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A Quarterly Review of Investment Trends and Strategy From Our Investment Committee

Quarter 2, 2024

Join Bob Brown, CFP® and John Burke, two of Stone House’s Managing Partners, as they discuss major market happenings heading into the third quarter of 2024, including inflation, Consumer Price Index (CPI), the upcoming election, stocks & bonds, and GDP. They also offer perspective on international markets and valuation metrics for the S&P500. 

   

*Filmed on June 20, 2024 

Inflation

Inflation and interest rates remain at the top of mind as we reflect on the second quarter and look forward to the upcoming summer.  Inflation has come down significantly, although it remains elevated compared to the Federal Reserve’s 2% target. Prices for most goods and nearly all services continue to strain middle-class budgets. However, there are positive signs of receding inflation, which bodes well for economic stability.  Despite the challenges posed by inflation and other uncertainties, the stock market has shown resilience. The strength of the U.S. economy and corporate earnings growth have contributed to robust large company stock performance for the quarter and year to dateFor the quarter, the S&P500 gained about 4.5% while smaller US stocks declined by about 3%Stocks outside of the US made little progress as the US economy continued to lead the way.  Bonds stabilized during the quarter and finished nearly flat after a weak start to the year. 

Consumer Price Index (CPI)

As of June, the Consumer Price Index was 3.3% year over year which was 0.1% less than anticipated. Notably, the energy index fell by 2% in May, primarily due to a 3.6% decrease in the gasoline index. However, the index for shelter rose by 0.4% for the fourth consecutive month. Overall, inflation remains persistently above the Federal Reserve’s 2% target, and the debate remains on whether we will see any rate cuts in 2024During the Fed’s June meeting announcement, they lowered their forecast to just one 0.25% decrease this calendar yearThe good news is that inflation is falling and many of the components of CPI are well below the 2% target. 

Election Year

After a strong start to the year, it would be natural for an investor to wonder if the strength can continueWhile pull backs happen every year in the market, it’s interesting that during an election year, if we get off to a strong start, it’s likely it will continueIf we review the following chart, we’re amid the fourth strongest start to a year during a presidential election yearOnly one of those years that were positive through the end of May saw the next seven months be negativeWe can’t of course predict the future, but in the past, strength normally continues in situations like this. 

Valuation Metrics

One of the many challenges we have as investors is which types of stocks to purchase and in which of the global marketsThis selection process is aimed to balance risk and returnIn terms of geography, the United States has led the way for many years and in terms of style, growth stocks have led the wayEven after a strong run, we continue to lean on those areas with current portfolio positioningThat said, we are watching valuation metrics for the S&P500A straightforward way to look at valuation is through the price to earnings ratioThis is a multiple that an investor is willing to pay for a dollar of earningsHistorically, this has been in the 15-18 rangeWith the solid performance of US stocks, especially large tech companies, this has risen to around twenty-one times next year’s earnings.  What we find is that on a one year forward basis, valuation being higher than normal hasn’t been a good predictor of future returnsWe have had many years with high valuation still resulting in investor returns above 10%But since 2000, we find that fiveyear forward returns become challenged as valuation rises to around these levelsThis makes sense over the longer horizon as we consider buying companies at cheaper valuations offers better upside than buying them when they are already expensive. 

Stocks & Bonds

In addition to valuation, another recent challenge is the correlation of stocks to bondsDuring much of the period from 2000-2020, bonds had a negative correlation to stocksThis means that for most days, if stocks dropped, bonds rose and vice versaThis helped provide nice diversification and a smoother ride for investorsBut, as of May 2024, they are trading at their highest correlation since 1926.  We are managing this correlation by being selective on the types of bonds we own as well as managing the target duration, or length, of those bonds.  That said, bond yields are much higher today allowing increased income and a buffer to reduce losses if interest rates rise marginally in the future. 

Presidential Election

We’ve been hearing client concerns about the 2024 presidential election and the possible impact on the market. We believe this election is unique in that the market advanced nicely under both candidates. But it’s likely that we’d own different sectors of the market pending who is elected. Despite election fears, the stock market has performance well under Democrat or Republican leadership over the past ten-year and seventy-year periods. It’s important to note that the time under either leadership isn’t balanced but, the point remains the same; staying invested is the key to long-term returns. 

