Artificial intelligence continues to inflate the stock market. Just ask ChatGPT.
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How AI, interest rates and the presidential election will shape markets in the second half of 2024
The bullish stock price rise in June 2024, Q2, and thus far can be summed up in two words: “AI Boom.”
But not all stocks are enjoying the tech rally. The stock market is shrinking and winners are dwindling. Large growth stocks like AI darlings NVIDIA (NVDA) dominates the performance charts.
The S&P 500’s total return in June was 3.59%, with a second-quarter gain of 4.28%, and the large-cap index is up 15.29% in the first half of the year. But if you exclude Nvidia’s 150% gain through the end of June, the S&P 500’s six-month return would shrink to 10.72%, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. And if you subtract the performance of the Magnificent Seven, the market benchmark’s year-to-date return falls to 6.28%.
AI-related stocks surge on the stock market
The Dow Jones Industrial Average lagged behind, rising 1.12% in June but losing 1.74% in the second quarter. Small caps have also struggled, with the Russell 2000 losing 1.08% last month and 3.62% in the last quarter. The small cap index is up just 1.02% so far this year, while the Nasdaq is up 18.13% for 2024 after rising 6% in June.
“If you’re invested in large-cap stocks, market-cap weighted indexes or the Magnificent Seven, it’s halftime and it’s party time,” Silverblatt said.
A review of mutual fund and ETF performance highlights the dual nature of the market. For example, the average U.S. diversified equity fund rose 1.02% in June, according to Lipper Refinitiv data. But this respectable return over the past month pales in comparison to the 5.9% gains in tech funds, 5.89% gains in large growth funds and 3.55% gains in S&P 500 index funds, according to Lipper Refinitiv data.
Large cap stocks boost stock market
Growth and large-cap funds led the way, while value and small/mid-cap funds didn’t participate. For example, large-cap value funds were up just 0.27% in June, while large-cap growth funds are up 19.6% year to date, compared with 9.01% through June.
Similarly, the average small-cap growth fund and small-cap value fund both ended June in the red, down 2.76% and 3.78%, respectively, in the second quarter.
A look at the best-performing ETFs also highlights concentrated interest in tech and growth stocks. The best-performing diversified equity ETF this year, Invesco S&P 500 Momentum (SPMO), is up 33.86% and up 7.5% in June. Topping the list was Nuveen Growth Opportunities (NUGO), which was up 8.5% last month.
Sector performance was also dominated by technology. The microsector FANG+ ETN (FNGS) holds five major technology stocks. Meta Platform (Meta), apple (AAPL), Amazon (AMZN), Netflix (NFLX) and alphabet (GOOGL) and five other actively traded tech growth stocks surged 10.01% in June, extending their gains to 30.18% through 2024. Round Hill Magnificent Seven (MAGS) gained 9.01% in June and Van Eck Semiconductor (SMH) gained 8.41%, extending their sector-leading year-to-date performance to 49.08%.
“The big-name (stocks) continue to perform well,” said Sandy Sanders, portfolio manager of the John Hancock Fundamental All-Cap Core fund, winner of the 2024 IBD Best Mutual Fund award.
Size matters in the stock market
Sanders said mega-cap technology companies like Nvidia and other holdings in the fund are outperforming. Microsoft Microsoft, Amazon and Apple all have strong market positions because the company outperforms its competitors. “The company’s sustainable competitive advantage continues to grow and its cash flow drivers remain strong,” he said.
AI-chip maker Nvidia, a core holding in the John Hancock Fundamental All Cap Core (JFCIX), and other mega-tech companies that gained an early foothold in the AI space have a long road to growth, Sanders says.
“When you think about the broader picture of where AI computing and market penetration is, we’re still in the early stages,” Sanders said, adding that the tricky thing about a stock like Nvidia is that the chipmaker’s revenue and cash flow continue to beat expectations even as its stock price has risen dramatically.
Growth vs. Value
And in a clear illustration of the vast disparity between growth and value stock performance, Vanguard Growth (VUG) rose 6.78% in June, bringing its year-to-date return to 20.62%. In contrast, Vanguard Value (VTV) was up just 0.15% last month and is up 8.65% for 2024, 12% below the growth stocks’ gains.
Bond investors fared well in June, with iShares Core US Aggregate Bond (AGG), which invests in a diversified basket of investment-grade bonds, rising 0.88%, trimming its loss for 2024 to 0.71%. Foreign stock ETFs didn’t offer investors much diversification either: iShares Core MSCI EAFE (IEFA), which tracks an index of large-, mid- and small-cap developed market stocks excluding the U.S. and Japan, fell 2% in June, trimming its gain for 2024 to 5.1%.
