June Investment Comments
The S&P 500 has rebounded to all-time highs, up over 10% year-to-date after recovering from a dip of over 5% in April. Earnings season is upon us, with over 90% of companies already reporting results. Using FactSet’s blended formula that combines reported earnings with remaining estimated earnings, analysts expect 5.4% year-over-year earnings growth in the first quarter. The index's top five contributors to earnings growth are Nvidia, Alphabet, Amazon, Meta, and Microsoft. Excluding these five companies, year-over-year earnings growth is estimated to decline 2.4%. Medium-size companies represented by the S&P 400 have advanced 8% this year, broadening the rally. Small companies remain far behind, with the S&P 600 up only 1% year-to-date.
The Dow Jones Industrial Average looks to pierce through 40,000 for the first time in history. The index of 30 blue chip companies, up nearly 5% in 2024, is price-weighted rather than market-cap-weighted. The Dow has lagged other indexes for many years as market-cap indexes continue to benefit from the outperformance of mega-cap companies. However, the potential of these large companies to spend hundreds of billions of dollars on hardware and software in the next few years to develop artificial intelligence and alternate reality environments is a source of great anticipation. It will be interesting to see how this investment will shape their future earnings growth.
The 10-year Treasury bond yield, at 4.35%, is down about 35 basis points from late April highs as rate hike fears subside. This coincides with the rebound in equity markets, as lower rates boost the present value of future earnings via a lower discount rate. Companies with the highest growth prospects benefit most from lower rates.
Investors cheered April’s CPI data, which came in slightly below estimates, while shrugging off the PPI data that came in above expectations. Used vehicle prices continue to fall as new vehicle inventory improves from pandemic supply shortages. Gasoline and housing prices put upward pressure on inflation. Higher home prices and interest rates continue to drive up shelter costs. Homeowners are staying in their homes longer, unwilling to give up their low mortgage rates. First-time homebuyers are finding it difficult to find starter homes as homeowners are staying put and higher interest rates are impacting affordability.
According to the CME Group FedWatch tool, which estimates the likelihood that the Fed will change the Federal target rate, investors expect multiple rate cuts before year end. Investors do not expect a rate cut at the upcoming June 12 FOMC meeting, but at the July 31 meeting, there is nearly a 1/3 chance of a cut. Recent commentary from Jerome Powell in Amsterdam indicated that because disinflation has slowed considerably this year the Fed needs to rethink its policy direction. He does not expect the Fed to raise rates but to hold them steady longer than they previously expected. The Bank of England and the European Central Bank appear to be in a similar situation. Both have recently held rates steady and indicated they expect rates to decline in the coming months.
30-year mortgage rates tend to be most impacted by the change in 10-year Treasury yields. Due to homeowners moving or refinancing, the average life of a 30-year mortgage averages closer to 10 years. The 30-year, fixed-rate mortgage has also declined since late April, and further decreases would be welcomed by would-be buyers. Home prices have remained high due to limited inventory. Homeowners are reluctant to give up their low-interest rate mortgages, and homebuilders cannot satisfy demand. The First-time Home Buyer Affordability Index provided by the National Association of Realtors details how much the market has changed in just a few years. In 2021, The average starter home price was $303,500, mortgaged at an effective interest rate of 3.26%, resulting in a monthly payment of $1,190. In 2024, the average starter home price is $331,000, mortgaged at 7.08%, with a monthly payment of $2,000. The median income of $65k for first-time homebuyers in 2024 is 18% higher than in 2021, yet monthly mortgage payments are up 70%. Falling interest rates would make refinancing an attractive option for recent mortgagors, boosting consumer spending power and home affordability.
Gold has been a strong performer in 2024, up nearly 14%. Geopolitical concerns have contributed to its strength as investors seek a safe haven. Bitcoin may be another area investors consider as geopolitical events develop. The alternative asset is up nearly 40% year-to-date to $61,000. Retail investors' enthusiasm for stocks is making a comeback. AMC Entertainment and GameStop experienced volatility similar to the pandemic-era madness. AMC used the opportunity to raise equity capital desperately needed to pay down pre-pandemic debt. The company took on significant debt to make several acquisitions prior to the economic impacts of the COVID-19 pandemic. Anticipation of falling interest rates and continued economic growth appears to be encouraging speculators off the sidelines.
The S&P 500's price-to-earnings ratio continues to trade at a premium to historical valuations. According to FactSet, the index's forward P/E is 20.4, nearly 15% higher than the ten-year average of 17.8. Analysts expect 11% earnings growth in 2024, followed by 14% growth in 2025. Investors might consider comparing the current dividend yield versus historical averages to evaluate the attractiveness of the index. The strong performance of the S&P 500 has pushed the dividend yield lower, currently around 1.4%. This is down from 1.8% in October 2022 and lower than the 2% or more experienced during most of the 2010s. If earnings are as robust as analysts expect in the next few years, dividend increases will likely follow.
Small and medium-sized companies continue to trade at a discount to their historical averages and well below large companies. Stock pickers can still find bargains looking beyond the largest top 10 companies. The challenge with investing is the past is history. We must navigate the unknown future. Owning solid companies at fair valuations remains the best way to make money reliably over time.
Eric Wathen, CFA