The overall market performance remained strong in the second quarter, with the S&P 500 gaining 4.3%. That performance was largely driven by a relatively small number of individual stocks in the S&P 500. In fact, while the six companies with trillion-dollar valuations surged 16.8%, the other 494 companies declined 0.8%. As the valuations of those popular mega cap stocks reach nosebleed levels, we caution that momentum is a double-edged sword; the AI craze might be producing artificially high, and not so intelligent, stock prices.
Inflation expectations and interest rates remained front and center for most investors. Going into 2024, market participants expected six rate cuts in 2024, taking Fed Funds down to approximately 4%. During the second quarter, it became increasingly clear that the Fed plans on holding rates “higher for longer” and, at best, might cut twice by year end. This shift pressured valuations and delayed a recovery in interest rate sensitive companies and for the entire small cap universe – the Financial sector Index XLF (Financial Select Sector SPDR Fund) and Small Cap 600 declined 1.8% and 2.5%, respectively. The tight monetary policy and hawkish language persisted as the year-over-year inflation readings remained stuck at around 3.5%, although the May data showed a sharp drop with no increase from the previous month.
On another positive note, corporate earnings got off to a good start for the year with first-quarter earnings exceeding analysts’ expectations for the fifth consecutive quarter. Roughly 78.3% of S&P 500 companies reported earnings that beat expectations, as companies posted a 6% year-over-year increase, nearly double the consensus forecast from March 31.
The yield on the 10-Year Treasury inched up 13 basis points to 4.34%, with those high relative rates generating foreign investment and leading to the U.S. dollar ending the quarter trading at its highest price since November 2023.
Gold rose more than 4.0% in the second quarter and nearly 13.0% in 2024 to date as anticipated interest rate cuts by central banks supported trading precious metals. In addition, higher demand for gold by several Asian central banks that are reducing their dollar holdings, particularly the People’s Bank of China, helped lift the price of gold, which reached a record high of $2,450 per ounce in May. Crude oil prices were volatile due to the unrest in the Middle East but settled at $81.51 per barrel on the last business day of June, down slightly from the beginning of the quarter.
Home mortgage rates began the quarter at about 6.82% for the 30-year fixed rate, according to Freddie Mac. Rates jumped as high as 7.03% at the end of May, ultimately settling at 6.86% on June 27. Existing home sales remained very constrained, as homeowners that have locked in much lower mortgage rates are reluctant to move. With that lack of supply on the market, existing home prices continued to rise, contributing to the stickiness of the inflation data. “Shelter” costs represent approximately 35% of the CPI basket.
We remain optimistic about the health of the U.S. economy, with moderate inflation and slow& steady growth. We believe that the Fed will be rational and reduce rates in the back half of 2024, and that investors will act intelligently and broaden their holdings outside of the artificially high momentum stocks.
We appreciate your continued confidence in North Star. Please feel free to contact us with any questions.