Q2 2024 Market Perspective

Throughout the last three years, the financial markets have almost exclusively been focused on the interplay between inflation and the interest rate policy set by the Federal Reserve (Fed). While the future direction of interest rate policy will continue to influence market results during the second half of this year, for the first time in many months, it seems like investors have diverted attention elsewhere (for the time being).
The S&P 500 index has appreciated more than 15% thus far in 2024, however, investors are closely monitoring the concentration of performance amongst a few select companies. The S&P 500 index is thought to be one of the best measures of the U.S. stock market, however, as a market value-weighted index it is disproportionately influenced by the performance of its largest stocks. Many of these outperforming stocks are within the Information Technology sector, which has benefited from significant investments in artificial intelligence. Meanwhile, there has been a tremendous amount of volatility amongst the other members, with more than 80% of the S&P 500’s stocks underperforming the index this year. We actively monitor this volatility under the surface and continually look for rebalancing and tax-motivated trading opportunities that may arise.
Meanwhile, the presidential debate held in late June has served as a market catalyst in terms of investor positioning across various asset classes. We expect media coverage to intensify over the next four months and such uncertainty could lead to near-term market volatility. We reassert, however, that election years have generally been positive for equity returns when looking at historical S&P 500 data.
Most importantly, it is widely believed that the U.S. economy is trending towards a soft economic landing. Economic data over the next few months will determine whether the Fed will begin cutting interest rates before the end of the year. Inflation is trending lower, while the labor market has cooled slowly, and should this scenario continue we anticipate that the Fed will shift its focus towards easing financial conditions.
As economic and market conditions evolve, we reiterate that Altium’s main objective is to focus on factors within our control. Our investment committee remains thoughtful as to how these evolving factors may impact asset allocation decisions across client portfolios. Additionally, our trading team is actively rebalancing portfolios to their desired allocation targets as investments drift with the markets, while maintaining a high sensitivity towards tax management. With current market conditions leaving many investors complacent, Altium is well positioned to capitalize on portfolio rebalancing opportunities.

* Index Return [1] Source: Q2 2024 Total Return as of 06/28/2024, Bloomberg

• The second quarter began with increased market volatility, due to a combination of stronger economic data (inflation, jobs and growth) and hawkish Fed commentary. Yet after a sharp selloff in April, the S&P 500 index rallied nearly 10% on the heels of declining inflation and positive earnings growth, ending the quarter up 4.3%.[1]
• U.S. stock market appreciation was mostly attributed to gains in a few mega-cap stocks during the quarter, driven by the growth in spending on artificial intelligence (the top 5 performing stocks have added nearly 9%, or more than half of the yearly gains for the index).[2] Mid and small-cap stocks significantly underperformed during the quarter. Higher interest rates result in higher borrowing costs, impacting smaller-cap companies that are more dependent on borrowing to fund their growth.
• Yields in most fixed income classes are near decades-highs. While year-to-date returns for the major bond indexes are down slightly for the year, the combination of high yields and expectations of the Fed cutting interest rates offers a good entry point to increase exposure to fixed income assets.

SECOND HALF 2024 HEADLINE CONSIDERATIONS

Economy and the Fed: In January, we wrote about the various scenarios pertaining to economic growth, labor, and inflation outcomes the Fed could encounter and their most likely policy decision under each outcome. Early in the year, the markets mostly anticipated a soft economic landing, where inflation is successfully reduced to the Fed’s target rate, without causing a drastic rise in unemployment and without GDP growth turning negative. However, due to an uptick in inflation in late Q1, concerns mounted that economic growth would pick up and re-ignite inflation. From where we sit today, in early July, the optimism for a soft landing has returned. This outcome should create a positive environment for stocks and bonds.
As the Fed has continually indicated, the path of inflation and employment will largely determine the Fed’s decision on interest rates. Currently, the market anticipates inflation will return to the Fed’s preferred target level of 2% by September, and therefore expectations are for the Fed to cut interest rates by 0.50% before year-end. The Fed’s preferred gauge on inflation, the Core Personal Consumption Expenditures Price Index (PCE), grew at a 2.6% year-over-year rate in May, down from 4.7% a year ago and 2.9% in January. Meanwhile, the unemployment rate has risen above 4% for the first time in over 2 years, indicating a cooling but otherwise strong labor market.[3]

Election Positioning: Although historical data tells us that equity returns have been mostly positive during election years, not all market sectors and asset classes are treated equally when investors position their investments based on who they believe will win the election. One development we noted following the presidential debate in late June, was a flattening of the fixed income yield curve driven by an increase in longer-term interest rates. While we do not expect election positioning to drastically impact the markets, we should expect more market volatility leading up to the election as coverage intensifies.

Geopolitical Risks: The current conflicts and political unrest in countries outside of the U.S. have largely been non-influential on U.S. markets. However, many of these situations should be closely monitored for potential wide-ranging global market implications. Further, the resources and capital required to defend American interests are likely to remain a contributor to the U.S. budget deficit.

