by Jeremy Bryan, CFA
The first half of 2024 is now complete. The predominant investment theme of the year thus far has been the secular trend of artificial intelligence (AI), which has driven many of the largest companies in the S&P 500 to all-time highs.
From an economic perspective, 2024 has largely been characterized as resilient. Inflation has remained elevated, but consumers have continued to spend partly due to sustained job growth and wage gains. US Gross Domestic Product (GDP) grew in the first quarter and July 1 estimates from the Fed Reserve Bank of Atlanta reflect growth in the second quarter as well.
Consensus expectations of interest rate changes have varied throughout 2024, but the US Federal Reserve has kept the Fed Funds rate consistent throughout the year. Interest rates on US Treasuries are largely higher than at the end of 2023, and this trend has been a headwind to bond performance year to date.
In the stock market, companies considered to be AI beneficiaries have been a significant driver of performance for the S&P 500. Companies like Nvidia (NVDA), Microsoft (MSFT), Apple (AAPL), Amazon (AMZN), Alphabet (GOOG), and Meta Platforms (META) are generally expected to be at the forefront of AI deployment and are all positive performers year to date. As of June 28, these stocks are now the six largest companies in the S&P 500 and represent over 30% of the overall index.
As we look forward to the remainder of the year, we always look to the fundamentals of the economy, company earnings, and valuation as our guideposts.
The economy has been resilient but has shown evidence of slowing growth. Our expectations are that the unemployment rate will be higher than the current rate of 4% but will not reflect recessionary job conditions. We believe inflation is on the correct path toward normalization but may remain slightly elevated through 2024. As a result, we expect the Federal Reserve to enact either zero or potentially one cut in 2024.
Earnings for the S&P 500 are still expected to grow in the double digits for 2024 and grow again in 2025. If earnings grow at these levels, it is a tailwind for stock prices, but it isn’t a perfect correlation. On a yearly basis, stocks can grow as earnings decline, and vice versa, but over longer periods stock performance and earnings growth tend to flow in the same direction.
Stock valuations are elevated, which is a headwind for stocks. While we are not at all-time highs, valuations are above both 5- and 10-year averages. Valuation, in our opinion, is not a great signal for short-term price changes, but provides a better indicator of future long-term expectations. At the current elevated valuation levels, it is reasonable to expect stock returns in the next few years to be slightly below long-term averages.
Based on this information, we believe it is prudent to protect recent profits rather than chase greater returns with higher risk. It can be tempting, especially with a trend as large as AI, to want to extend risk by chasing what is working now. While rallies can always last longer than anticipated, and some assets should be held to take advantage of long-term growth trends, it is also important to remember that diversification works by spreading risk across different assets and lowering overall volatility, especially if current trends reverse.
As always, the proper mix of safety and growth is a personal decision and is based on a tailored plan that fits the goals, the risk, and the time horizon of the investor. In our opinion, setting an investment plan that considers each of these attributes, but is also nimble and flexible to opportunities, is still the best way to achieve the goals for your money.