Finding value in the stock market
One stock market strategist believes value stocks are worth it
If there’s any room for laggards in the stock market, it’s in the value space, according to Jill Carey Hall, U.S. equity strategist at Bank of America Global Research. “Value stocks are cheap,” she said.
How cheap? Value stocks are the cheapest stocks in the S&P 500 Index when measured by price-to-earnings multiples, and small-cap stocks are trading at the lowest valuations in at least the past two decades when measured by price-to-book multiples, according to Bank of America research.
“Rather than buying the S&P 500, I think there’s more upside in that part of the market,” Hall said.
Will there be any winners in the future?
Hall also believes the list of market winners will eventually broaden. There are many areas of the market that are out of favor, he said. The outlook for earnings growth beyond big tech companies will help spur more stocks to rise.
Hall says overall market earnings growth should accelerate by the fourth quarter, closing the wide gap with the tech sector and giving forgotten stocks a boost. “I expect overall market earnings to rise,” Hall said.
For example, first-quarter S&P 500 earnings growth was 8.2%, compared with 27% for the information technology sector, according to LSEG I/B/E/S data. This wide gap is expected to close rapidly by the end of the year, with the S&P 500 expected to grow earnings by 14.8%, just below the 16.4% growth forecast for the technology sector.
Playing the stock market cycle
Besides value stocks, Hall sees opportunities in so-called cyclical stocks in the energy and financial sectors. He also thinks real estate and real estate investment trusts will become more attractive once the Federal Reserve starts cutting interest rates. But he remains cautious about small-cap stocks, which have been hit hard by high long-term interest rates.
Sanders of the John Hancock Fundamental All-Cap Core Fund is also bullish on the financial sector, noting that it will benefit from a recovery in capital markets once the Fed starts to cut interest rates. KKR (KKR) tops his list.
Keep an eye on the Fed’s moves
Sanders said the Fed’s rate hikes “have effectively shut down the capital markets, halting IPOs, secondary equity offerings, and mergers and acquisitions,” adding, “We believe the Fed is effectively done raising rates, and there’s virtually no room for companies to go public, access capital, or raise secondary equity.”
Morgan Stanley (M.S.) and Goldman Sachs Sanders said GS, the world’s No. 1 and No. 2 investment banks, are positioned to see revenue and profit growth as the capital markets cycle begins to pick up the pace of growth. Private equity firm KKR also stands to benefit. “They’re more likely to be able to take some of the companies they’ve taken private public and monetize their investments,” Sanders said.
Sanders is bullish on housing construction Renner Sanders said Lennar should benefit from a continuing housing shortage and a resurgence in homebuying once mortgage rates start to fall. “There’s a housing shortage. There’s a real supply shortage. And Lennar is in the business of creating supply,” Sanders said.
And given home-buying challenges, Lennar, whose average sales price in the second quarter was $426,000, is well positioned to profit from buyers who can’t afford more expensive homes.
What is the outlook for bonds?
In June, the yield on the 10-year Treasury note fell 10 basis points to 4.402%, but still rose nearly 0.25% over the quarter.
Cash still has a loyal following, yielding around 5%, but Matt Brill, manager of the Invesco Core Plus Bond fund (ACPSX), says investors would be mistaken to hang on to cash for the long term and not take advantage of the higher yields that bonds offer and the capital appreciation that could occur if the Fed starts cutting rates.
“I think people have gotten used to cash and the high yields on the front end of the yield curve,” Brill says, “but I don’t think they realize that high yields on cash won’t last forever.” Eventually, the market will look ahead to a Fed rate cut, or a series of rate cuts, that will make cash less attractive and bonds more attractive, Brill says.
The stock market is watching inflation
Now that the worst of the inflation fears are over, Brill is considering giving the fund a bit more duration, or interest-rate sensitivity, so it can take advantage of capital appreciation when the Fed starts to cut rates and interest rates fall. Bond prices move inversely to yields. Brill likes high-quality corporate bonds. He’s a soft-landing guy, and he’s underweight Treasuries because he’s not worried about the economy doing a quick U-turn and missing out on a flight-to-quality upside.
He said bond volatility is likely to increase going forward, but given the persistence of inflation, current bond yields should act as a buffer against short-term volatility.
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