Fiscal Budget Deficit: The U.S. is nearly $35 trillion in debt and despite having strong employment and record tax receipts the annual deficit remains over $1 trillion. The debt service, or interest due on this debt, is substantial with annual payments set this year to reach approximately $890 Billion and grow to over $1 trillion in 2025. As a point of reference, $1 trillion is equal to the annual amount budgeted for Medicare. For the most part, this is viewed by investors as a situation that can be pushed out as long as the U.S. can safely afford to continue borrowing.[4]

Market Concentration & Stock Price Valuations: The S&P 500 index is currently trading at a forward earnings multiple of roughly 22.5x, which is higher than its 10-year average of roughly 19.4x. The drastic outperformance of the top six companies in the index has resulted in these companies now accounting for roughly 30% of the aggregate market cap. The S&P 500 index appreciated roughly 15% in the first half, yet when you equally weight all the stocks within the index, for comparison, appreciation would have been reduced to roughly 8.15% in the first half. While earnings growth north of 30% may continue to support the valuation of these mega-cap stocks in the near term, we continue to recommend investing with a disciplined approach, such as maintaining portfolio diversification amongst asset classes and trimming individual stock positions that become too concentrated.[5]

PORTFOLIO REBALANCING

The market movements during the first half of the year have presented portfolio rebalancing opportunities at both the asset allocation as well as the individual stock level. Maintaining balanced levels of risk in an investment portfolio is paramount to a successful plan. Adhering to the guidelines set forth in a client’s investment policy statement (or target asset allocation strategy) is a core tenet to Altium’s investment philosophy.
With equity indexes continuing to appreciate throughout the year, it is easy for portfolios invested with a balanced mix of stock and fixed income assets to drift towards an overweight stock allocation. We believe these portfolios should be continuously analyzed for opportunities to rebalance the investments back towards the desired target levels. This should be carefully executed for tax-efficiency, and with an awareness of each clients’ sensitivity to capital gains taxes relative to the risk reduction accomplished by each proposed trade. Furthermore, with some asset classes appreciating at a greater pace than others, we remain mindful of concentration risk within various segments of the market, including individual stocks.
As a point of reference, while the S&P 500 index has only had a maximum drawdown of 5% in the first half of the year, the average individual stock within the index has experienced a decline of roughly 15% at some point during the year. We remain well positioned to take advantage of this underlying volatility within the indexes.[6]

INVESTMENT COMMITTEE (IC) UPDATES

Altium’s IC for the most part operates behind the scenes, ensuring that evolving economic and market conditions are considered when designing asset allocation targets for our clients. However, we believe it is important to highlight a few recent decisions made by the IC during the first half of the year, specifically related to preferred equity, private real estate, and fixed income investments.
Preferred equities are often considered to be a hybrid security, having attributes of both common stocks and bonds, offering capital appreciation as well as high income potential. Earlier this year, the IC arrived at the determination that the absolute yields offered by preferred equities no longer present an attractive risk/return profile when compared to the more stable returns offered by government and corporate fixed income assets. Where appropriate we looked to reallocate assets away from these investments.
For a few years now, where suitable, we have allocated investments into private real estate. While this has been a good investment, we feel the risk/reward trade-off no longer
supports recommending the investment. When we first added the allocation, the fundamentals of the private real estate space were very attractive, especially when comparing income yields to more traditional fixed income assets. Recently though, the space has drawn some negative headlines as investors scrutinize possible risks rising from persistent post-Covid trends. Additionally, yield spreads above government and high-quality bonds are down significantly.
Many investors are either sitting on cash or in money market funds while they wait to see when the Fed will begin to cut interest rates. It is difficult to time the market, and fixed income markets will generally move based on economic data before the Fed makes any formal announcement regarding a change in rates. Yields on most fixed income asset classes are near decade-highs, and historically, bonds have performed well following the end of a Fed rate hike cycle. Strong performance after a peak in interest rates can last for several years and we believe this is a good entry point to either add exposure or increase the portfolio duration of fixed income assets. We appreciate that performance in fixed income has lagged expectations, due to the uncertainty around interest rates, however, a diversified bond portfolio can prove resilient across a range of possible rate outcomes.

SUMMARY

With equity indices currently at or near all-time highs, fixed income yields at decade-high levels, and while we are in the seasonally slow summer months for market activity, investors seem to have shifted their focus away from the Federal Reserve and the path of interest rates. While we believe this diversion of attention is only temporary (possibly until the November election draws closer), we reiterate that economic data during the third quarter will play a significant role in market volatility between now and the end of the year. The Fed is keeping a close eye on its dual mandate to maintain price stability and promote maximum employment. Currently, the economy appears to be on track to achieve a soft landing and this scenario should create a positive environment for the stock and bond markets. That said, the data can shift at any moment, and it is certainly too early to declare victory for the Fed.
Importantly, we emphasize that while there appears to be some complacency in the market, we see current opportunities to actively rebalance portfolios and update our investment committee’s best thinking. As always, should you have any questions or updates to your plan, please reach out to your team. We look forward to hearing from you.

APPENDIX

Chart A: 2024 Total Return of Major Asset Class Indexes

Source: Bloomberg; 2024 Total Return, MSCI EAFE, MSCI Emerging market, S&P 500, Barclays Agg & Barclays Muni index; 06/28/24

1 – Source: Bloomberg: S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index 2 – https://www.visualcapitalist.com/the-stocks-driving-sp-500-returns-in-2024/
3 – https://tradingeconomics.com/united-states/core-pce-price-index-annual-change; https://tradingeconomics.com/united-states/unemployment-rate
4 – Source: https://www.cbsnews.com/news/federal-debt-interest-payments-defense-medicare-children/
5 – Source: Bloomberg S&P 500 Total Return earnings multiples
6 – Source: Charles Schwab; https://www.schwabassetmanagement.com/story/hard-to-concentrate-top-heavy-market?segment=advisor&mkt_tok=MTUzLUhSWS0xOTQAAAGT652LCo9zWNrjinfkB1Ihm6dpTZGIrGpX1YWlkdhl5rrfAa-ChkXObbYE0qJ97-7I-0im4RJNJqlYe50OPIO2f5eE_gZPXILmIBZAJ3yfQAKCdQ

IMPORTANT DISCLOSURE

Altium is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Registration as an investment adviser does not imply a certain level of skill or training. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Altium and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Altium and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates. This material was not intended or written to be used or presented to any entity as tax or legal advice. Clients are urged to consult their tax and/or legal advisor for related questions.