July 15, 2024

Both domestic and international markets provided positive returns in the second quarter, building on the strong first quarter performance.  There were early signs of a broadening market environment domestically earlier in the year, but that didn’t last – the market actually narrowed back towards extreme levels this quarter, driving the market to all-time highs.  Economic growth appears to be moderating and inflation metrics indicate inflation may be slowing. The Fed remains vigilant and expectations are for a potential rate cut in September, but any change in monetary policy will remain data dependent – specifically inflation and employment levels. Internationally, geopolitical concerns remain with conflicts in Ukraine, the Middle East and continued saber rattling between China and the U.S. Internationally inflation has moved lower broadly which may give Central Banks globally flexibility to ease rates.

The narrowness of the market’s advance remains the story as gains were again fueled primarily by a handful of domestic mega-cap technology+ stocks riding the initial wave of artificial intelligence (AI) spending.  Other than M&C’s Global Tactical Allocation Model’s allocation to large cap growth (largest contributor to performance), most asset classes struggled during the quarter.  Continued outperformance by such a narrow group while more cyclical allocations, and small caps (largest detractor to performance) in particular, continue to lag is a sign that investors believe we are late in the economic cycle.  However, we are projecting a convergence of earnings growth between large US secular growth stocks and the rest of the market in the second half of the year.  We are also anticipating at least one, and possibly two, 25 basis point rate cuts by the Federal Reserve (“Fed”) before the end of the year.  If these indeed materialize, and we achieve a “soft landing,” we would expect the market’s performance to broaden out and the strategy’s diversification to drive strong absolute and relative returns.

While we’ve been positioned for broader asset class participation, we took additional steps during the quarter to increase our equity exposure.  We reduced the duration in the fixed income allocation after rates moved to the low end of their recent trading range by trimming our long bond allocation.    We used part of the proceeds from the fixed income sale to add to our developed international equity allocation.  We are expecting a strong rebound in earnings this calendar year, in line with domestic earnings growth, but with a more compelling absolute and relative valuation profile.  The balance of the fixed income proceeds were used to increase our position in the S&P 500 equal weight allocation.  As mentioned above, we are expecting a divergence in earnings growth during the second half which should disproportionately benefit the “average” stock in the S&P 500.  Similar to developed international, the equal weight index trades at a compelling valuation discount to its cap weighted counterpart.  In addition, we trimmed our position in health care, which is more defensive, and used those proceeds to increase the allocation to large cap growth, which still has a very visible and strong earnings growth profile.  If we are indeed embarking on a global easing cycle, defensive issues may be relatively challenged – and in an election year, pressures to reduce health care costs/drug prices and increased regulatory scrutiny in general may be a headwind for health care stocks.

In the U.S., the economy continues to grow, but we have seen some signs of moderation. We believe this reflects the lagged effects of the Fed’s tightening, although we are still expecting growth in both the economy and corporate profits in 2024. Developed international markets continue to experience strong growth and, by comparison to domestic markets, have attractive valuations. Central banks have the flexibility if needed as well to reduce rates. We are comfortable with the positioning and balance within the portfolio and believe this will serve clients well as we move into the second half of the year.