Monthly CIO Update | July 2024

MARKET WRAP

US equities continued their positive streak in June as the S&P500 (+3.5%) and Nasdaq (+6.0%) reached record highs while logging their fifth gain in the first six months of the year. However, gains were increasingly concentrated and on an equal-weighted basis, the S&P500 was down (-0.7%), marking the widest gap in market cap vs. equal weighted performance in over a year. With only 20% of S&P500 stocks outperforming in June, we saw the lowest performance breadth in over three decades. The Magnificent 7 Stocks (NVDA, TSLA, AAPL, AMZN, META, MSFT, GOOGL) now represent 34% of the S&P500 and accounted for 70% of the index returns in June.

Only 5 of the 11 sectors posted positive performance, led by Technology (+7.8%) and Consumer Discretionary (+3.9%) with Utilities (-5.5%) dropping from the top spot in May to the bottom in June. Real Estate remains the worst-performing sector YTD (-2.49% YTD).

US Treasury yields declined across the curve last month, apart from the 3-month T-Bill. The 5Y note fell to 4.33% and saw the steepest decline for the second month in a row (-19 bps). Concerns about Treasury supply were somewhat offset by strong auctions this month; however, longer-term fiscal pressure remains a key overhang to Treasuries.

US economic data has continued to soften at the edges and the June employment report showed signs of a cooling labor market. While 206,000 jobs were added in June, prior prints were revised downward by 111,000 and the unemployment rate increased to 4.1%, the highest level since Q4 2021. Core CPI increased +0.2% m/m in May, falling below consensus for the first time this year and Core PCE (the Fed's preferred metric) reached its lowest level since early 2021 (+2.6%).

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INVESTMENT OUTLOOK

MACRO: A loosening labor market combined with further progress on inflation have increased the odds of a September rate cut, with the market now pricing in a 61% chance vs. 46% at the start of the month. However, the Fed’s insistence that the next interest rate move will be a cut is driving an easing in financial conditions. This has provided a tailwind to markets, which we believe reflexively makes it more difficult to cut and potentially pushes out the timing of the first cut beyond September.

FIXED INCOME: This higher for longer interest rate environment is good for fixed income as resilient earnings have kept default rates and spreads contained. Tactically, this has removed the need to reach for higher yields by overextending into longer-maturity or higher-risk securities. We believe the medium-term outlook for fixed income remains attractive, particularly when coupled with the opportunity for modest price appreciation driven by the eventual decline in rates.

US ELECTIONS: As we look ahead to November, we believe the 2024US elections could produce significant shifts in political leadership and the investment environment. Following the first presidential debate, prediction market probabilities have moved meaningfully in favor of former President Trump. However, we see the most impactful policy changes for markets as likely to materialize only if the winning presidential candidate can also drive party control of Congress in a red or blue wave scenario. Under a Republican sweep (red wave), we see weaker regulation/deregulation benefitting banks, health care providers and oil and gas companies, with aerospace/defense companies the primary recipients of spending increases. A Democratic sweep (blue wave) would likely see continued stimulus support from the Inflation Reduction Act (IRA) and CHIPS Act directly benefitting renewable energy companies and EV makers as well technology and manufacturing subsets. Second-order beneficiaries include homebuilders and industrials, with looser immigration policy driving lower wage inflation.

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CHART OF THE MONTH

Valuations for small cap vs. large cap companies have continued to bifurcate, with larger companies becoming much more expensive than smaller companies (see chart below, S&P500 P/E ratios ranked by market cap). Fed hikes and higher costs of capital have weighed on smaller companies while multiples have expanded for large and mega cap names behind the AI narrative.

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