Q2 Market Update
Jeff Carbone:
Good afternoon, everyone. Thank you all for joining us today for the quarterly investment outlook and market update. I'm Jeff Carbone, Managing Partner of Cornerstone Wealth, and I'm joined by Cliff Hodge, our Partner and Chief Investment Officer. Cliff, it’s great to have you here as always.
Cliff Hodge:
Likewise, Jeff. It's great to see you and to be here.
Jeff Carbone:
As always, it's a pleasure for Cliff and me to provide you with an update on the current financial landscape, market trends, and key indicators. We'll go over all of that as we usually do. As we all know, the global economy continues to be dynamic, constantly in a state of flux and change. Whether it be geopolitical, electoral, or technological advances, we've seen a lot in the first six months of 2024. AI has certainly made things interesting. We'll discuss these implications on the market and broader economy and how to make informed investment decisions, which is always top of mind for us.
Our job is to provide you with confidence and clarity as Cornerstone Wealth is a cornerstone of your financial lives. We’re recording this session today, as we always do, and we'll post it to our website, Facebook, YouTube, and other platforms. This will allow you to share it via email with colleagues, family, and friends.
During the session, we'll be taking questions. If you have any, feel free to use the chat box at the bottom.
Market Overview:
In the past quarter, we've observed significant movement in the major indices. As we start the third quarter, today has not been a great day for the market, which is really moving. Cliff, today we're going to dive deeper into the key drivers of what we've been watching and what we see ahead. These include economic growth, inflation, interest rates, and the Fed meeting coming up in September, which may result in the first rate drop. We're also in the middle of earnings season, with several announcements coming out right now. Corporate earnings are top of mind this week and next, which are the busiest times for earnings in the quarter.
Geopolitical and Political Developments:
We've seen quite a few geopolitical and political developments, from the potential assassination attempt on President Trump to President Biden no longer running, and now it looks like Kamala Harris, the VP, will be taking the forefront for the Democratic party. We'll continue to watch these and many other developments.
Our goal today is to provide a comprehensive understanding of the current environment and conditions. We want to equip you with the education and insight to navigate and understand the complexities we're seeing out there. We'll also address the allocations and adjustments we've been making. We've been busy with our bond portfolios and are starting on our equity portfolios as we adjust for the next quarter and beyond.
Cliff Hodge:
Thanks, Jeff, for teeing everything up for us today. There's certainly been no shortage of headlines and market-moving events so far in 2024. As we turn the page to August and get ready for back-to-school season, the markets have largely taken things in stride, and overall, we're having a pretty nice year. For example, the Dow Jones Industrial Average is up 10%, the S&P 500, dominated by the "Mag 7" mega-cap growth tech stocks, is up 16%, and international markets are up 8%. Bonds have finally started working as well, with interest rates peaking and the Fed getting closer to starting the rate-cutting cycle.
We've seen rate moves happen in Canada, the Bank of England just announced rate cuts, and the European Central Bank as well. The market is currently pricing in the first cut in September, as you mentioned, Jeff. We think that makes a lot of sense. In response, we've seen bonds perform well. For example, the Bloomberg Barclays Aggregate Index, which is to the bond market what the S&P 500 is to the stock market, is now up almost 2% for the year.
However, there are some storm clouds on the horizon that have our attention. We'll walk through what those are, and as always, I have some slides to run through. Let's get started with three key takeaways. First, the macro data has come in strong for the first half of the year. Recent data releases, especially related to the labor market and leading economic indicators, are starting to show a slowdown. Inflation is trending lower towards the Fed's 2% target, with June showing a slight deflation for the first time since COVID. This gives the Fed more room to maneuver if the economy continues to slow.
From an investment perspective, stock markets don't look very attractive right now on a go-forward basis. Valuations are elevated, and earnings expectations are high, which doesn't align with the macroeconomic forecast of a slowdown. Investors have largely pushed their chips in, with a lot of euphoria surrounding AI, leading to increased volatility over the past couple of weeks. We're considering repositioning on the equity side, taking some chips off the table in favor of other asset classes like bonds and alternative investments.
One key data release to watch is the July employment report coming out tomorrow. The labor market is crucial for everything macro and market-related. We haven't even talked about the election yet, which is less than 100 days away. While elections cause short-term noise, long-term data shows they don't significantly impact market returns.
Looking at our dashboard, we see more yellow and red than green. We believe we are late in the cycle, with growth and inflation slowing. The Federal Reserve hasn't started easing yet. Fundamentals are still expensive on equities, and earnings expectations are high.
Reviewing GDP, consumer spending showed a nice rebound in the second quarter, with GDP growth at 2.8%, driven by consumer spending and inventory restocking. Inflation is trending down, peaking at over 9% post-COVID in 2022, and is now moving towards the Fed's 2% target. June's deflation was a welcome sign, allowing the Fed to consider easing interest rates.
High-frequency data shows some worrisome trends for stocks. The Citi Economic Surprise Index, which tracks realized data versus expectations, shows data coming in lower than expected, indicating potential volatility. The ISM report this morning showed contraction in manufacturing sectors, further weakening market sentiment.
The labor market remains a key focus. The Beveridge curve, which shows the relationship between job openings and unemployment, indicates cooling without rising unemployment so far. However, June's data showed signs of potential inflection, which could increase recession risks. Historically, every time unemployment rates have bottomed and turned higher, a recession has followed.
Our view is that the economy may face a shallow recession, similar to 2001 rather than 2008, with lower leverage in the system. If a recession occurs, unemployment could rise to 6.5%, leading the Fed to lower interest rates, supporting the housing market and economic recovery. Equity markets could see a 20-25% decline due to high valuations and concentration in mega-cap stocks.
Jeff Carbone:
Cliff, you've shared a lot of detailed information. Inflation is moderating but remains above the Fed's 2% target. Growth is strong, but we see signs of cracks, especially in the labor market. History suggests we might not avoid a recession, so we are making adjustments to our portfolios.
We've been focusing on bonds, trading credit risk for interest rate risk, and favoring high-quality government bonds. In equities, we've made some tweaks but expect to do more as earnings season progresses. Equities look less attractive due to high valuations and earnings expectations. We prefer defensive stocks and are cautious about growth and cyclicals.
Cliff Hodge:
Thanks, Jeff. Our investment strategy focuses on risk management, not market timing. We aim to adjust allocations thoughtfully, considering valuations and economic indicators. We like bonds for their yield and total return potential, especially if the Fed starts cutting rates.
Within equities, we prefer defensive sectors like utilities, healthcare, and consumer staples. We are overweight fixed income, favoring high-quality bonds, and underweight high yield and emerging markets. Alternatives provide diversification, and private credit offers attractive yields for investors who can handle some illiquidity.
Election Impact:
Elections add short-term volatility, but historically, they don't significantly impact long-term market returns. The market tends to follow a typical election cycle playbook, with some sell-off before the election and a rally afterward. Regardless of who wins, the market adapts to the new normal.
Market Update Conclusion:
Thank you, everyone, for your attention and participation. We will continue to navigate market complexities and make informed decisions for our clients’ financial goals. Stay cool and enjoy the rest of your summer.
This is for informational purposes only. Transcription is edited for ease of readability. Investment advisory services offered through Cornerstone Wealth Group, LLC dba Cornerstone Wealth, an SEC registered investment adviser.
