This writeup is being completed after market close on 8/5/24, after 3 consecutive days of stock market pullback to start August. The first part of the writeup will focus on a review and analysis of market activity through Wednesday, July 31, but the last couple pages will include comments on the early August pullback.
Asset class recap for July
Overall, July was a good month for stocks. With the +1.2% return for the S&P 500 index in July, eight of the last nine months have posted positive total returns. Bonds also did well, as interest rates dropped a bit during July. Among the twelve high level asset classes we track in the table below, only large growth had a negative return during July, which can easily be forgiven as large growth still has a 26.9% total return for the last one-year period.
The S&P 500 hit its all-time closing high of 5,667.20 on 7/16/24. The corporations that led the way and had the largest price increases through July 16 were primarily involved in the artificial intelligence field. That all started changing on July 17, when former President Trump commented in a speech that Taiwan should pay the U.S. for defense. As many computer chip makers are headquartered in Taiwan and make many of their computer chips in Taiwan, investors took this statement to imply that if Trump wins the upcoming election, we may see tariffs or other taxes levied on non-U.S. chip makers. With that speech, prices for technology related firms started a slide that has lasted a couple weeks, spurred on by multiple additional factors, including disappointing earnings for Alphabet and Tesla on July 24.
The pullback in stock prices in the last half of July was much more focused in growth stocks than it was in value or small cap stocks. While we hate to see broad markets come off their all-time highs, this pullback has many hallmarks of routine profit-taking in very highly appreciated stocks, not a pullback that can throw a whole year of returns off course. Diversification is being rewarded with lower drawdowns and volatility.
All of the bond asset classes we track below had positive returns in July. Many investors expect the Fed to lower interest rates at their September meeting, which would provide a boost for bond prices. Bond prices also rose as some investors shifted assets from stocks to bond to get defensive.
Looking Forward
During mid-July, we made a slight shift from value to growth stocks to increase our existing value overweight in many portfolios. In mid-July, Price-to-Earnings ratios reached 18 for large value stocks and 43 for large growth stocks – a 25-point differential between growth and value that was a very large number vs historical averages. That growth / value ratio differential was reduced by a couple points as growth stocks gave up some price during the last few weeks. The TTM P/E ratio for Vanguard Growth Index Fund ETF (ticker: VUG) is now down to a slightly less lofty 41. We expect to hold our heightened Value overweight until the P/E differential between growth and value shrinks to be at least below 20.
During mid-July, we made a slight shift away from international stocks and into large cap and small cap U.S. stocks. There has been a lot of discussion among politicians about adding tariffs, taxes, or other financial and non-financial burdens to non-U.S. corporations. If they come to pass, these sorts of changes will be detrimental to non-U.S. stock returns.
Among bonds, we are continuing to maintain our duration underweight. The yield curve is starting to steepen, making longer term bond yields more attractive, but we feel that long bonds are not yet worth the duration risk that comes with owning them. When the Fed starts to lower their overnight lending rate in the near future, we expect our short term bonds to appreciate in price as their fixed coupons are more attractive than lower yielding new issues with similar maturity dates.
Addendum for July / August 2024 Volatility
Our Advyzon Investment Management investment team has fielded a few calls from advisors looking for advice about what to tell clients about the recent stock market volatility. While we want clients to focus on the long run, many of them understandably take note of a high-water mark like the S&P 500’s exciting all-time high closing level of 5,667.20 on 7/16/24, and base their financial happiness on the market’s price change since that day. Since 7/16/24, the S&P 500 index has pulled back 8.5% in price. In the right column, the table below shows the running drawdown in the S&P 500 that started after the 7/16/24 high. I track market events for any day with a return outside -1.0% to +1.0% and list them in the Notes column in the table below.
The pullback has hit growth sectors much more strongly than value sectors. Year-to-date returns for all sectors except Consumer Discretionary are positive year-to-date. The S&P 500 is still up 9.6% year-to-date through 8/5/24.
We offer a few takeaway viewpoints that can help investors understand and digest recent market events.
1.Some economists have interpreted some recent soft economic readings and the recent stock market pullback as predicting an impending economic U.S. recession. Many of these market experts are the same ones that predicted a recession in the first half of 2023 (which never materialized). We want to remind investors that the economy and stock market prices are two different things. The market’s pullback looks to be more caused by disappointing earnings for a few overpriced tech stocks, and not caused by wide expectations for lower earnings for a majority of U.S. stocks (due to a recession).
2.Even after the recent pullback, technology stocks still look overvalued to us. Price-to-Earnings ratios are still at 41 for broad technology funds and indexes – levels where there is a significant chance that there could be many more overpriced technology stocks that could drop further in price when their revenues and earnings come in lower than hoped for. Monetizing A.I. developments will be difficult.
3.In the event that the economy stumbles during the next few quarters, the U.S. Federal Reserve is in great shape to cut interest rates and stimulate the economy because they raised rates in 2022. A couple years ago, when rates were near zero, this was not the case. This backstop help gives us confidence that this current drawdown will be short lived and that investors should stay the course with their investment plan and stay invested.
Important Disclosures
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