Global equities continued to rally in the second quarter, led by surging U.S. mega-cap technology and growth stocks, particularly companies related to Artificial Intelligence (AI).
The S&P 500 index gained 6.6% in June and 8.7% in the second quarter, driving its year-to-date return to 16.9% overall. The technology-heavy Nasdaq Composite has driven the majority of returns in U.S. stocks, rising over 13% in the second quarter and 32% year to date.
Outside the U.S., stocks in Europe and emerging markets have also posted solid results. Developed international stocks (MSCI EAFE Index) rallied 4.6% in June, gaining 3% for the quarter and 11.7% YTD. Emerging markets stocks (MSCI EM Index) rose 3.8% in June, resulting in a 0.9% gain for the second quarter and a 4.9% return YTD.
In the fixed-income markets, core bond returns were slightly negative for the quarter as interest rates continued to rise and prices fell. The benchmark 10-year Treasury yield ended the second quarter at 3.8%, up from 3.5% at the end of March. Riskier high-yield bonds gained 1.6% for the quarter and are up 5.4% YTD. Municipal bonds were generally flat on the quarter and up 2.3% YTD.
The Narrowest Market in at Least 50 Years
The market-cap-weighted S&P 500 Index’s rally this year has been one of the narrowest on record, with less than 28% of the index’s constituents beating the overall index return. In an average year around 49% of the index’s 500 companies beat the overall index. (The only other year comparable to this year was 1998, as the Tech/Internet stock bubble was inflating).
More granularly, with the sudden frenzy in all things AI, the average YTD return for Apple, Amazon, Alphabet, Meta, Microsoft, NVIDIA, and Tesla is 96%. The gains in these “Magnificent Seven” mega cap tech stocks are responsible for almost the entire S&P 500 return for the year. In fact, the Nasdaq-100 recently performed a special rebalance on July 24th to reduce the concentration’s domineering impact. Moreover, the combined market cap of these seven stocks now comprises over 27% of the total index, the largest concentration in history for the top seven stocks.
It remains to be seen whether this extremely narrow market rally resolves via the rest of the market catching up or the mega-cap tech stocks referenced above “catching down”. Certainly, improved market breadth would be a plus. On a positive note, it appears the rally is potentially broadening; the small-cap Russell 2000 index shot up 8.1% in June, while the large-cap Russell 1000 value index climbed by 6%.
Investment Outlook and Portfolio Positioning
Macroeconomic data remains mixed. On the one hand, the U.S. economy has been more resilient than most expected through the first half of the year with the labor market remaining strong and supporting consumer spending. Headline inflation has also dropped meaningfully, thanks to a sharp decline in energy prices. On the other hand, key leading indicators of an impending recession are still flashing red, including a deeply inverted yield curve and tightening credit conditions, among others. Moreover, core inflation (excluding food and energy) remains stubbornly high, with the Fed signaling will be data dependent and continue with rate hikes this year as needed.
While we are not in the business of prognosticating, we are still very much aware of the possibility of recession later this year or next. With this in mind, we continue to believe in our strategy of ensuring client portfolios are within appropriate asset allocation ranges. While nothing can fully insulate portfolios from the effects of recession, we believe the proper allocation between cash, bonds, and equities will continue to position client portfolios for long-term growth despite any short-term economic headwinds.
Closing Thoughts
While we continue to see indicators for short-term economic challenges both here and abroad, we also see reason for optimism. Within the U.S. stock market there are companies and sectors that are reasonably priced and offer attractive return potential. The fixed-income landscape is becoming more attractive, thanks to higher yields brought on by the Fed increasing interest rates so drastically over the last year.
We also see strong total return potential from international stock markets, which have been out of favor and underperforming for more than a decade. We continue to stress patience with international managers as we believe the best years for these managers are ahead of them.
Successful investing requires a balance between offense and defense. Earning superior long-term returns does require one to take calculated risks when opportunities present themselves, but to also exercise caution during periods of market exuberance. By maintaining a disciplined and balanced investment approach, we are well-positioned to weather the inevitable market storms and capitalize on the opportunities that are also sure to arise.
As always, we thank you for your trust and encourage you to contact your Isaacson team with any questions you may have.