GDP

An emerging challenge that we discussed last quarter was the current debt level of our countryAs mentioned, we’re running about a 25% borrowing levelAnother way to look at spending is reviewing spending to total GDPThis ratio is running at war time levels and isn’t sustainable going forwardSpending is currently around the same level, in % of GDP, as during the Great Financial Crisis of 2008This is important for us to consider not only for future generations, but also for the direction of interest rates.  Bonds have not only been challenged by higher inflation but also higher rates due to the large supplies of US Treasuries coming to auction. 

So, with that backdrop, how do we look to investBy leveraging areas in the future that present opportunityOne example of this is in the small and medium-sized company areaIf we use small capitalization (cap) as an example, those stocks are trading at a forward P/E at a two standard deviation level less than averageThis takes them all the way back to 2000 to find a similar periodDuring the subsequent 2000-2003 period, small companies outperformed large by about 40%. 

International Markets

We are seeing similar valuation differences in some international markets.  International stocks have lagged their US counterparts for many yearsIn doing this, their valuations have become relatively cheap and dividend income is about twice that of the S&P500.  Part of this valuation difference is the concentration of US tech companies in our indexThere just hasn’t been as much innovation for publicly traded companies outside of the US that we’ve seen hereCompanies like Nvidia, Microsoft, Apple and Broadcom have rallied tremendously with the advent of Artificial Intelligence (AI). 

Stone House Recap

In terms of our portfolio changes and positioning, we’ve continued to run stock concentration slightly above our long-term targets.  For example, our moderate risk portfolio on Diversidex® contains about 64% stock and 36% bond while that option with our Flex portfolio is running about 68% stock and 32% bond.  We ended the quarter with the active option called “Flex” in a money market.  We triggered to raise cash near quarter end after the sizeable advance the S&P500 had in the May-June period.  We are also seeing increased risk in the market due to the concentration of those large tech companies as previously mentioned such as Nvdia, Microsoft, Meta, etc. 

We did slightly increase our average bond duration to about six years as we believe we’re at the top of the Fed interest rate cycle and eventually will see the long-awaited rate cuts as we finish 2023.  Within our Essential portfolio, we now hold about 25% small and medium-sized stocks as well as about 30% in international markets.  That contrasts to Diversidex® at about 15% small/medium and around 20% outside of the USA. 

It seems likely that we’ll see some volatility as we go through the remainder of summer and into the fall after such a strong start to the year, but as mentioned, strength in the beginning of the year has historically led to higher returns the remainder of the year. 

We wish you a wonderful and relaxing summer.  If you have any questions or would like to talk further, please contact your advisor. 

Have you tuned in to our weekly video podcast, Blue Collar Wealth Presented by Stone House®?

Previous Video Market Updates

*These videos reflect the trends and worldly events taking place at the time of filming.*

Quarter 2, 2024

Quarter 1, 2024

Quarter 4, 2023

Quarter 3, 2023

Quarter 2, 2023

Quarter 4, 2022

Quarter 3, 2022

Quarter 2, 2022

Quarter 1, 2022

Quarter 4, 2021

Quarter 3, 2021

Meet the Stone House Team

Decades of combined experience in helping people enjoy retirement and reach financial freedom.

Robert Brown

Robert J. Brown, CFP®

Partner

Raymond "Scott" Stone

Raymond "Scott" Stone

Partner

John Burke

John Burke

Partner

Kirk Lunger

Kirk Lunger

Partner

Christine Slusark

Christine Slusark

Financial Paraplanner

Sherri Roberts

Sherri Roberts

Financial Paraplanner

Barbara Grimaud, Esq.

Barbara Grimaud, Esq.

Senior Advisor

Chad Taake

Chad Taake

Senior Advisor

Ben Robinson

Ben Robinson

Lead Advisor

Ryan Vassil, WMS℠

Ryan Vassil, WMS℠

Lead Advisor

Mike Cravath, WMS℠

Mike Cravath, WMS℠

Lead Advisor

Leanne Kulah

Leanne Kulah

Senior Client Service Specialist

Larry Alderson, CFP®

Larry Alderson, CFP®

Senior Advisor

Jennifer Schultz

Jennifer Schultz

Client Relationship Manager

Lori Brown

Lori Brown

Client Relationship Manager

Katie Johnston

Katie Johnston

Lead Advisor

Stacey Valent

Stacey Valent

Office Manager

Lindsey Chiarelli

Lindsey Chiarelli

Director of Marketing & Operations

Anna Layaou

Anna Layaou

Marketing Content Manage

Have you tuned in to our weekly video podcast, Blue Collar Wealth Presented by Stone House®?