In the first half of 2024, the S&P 500 Index posted a robust result, uniquely and disproportionately derived from just a single business. For the same period, the equally weighted S&P 500 Index returned 5.1%, the Dow returned 4.8%, and the Russell 2000 Index returned 1.7%.
Through June 30th, the year-to-date return for the S&P 500 Index was 15.3%. Almost half of that gain came from Nvidia’s return of 150% for those six months. The rest of the Index, the “S&P 499,” returned about 8.4% for the same period. NVDA was running, and animal spirits and the herd were running with it.
The Interest Rate Cut Rally Without a Cut?
The most surprising thing to date this year has been the presumptive catalyst for the market’s rally failed to materialize, and nobody noticed. The catalyst was the forecast for interest rate cuts, which came from the Fed last November. Since then, with inflation staying sticky, there has not been a cut, and the prospects for a future cut wax and wane with each emerging bit of economic news. Nonetheless, the market has increased by about 30% since the “Fed Rally” started, while earnings expectations have not materially increased.
Concentration
Add to this the continuing factor of concentration in the S&P 500 Index. Approximately 40% of index capitalization lies in just thirteen companies, which is an unprecedented concentration level. This handful of companies trades at a large valuation premium to the rest of the Index.
Strategy
So, what does a thoughtful, rational, long-term investor do in this environment of expensive concentration?
Here is our short checklist:
Part I: Equities
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- Focus on investing in high-quality companies at reasonable prices. Premium valuations are likely to be a meaningful risk factor. Valuation discipline will matter.
- Maintain diversification, even when it falls out of fashion in a concentrated rally.
- Be wary of expanding multiples without expanding earnings.
- Stay focused on strategy and your goals, even when tactics distract. This includes an intense emphasis on fundamentals and business values.
Part II: Fixed Income
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- Due to a blend of issues, including deglobalization, labor participation, and the scale of our national debt, we anticipate that inflation will persist. This will put continued pressure on interest rates and stress the bond market. We are emphatic about managing risks for duration and credit. Keep maturities short and be discriminating about credit.
- The interest rate cycle from 1982 to 2021 lasted so long that we forgot it was a cycle and came to think of declining inflation and declining interest rates as the normal state of affairs. Beware the Ides of Complacency.
Rational Investor
Mid-year is the right time to pause and think critically. It is unrealistic to think we have another 30% rally without earnings growth ahead of us. The roster of distractions seems uniquely complicated. With the presidential election, the concerns attendant with a slow growth economy, and the multiple geo-political hazards, there seems to be no shortage of potential headwinds. We are not feeling overwhelmed by the challenge, rather find it to be curious that valuations keep expanding in their midst. It just may be that risk management turns out to be a meaningful discipline for the balance of the year.