By
Linda Bakhshian
August 21, 2024
Second quarter 2024 recap
US equity markets continued their upward trend in 2Q24, a pattern consistent with 1Q24 and much of the previous
year. The “Magnificent 7” giants primarily drove this performance, achieving 31 record highs in the first half of the year,
which in turn boosted S&P 500® Index returns. During the quarter, the S&P 500 Index returned 4.3%, outperforming
the S&P 500 Equal Weight Index, which declined 2.6%. Some of the strongest performers during the quarter were large
US software and hardware companies, which are expected to benefit from broad adoption of artificial intelligence (AI).
The Magnificent 7 are now collectively the equivalent of the second largest country stock market in the world, after
the US stock market.
During the quarter, the strongest-performing sector in the S&P 500 Index was information technology (IT) at +14%,
while the weakest was materials at -5%. Across US equity markets generally, small-caps lagged large-caps, and growth
again outperformed value. Outside the US, there was a wide range of returns during 2Q24. In US dollar terms, the
worst performer among the major developed markets was the Nikkei Index in Japan, which generated a total return
of -7%, while the strongest was the Hang Seng Index in Hong Kong, which delivered a total return of 9%.
The recent macroeconomic environment has been characterised by a complex interplay between inflation, economic
resilience, and shifting US Federal Reserve (Fed) expectations. While signs of a soft landing and disinflation provide
grounds for optimism, underlying vulnerabilities and uncertainties continue to warrant a cautious approach to an
economic and market outlook.
As we noted in 1Q24, the ultimate drivers of equity returns are broad economic trends and corporate earnings,
which have continued to be fairly solid through 2Q24. Additionally, the Fed remained unconvinced, despite markets
interpreting moderating labour markets and consumer spending as signs of slowing inflation, potentially paving the
way for rate cuts later in the year. However, investors fear that moderation may give way to a bumpier landing if the
Fed does not act soon. Nevertheless, consumer spending patterns and the employment landscape are becoming
increasingly uncertain, raising the risk of economic mishaps.
Post-2Q24 developments
Since the end of June, equity markets around the world have experienced higher volatility but have largely continued
to rise, apart from a sharp dip in early August. Some of the strategies and themes that were most successful for
investors in 2Q24 have stumbled, while other themes that had been out of favor for an extended period have begun to
do well. Generally, 2Q24 earnings have met expectations, though companies continue to foreshadow slower consumer
demand in the US and globally. We believe that our investment teams are well positioned to adjust to this new
environment, and that active management is likely to succeed in these choppy market conditions.
What we are watching
The second half of 2024 will provide a number of events and data for investors to consider as they begin positioning
for 2025, but perhaps most important are the September US Federal Reserve meeting and the US presidential election
in November.
We continue to believe that equity investors expect central banks to start cutting interest rates in 2024, given the
evidence that inflation is continuing to decline in most countries. Some of the major global central banks, including the
European Central Bank (ECB), the Bank of Canada, and the Swiss National Bank, have already begun to cut rates. In the
US, investors are anticipating the first rate cut to be in September, though this has been a moving target. Investors
have become increasingly anxious, questioning whether the Fed is behind the curve and whether the likelihood of
a hard or soft landing has shifted towards the increasing possibility of a bumpy landing. Economic data, especially
around employment trends, are weakening, and concerns about the health of the US consumer have intensified,
while inflation continues to moderate. Historically, US recessions have been closely tied to the job market, which is
currently showing signs of slowing, as evidenced by recent unemployment claims, job openings, and company hiring
intentions. Complicating the situation are the upcoming US elections and the respective consequence of a Republican
or Democratic winning the White House. Hence, the next couple of quarters are likely to be more volatile in the equity
markets, as investors weigh a mass of incoming data.
As we mentioned last quarter, globally about half of the world’s population is participating in competitive elections this
year, and surprises have been the norm thus far. In early June, right-wing parties slightly strengthened their presence
in the European elections, though they won fewer seats than initially forecast. From late May to early June, elections
in India left the governing party with a smaller majority than expected. In July, general elections in the UK resulted in a
dramatic decline in the number of seats held by the Conservative party, which had been in power for the past 14 years.
And in France, two rounds of national elections in late June and early July resulted in no single party winning a clear
majority, leaving the near-term political outlook there somewhat uncertain.
Next, the US elections will dominate the airwaves as political rhetoric enters overdrive. However, history, going back
to the 1930s, has shown that elections have a limited impact on the trajectory of equity markets in the medium and
long term.
Figure 1:
Compounded returns of $1,000 invested in the S&P 500 Index, by political party of the sitting president
Sources: Macquarie, Macrobond.
