Driven by the insatiable investor demand for all things relating to Artificial Intelligence (AI), the S&P 500 index posted a solid second quarter and finished the first half of the year up 15.3%. The market gains were quite narrow in scope; one stock (Nvidia) accounted for 30% of the index gain in the first half of the year. Add in the performance of Microsoft, Alphabet, Meta (Facebook) and Amazon, all of whom have announced significant investments in the AI space, and these largest five stocks in the index have year to date contributed over 50% of the index return.
Another way to emphasize the highly concentrated nature of equity market returns thus far in 2024 is the fact that the equal weighted S&P 500 index is only up 5% on the year. The 10% difference between the capitalization-weighted index (+15.3%) and the equal weighted index is the biggest first half gap since 1990.
These equity market gains took place over a period when short-term interest rates remained unchanged. Entering 2024 investors were expecting numerous rate cuts to provide support to equity valuations, but the Federal Reserve thus far has not seen inflation and employment data to support lowering rates. Rates on the benchmark 10-year Treasury note started the year yielding 3.86% and closed the first half yielding 4.34%.
For many long-term investors, the speed and magnitude of the market capitalization gains from Nvidia and many other mega-cap technology companies are reminiscent of the dot com era. However, we believe the caliber of companies that have led the market higher over the past decade are vastly superior businesses than what we saw in the late nineties, with much stronger balance sheets and the ability to grow by mergers and acquisitions that were not possible under much stricter anti-trust enforcement. We chose not to buy a number of these stocks due to their extremely high valuations and we retain a degree of skepticism as to whether these companies valued at over $2 trillion dollars can grow fast enough to lead the equity markets higher.
We believe the very low level of market volatility thus far this year could shift upward in the months to come. The upcoming election’s impact on the financial markets is hard to handicap, given that the governing agenda will depend on which party controls the executive and legislative branches. The major wars in the Middle East and Ukraine show no signs of resolution, and the recent national election in France and Presidential debate in the U.S. led to unanticipated results and the prospect of further electoral surprises.
We will maintain our long-term strategy of owning high quality companies with stable balance sheets and solid long-term prospects.
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