Your Money, Your Update
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 date. For 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 2024. During the Fed’s June meeting announcement, they lowered their forecast to just one 0.25% decrease this calendar year. The 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 continue. While 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 continue. If we review the following chart, we’re amid the fourth strongest start to a year during a presidential election year. Only one of those years that were positive through the end of May saw the next seven months be negative. We 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 markets. This selection process is aimed to balance risk and return. In terms of geography, the United States has led the way for many years and in terms of style, growth stocks have led the way. Even after a strong run, we continue to lean on those areas with current portfolio positioning. That said, we are watching valuation metrics for the S&P500. A straightforward way to look at valuation is through the price to earnings ratio. This is a multiple that an investor is willing to pay for a dollar of earnings. Historically, this has been in the 15-18 range. With 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 returns. We have had many years with high valuation still resulting in investor returns above 10%. But since 2000, we find that five–year forward returns become challenged as valuation rises to around these levels. This 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 bonds. During much of the period from 2000-2020, bonds had a negative correlation to stocks. This means that for most days, if stocks dropped, bonds rose and vice versa. This helped provide nice diversification and a smoother ride for investors. But, 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 country. As mentioned, we’re running about a 25% borrowing level. Another way to look at spending is reviewing spending to total GDP. This ratio is running at war time levels and isn’t sustainable going forward. Spending is currently around the same level, in % of GDP, as during the Great Financial Crisis of 2008. This 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 invest? By leveraging areas in the future that present opportunity. One example of this is in the small and medium-sized company area. If 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 average. This takes them all the way back to 2000 to find a similar period. During 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 years. In 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 index. There just hasn’t been as much innovation for publicly traded companies outside of the US that we’ve seen here. Companies 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.
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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 J. Brown, CFP®
Partner
Raymond "Scott" Stone
Partner
John Burke
Partner
Kirk Lunger
Partner
Christine Slusark
Financial Paraplanner
Sherri Roberts
Financial Paraplanner
Barbara Grimaud, Esq.
Senior Advisor
Chad Taake
Senior Advisor
Ben Robinson
Lead Advisor
Ryan Vassil, WMS℠
Lead Advisor
Mike Cravath, WMS℠
Lead Advisor
Leanne Kulah
Senior Client Service Specialist
Larry Alderson, CFP®
Senior Advisor
Jennifer Schultz
Client Relationship Manager
Lori Brown
Client Relationship Manager
Katie Johnston
Lead Advisor
Stacey Valent
Office Manager
Lindsey Chiarelli
Director of Marketing & Operations
Anna Layaou
Marketing Content Manage