Hot Topic: 2024 Summer Stock Pullback
Despite just posting our July market recap we thought it was appropriate to recognize the continued slide in equity markets that started mid-way through July and picked up steam last Wednesday (July 31) after the Federal Reserve's interest rate meeting. Below is our explanation on what has happened the last couple of weeks, some explanations on why and some thoughts moving forward.
What has happened?
On July 16th, the S&P 500 index reached an all-time high near 5,700. What followed for the month of July was a sell-off of the most loved mega-cap technology stocks known as the "Magnificent 7". The sell-off was sparked by concerning earnings reports (mainly Tesla and Google) that caused investors to question the amount of money the large tech companies are spending in the AI arms-race and the ultimate profitability of those investments. From July 16th, to the end of the month the S&P 500 index was just -2.53% off of it's high and the tech heavy NASDAQ index was -5.61% from it's peak. You can read more about how US stock market performance is being dominated by the largest companies here.
The stock market slide picked up steam last Wednesday following the Federal Reserve meeting and news that a Hamas leader was killed in Iran presumably by Israel. Ultimately, the market closed the week (ending 8/2/2024) with the S&P 500 -5.62% from the high-mark just two weeks prior and the NASDAQ index in a "correction" -10% from its peak.
High elevations (valuations) make investors jittery
The famous investor Benjamin Graham is famous for saying that "in the short run, the market is a voting machine but in the long run it is a weighing machine". Graham's point is that markets try and predict how successful (profitable) a company will be in the future based on the facts it knows today and forward looking assumptions. Ultimately, a company's stock gets rewarded or penalized based on if they achieve those outcomes.
Investors voted heavily in favor of large US companies in 2023 continuing into 2024. At the end of July the Price-to-Earnings ratio of the index was 20.7x, 25% higher than the historical average. The top 10 stocks in the index, which include the "Magnificent 7", have garnered the most enthusiasm from investors and as of the end of July were trading at 31.3x their historical average or 53% more than the historical average. With valuations at these high levels it requires a lot to go right in the future. The combination of concerns about earnings and the economy caused investors to worry that their rosy outlook of the future may not play out and those worries were felt the most in the stocks with the most lofty valuations.
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management. The top 10 S&P 500 companies are based on the 10 largest index constituents at the beginning of each month. As of 7/31/2024, the top 10 companies in the index were AAPL (6.9%), MSFT (6.7%), NVDA (6.2%), AMZN (3.7%), META (2.2%), GOOGL (2.2%), GOOG (1.8%), BRK.B (1.7%), AVGO (1.5%), TSLA (1.4%), and LLY (1.4%). The remaining stocks represent the rest of the 492 companies in the S&P 500. Guide to the Markets – U.S. Data are as of July 31, 2024.
Pre-election uncertainty has historically created market volatility
We have upcoming posts that will discuss the impact (or lack thereof) elections have the investment markets. For now however, it's worth noting that in the midst of the July pullback President Biden withdrew from the 2024 election confirming that regardless of the outcome in November there will be a new administration in the White House. Since President Biden's withdrawal Former President Trump's lead in the polls has closed considerably throwing more uncertainty into the wind. As you can see from the chart below, in the month's prior to an election in which the incumbent party is predicted to lose the market has historically sold off. On the positive front the market has historically responded positively regardless of the election outcome once the smoke clears.
Historical Context - Despite average intra-year drops of 14.2%, annual S&P 500 returns have been positive 75% of the time
The chart and the headline above do most of the explaining. It is very rare that the market marches on an upward trajectory from start to finish of the year. While they never feel good at the time, intra-year pullbacks are common. Over the last 24 years the draw downs have averaged about 14% and while the last several years have been relatively docile we did have a 25% pullback just 2 years ago. A 5% downturn is all but guaranteed in most years and double digit draw downs have happened around two-thirds of the all years since 1928.
Outlook
The stock market is supposed to fall every once in a while. It can't just keep going up forever. We have been concerned about market valuations for a while and have expected a pullback. As some of the uncertainties concerning investors begin to dissipate we should see markets calm down. In the meantime, while it's uncomfortable to see losses and it's natural to fear the worst underlying it all are opportunities. Opportunities to invest cash, buy stocks at a cheaper price and perhaps do some tax loss harvesting.
Important Notice: This communication is not intended to constitute any offer or solicitation to buy or sell securities. Offers of securities or investment advisory services may be made only pursuant to appropriate offering or other disclosure documents, and only after prospective investors have had the opportunity to discuss all matters concerning the prospective investment or engagement with their advisers, the issuers of the securities or MacroView Investment Management LLC. It should be noted that past performance is not indicative of future results. This communication is confidential and intended only for the addressee. If you are not the intended recipient, you may not copy, disclose, or distribute this message to anyone else; any such actions may be unlawful. If you have received this communication in error, please contact the sender of the message to inform him or her of the error.