Additionally, whether a specific party holds office or the government is split has not significantly affected the overall
direction of stock market returns over the longer term. This pattern is again observed over the past two presidential
cycles. Despite the distinct differences between President Biden’s and President Trump’s policies, economics, rhetoric,
Fed rate cycles, geopolitical tension, and a pandemic, the stock market returns under both presidencies have been
nearly identical. The S&P 500 Index, on average, has returned roughly 14.5% per year,1 highlighting that markets are not
exclusively driven by election outcomes. Although headlines, investor sentiment, and “fast money” may create shortterm
volatility, underlying fundamentals continue to guide long-term returns. Historically, issues such as inflation, the
economy, and company earnings have impacted equity performance more than elections. However, even here the
markets are forward-looking, tending to price potential changes well in advance. So too are companies, which will alter
their investments and activities to meet the changing landscape. Hence, we believe that investment decisions should
be based on longer-term fundamentals, not near-term political outcomes.
Figure 2:
Average annual total return of the S&P 500 Index (1933-2024)
Sources: Macquarie, Macrobond. Data through July 31, 2024.
We are, however, mindful that any election can bring potential for dislocation and volatility in the short term, and
the outcome of the 2024 elections will likely be no different. Two economic policies have emerged as central issues
thus far: The debate surrounding the Tax Cuts and Jobs Act (TCJA) provisions set to expire by the end of 2025,
and additional, higher tariffs, especially on Chinese goods. Both issues may impact consumer spending patterns,
corporate investments, inflation, and Fed policy, creating short-term market volatility. For example, an increase in
tariffs may heighten geopolitical tensions, especially with China; the technology sector will potentially be impacted,
and US companies may hasten their reshoring activities, impacting inflation and Fed policy, to mention a few. On the
other hand, a change to tax rates would impact profitability, margins, and future investment activity, as companies
adjust to meet new challenges. Additionally, certain sectors, such as healthcare and clean and traditional energy, are
commonly at crosscurrents during election periods. In this election, semiconductor, consumer discretionary, and
industrial companies that are most exposed to trade would be highly impacted by the Trump campaign’s current tariff
proposals, which are much larger than those implemented by the Trump administration in 2018-2019 and could thus
cause trade patterns to shift significantly.
Our investment teams generally aim to build portfolios that tend to deliver risk-adjusted positive long-term returns
regardless of which political party is dominating a country’s government. We will continue to monitor political and
economic developments around the world, including central bank activities, as we analyse underlying fundamental
opportunities and portfolio construction drivers. By focusing on the intrinsic value of investments, based on an analysis
of companies’ financial health, competitive advantages, and market position, investors can identify opportunities that
may be less susceptible to short-term market volatility and political uncertainties. This approach encourages a deeper
understanding of the underlying drivers of value, leading to more informed investment decisions that are better
insulated against the whims of market sentiment and political changes.
Moreover, a long-term view facilitates a patient investment strategy, allowing investors to ride out the inevitable
ups and downs of the market and political cycles, capitalising on the power of compounding returns over time. This
patience may also reduce the risk of selling low and buying high, which can erode returns. In essence, by adhering
to fundamental investing principles and maintaining a long-term perspective, investment teams can build resilient
portfolios that are well positioned to navigate the complexities of the global political and economic landscape,
ultimately delivering sustainable risk-adjusted returns to their stakeholders.
Additional observations
Turning to the global economy, our economists and strategists believe the UK has emerged from its recession.
Meanwhile, China continues to grapple with a slowing economy, reduced consumer spending, and real estate
dislocation. Europe, heavily influenced by its trade-interconnectedness with China, is likely already experiencing
a mild recession. Furthermore, there remains a chance of a recession in the US by 2025, as the employment and
consumer spending outlook continues to moderate. However, we remain cautiously optimistic about economic
conditions in the US and other developed countries. This optimism is primarily due to central banks’ awareness of
moderating inflation, the resolution of post-COVID-19 excesses, and signs of easing financial conditions globally. From
a valuation perspective, Europe continues to present a compelling case for investors based on a variety of metrics.
The combination of underappreciated earnings momentum and attractive valuations could position Europe favourably
relative to the US in the quarters ahead.
AI-influenced stocks are currently maintaining high valuations, with the S&P 500 Index’s forward price-to-earnings
(P/E) ratio standing at 21, significantly above its 30-year average of 16.7. This elevated valuation level underscores
the considerable impact that AI stocks have on overall market valuations, a phenomenon driven by these companies’
robust balance sheets and impressive free cash flow, and the structural growth potential associated with AI adoption
and utilisation. We view AI as a crucial, long-term opportunity that is expected to bring about efficiency and
productivity improvements. Despite the current high valuations, which may suggest investor overenthusiasm, the
intrinsic structural growth within the AI sector supports our ongoing focus in this area.
However, there are rising concerns about market concentration, as AI stocks now account for more than 30%
of the S&P 500 Index’s weight, a concentration level comparable to that seen in the early 2000s. This significant
concentration raises issues regarding market diversification and breadth. Year to date as of 30 June 2024, the S&P
500 Equal Weight Index and S&P 500 Index posted annualised returns of 10.4% and 33%, respectively, highlighting the
substantial influence that leading AI stocks have on market performance.
