SP500 becoming one of the worst asset classes to invest in, while small stocks, REITS, and international all had their years in the sun. Valuations do provide a good indication of future returns, however are very poor at timing those shifts between asset classes.

Fed speakers will dominate the “economic” calendar over the next few weeks as many of the important data points have been reported for the month. Retail sales should help determine the persistence of the consumer to keep spending.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.