
So far, bad prediction – at least at the index level. With the first 6 months of 2024 under its belt, the S&P 500 is up 14% and change; the NASDAQ up a little further.
But pull back the covers a bit, and the analysts are not that far off the mark. For example, the S&P 500 equal-weight index is up a more modest 3.82% for the year. What’s that, and why does it matter?
The S&P 500 is a market capitalization-weighted index. The companies with the largest market capitalizations, or the greatest values, will have the highest weights in the index. For example, as of June 1, 2024, the largest constituent of the S&P 500 index was Microsoft with a weight of 7.2%. The Top 3 (Microsoft, Nvidia, and Apple) make up almost 20% of the index. [Apple, by the way, joined the AI party mid-month with the announcement of an AI integration coming to the next iPhone operating system, lifting the stock 10% and reasserting itself into the cap-weight leadership position.]
On the other hand, if you were to take those same 500 constituents and give them each an equal weighting of the index, regardless of how large or small any particular company, you’ve now got an equal-weight index. In this scenario, the big guns of the bunch no longer have an outsized influence over index performance. Hence the return of 3.82% YTD.
And it’s more than just return. The NASDAQ has seen a max drawdown of -7% for the year. That’s at the index level. But the average stock within that index has seen a max drawdown of -38% for the year. In one recent example, Walgreens (WBA) plunged 22% on Thursday after quarterly results disappointed.
There has been lots of chatter of late regarding the bifurcated market we find ourselves in. Liz Ann Sonders, Chief Investment Strategist for Charles Schwab, recently noted the tale of two markets on CNBC: “Resilience at the index level, but considerable weakness at the individual stock level.”
Why The Resilience?
As Jared Blikre noted in an article on Yahoo Finance, a seesaw theme has become a subtle but important market narrative. On days when AI isn't leading the charge, select pockets of strength keep the S&P 500 from more pronounced sell-offs.
The recent "plunge" in market leader and AI darling Nvidia is instructive. Within the course of 3 days, Nvidia hit an all-time intraday high, and corrected – down 16% at one point. If you had caught a minute or two of cable business news, you would have thought Wall Street was doomed.
But during that scary elevator ride down, a funny thing happened: The Dow Jones Industrial Average - up only 3% this year – perked up. Energy came alive, biotech jumped, and out-of-favor pockets of the market showed signs of life. The S&P 500 and NASDAQ held their trendlines during that time as other constituents picked up the slack.
“This seesaw-offsetting behavior is everywhere right now in lieu of correlations between even stocks in similar sectors,” writes Blikre. “Stocks simply do not want to move in the same direction.”
In a bull market, when the stocks generating all the headlines falter, other parts of the market can rise to the occasion. Sector rotation keeps volatility low at the index level as new winners offset losers. And the indices grind higher.
Of course, at some point, the music stops and all sectors start selling off in unison, kicking off a new bear market. But we’ll save such talk for another time.
The Next Half of 2024
- PIMCO’s Erin Browne: “I’m constructive. We’re in an environment right now where growth [in the economy] is still good, we have inflation coming down - that should be supportive of corporate profit margins. And when we look into the second half of this year, we’re expecting so see an earnings pickup and a gradual broadening out [beyond the AI sector and Tech].”
- NB Private Wealth’s Shannon Saccocia: “From a fundamental outlook, we are more optimistic than when we started the year.”
- Oppenheimer’s John Stoltzfus: “The bull market appears sustainable.”
Are their risks? Yes, among them geopolitical tensions, overconfidence in the “soft landing” scenario, and the upcoming U.S. presidential election which could introduce uncertainty (that said, historically, election years have been favorable for the stock market).
And now one more…
- Ritholtz's Josh Brown: “I’m on record saying the biggest risk to this market is a hiccup in the AI story. The big driving force behind the entire stock market right now – at an index level – is the AI story. And frankly, people need to understand that will work in reverse, as well.”
The market is never a cake walk. There will be downturns and corrections along the way – very likely in the second half of 2024. But so far, the underlying economy continues to hold up, the Federal Reserve is marching toward rate reductions, and corporate earnings continue to impress. Acknowledging that there are always risks, I’m guardedly optimistic.
And For What It’s Worth…
Joey “Jaws” Chestnut, widely considered the greatest professional eater in history, won’t be allowed to compete at the Nathan’s Famous hot dog eating contest on July 4 after signing an endorsement deal with plant-based company Impossible Foods.
As per The Washington Post, the deal with Impossible, which is trying to attract more meat eaters with its new plant-based hot dog, does not prohibit Chestnut from entering eating competitions. “We love Joey and support him in any contest he chooses,” said the California-based company. “It’s OK to experiment with a new dog. Meat eaters shouldn’t have to be exclusive to just one wiener.”
But Nathan’s demands loyalty from its competitors. A key agreement for all competitors at the Nathan’s contest — where people compete for the “Mustard Belt” and prize money — is to not represent a rival hot dog brand.
The good news is life expectancy. One study suggests that eating a hotdog shaves 36 minutes off your life. If 2021 is any gauge, when Joey wolfed down 76 hotdogs and buns in 10 minutes, disqualifying for the contest should add 1 day and 22 hours to his life.
To your health, Joey. And also, look both ways when crossing the street.
As noted before, long term, the strategies will get the trends right. Short term, there may be a miss or two as the market juggles conflicting signals. So keep allocations of strategies reasonable within your portfolio, and remember that protection* remains paramount.
--David
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* WHAT DOES PROTECTION LOOK LIKE?
At the extreme, it’s cash. As I mentioned last month, it’s OK to hold some cash. Cash is, in fact, a position. It means you’re prepared to act when circumstances better align with your risk tolerance.
Protection can mean an overweight position in a model built for protection. Lower volatility and lighter drawdowns often indicate that a model is more protective in nature. Bond Bulls, for example, has the lowest volatility and max drawdown of any of the models.
Check out the updated white paper Conservative vs. Aggressive Portfolios for a list of all the strategies ranked from lowest risk to highest in terms of max drawdown.
Protection can mean putting multiple strategies to work in a portfolio, especially when those models tend toward an inverse relationship with each other, or focus on different asset classes or market sectors. Think Bond Bulls and American Muscle. Or Global Trader and The 12% Solution. Or even a bit of the Zen Knuckle combined with a couple of the above.
Because each strategy uses a slightly different mechanism to identify market risks, and because each can employ different funds representing different market sectors (although there is obviously some overlap), there is beneficial diversification at work when using multiple strategies within a portfolio – helping to reduce volatility and max drawdown.
Further down the page in Conservative vs. Aggressive Portfolios you can see examples of various combinations and how they have performed over the years.
Protection can mean keeping an eye on provisional picks during the month. These can provide a heads-up on potential trends -- and breakdowns of existing trends. Look for asset class shifts (a switch from an equity fund to a safe harbor asset like cash or bonds, or the contrary).
See if such a shift holds up for a few days. Not every such move is a trading opportunity or justifies a rebalancing, but information is power.
Finally, employing stop-loss and stop-limit orders. A stop-loss order is an order placed with a broker to buy or sell a specific stock (or ETF) once that asset reaches a specific price. It's designed to limit an investor's loss on a security position. While not perfect, and you'll find my own pro-and-con thoughts on the Q&A tab in the Members Pages, stop-losses have their place in risk management.
Read more on the Investopedia page for Stop-Loss Orders.