On a relative basis, we view small- to mid-caps (smid-caps), emerging markets (EM), and value-oriented styles as
offering attractive opportunities for long-term investors. Specifically, smids now have the largest relative P/E spreads
between large- and small-caps since the early 2000s and historically smid-caps tend to outperform following the first
Fed rate cut, mainly a result of lower interest coverage ratios and from having a greater proportion of floating-rate
debt (See “Expert views” below). We also favour exposure to real assets, driven by positive secular trends in energy
transition, digitalisation, electrification, and the onshoring and reshoring of manufacturing. We believe that real assets,
in general, not only offer diversification within themselves but might also provide a crucial layer of inflation protection
for traditional portfolios that may lack this feature.
Expert views from our network
Each quarter, we ask our investment analysts and portfolio managers for their views on issues they consider to be the
most topical. During 2Q24, three of the most salient themes involved opportunities in small-cap value stocks, in real
estate, and in the software industry related to AI. Here’s what our respective experts had to say about each topic.
Opportunities in small-cap value stocks
Kent Madden | Co-Head of US Small-Mid Cap Value Equity
After a brief period of outperforming large-cap stocks in 4Q23, small-cap stocks continued their recent
underperformance relative to large-cap peers in 1H24. In fact, in 1H24, the small-cap Russell 2000® Index trailed the
large-cap Russell 1000® Index by the most since 1973.2 The underperformance over the past three years leaves smallcap
stocks, and small-cap value stocks in particular, at extremely attractive valuation levels relative to large-caps.
Small-caps have only been cheaper than they are now, relative to large-caps, in 10% of historical periods. With the Fed
likely to begin cutting rates in 2H24, we believe that the setup for small-cap value stocks, which tend to outperform
during Fed rate-cutting cycles, is favourable given current valuations and interest rate sensitivity. While the equity
market may be challenged during the early stages of any pronounced economic slowdown, we believe a higher quality
bias through stock selection and the long-term prospects of small-caps will be favourable for long-term investors.
Opportunities in real estate
James Maydew | Head of Global Listed Real Estate
Over the past year, headlines and investors have focused on office challenges within the real estate sector, as the
office subsector grapples with a post-COVID-19 world. Additionally, as interest rate cuts are pushed out, the US real
estate sector has sold off disproportionately. But this is where the opportunities lie for investors. Real estate is capital
intensive, so higher interest rates and inflationary periods are a headwind for the sector. But those same headwinds
turn into a tailwind when interest rate rises move to the rear view. This line in the sand is getting closer. In fact, a
number of central banks globally have already begun to cut rates, and the US Fed is likely to follow soon. Additionally,
real estate operating income growth, the bedrock of earnings, is growing at a rate greater than historical averages.
Other than in multifamily dwellings, supply of new inventory is historically low, ensuring rents are the only lever and
moving higher.
The office subsector, more specifically, is somewhat muted. Because office represents only 4.5% of the benchmark
FTSE Nareit Equity REITs Index (US REITs), the issues in this subsector are isolated and simply not impacting the
remaining strong fundamentals, such as those seen in senior housing, affordable housing, and data centres. These
three subsectors are driving long-term growth for the entire sector, driven by long-term thematic and structural
tailwinds. Data centres, which make up more than 11% of the US REIT benchmark, are in a sweet spot for the same
reasons that AI companies are attracting capital in the technology sector. Real estate remains one of the cheapest and
most opportune sectors in the market, in our view.
Opportunities in software and AI
Chris Bubeck | Senior Equity Analyst
Impressive AI demonstrations by OpenAI’s ChatGPT, Google Gemini, and others have driven a great deal of excitement
about the potential of products that will be built using new large language model (LLM) technology. That excitement
has driven significant outperformance for stocks within the technology sector, beginning in 2023 and continuing
year-to-date in 2024. Within the tech sector, the software industry has participated in this enthusiasm, although in
the short term their customers seem to have paused IT spending somewhat as they focus on better understanding
this new technology. Debates about whether LLM capabilities will drive an increase in competition within software (via
new entrants like ChatGPT, or via a large volume of new startups) have become more frequent. Our long-term thesis
is that these large, generalised models will commoditise and that the value will accrue to the software companies
that possess unique data sets, the more critical piece required to build new capabilities with LLM technology. On this
basis, we still very much like the long-term return prospects for stocks in the software industry, and we see the recent
pullback as a great opportunity for long-term investors.
Conclusion
Looking ahead, market and investor focus is shifting to the potential impacts of the Fed’s upcoming meeting in
September and the US presidential election in November. Despite uncertainties, our investment teams remain oriented
towards high-quality, long-term fundamentals and focus on identifying dislocations in the market. Amid shifting forces,
we look to diversify across smid-caps, the value style, EM, and real assets to participate in future opportunities.
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1Based on the date of elections.
2Jefferies, FTSE Russell, Center for Research in Security Prices (CRSP) data.