Changing Tides in the Stock Market + 7.24.24
A notable shift has occurred in the stock market over the last few weeks. There has been a rotation away from the largest, fast-growing stocks toward smaller, more value-tilted companies. There are a variety of potential explanations for the move. It could be that valuations for the high-flying growth companies had finally reached such an extreme that there was nowhere else to go but down. Alternatively, market fundamentals could have also played a role.
A key variable that has likely contributed was the June Consumer Price Index (CPI) report published on July 11th. The data revealed inflation had slowed more than the market was expecting. This, in turn, fueled expectations that the Fed was getting closer to having the confidence needed to begin easing monetary policy. As of this writing (7/23), the market is pricing in a nearly 95% chance of an interest rate cut at the September meeting. On average, small and value-tilted companies have been more negatively impacted by higher interest rates. Expectations for a rate decline in the near term would, therefore, benefit them the most.
The shift in market leadership was both abrupt and dramatic. Over just five days following the release of the CPI data, small-value stocks outperformed large-growth stocks by 13.98%. As the chart below illustrates, that short period represents the most dramatic outperformance between those market segments since the Technology Bubble period of the late 1990s!
Source: Morningstar Direct. Data from 4/2/1997-7/22/2024. Large Growth is based on the S&P 500 Growth Index, While Small Value is based on the S&P 600 Value Index. Chart reflects the rolling 5-day cumulative market return difference between the two indices.
A few weeks later, small value has continued its streak of strong relative performance. The question on the minds of many investors is whether this will continue. Unfortunately, there is no way to know.
While nobody was calling for such a dramatic shift in relative performance in the days leading up to the CPI print, there are some reasons to believe the trend can continue. As we began the third quarter, valuations between the two market segments sat at an extreme level rarely seen in decades. While the spread between the two has undoubtedly narrowed over the last few weeks, large growth is likely still trading at a substantial premium to small value. As a result, it would not be unreasonable for small value’s relative outperformance to continue as the valuation spread normalizes.
Source: Morningstar Direct. Large Growth is based on the S&P 500 Growth Index, While Small Value is based on the S&P 600 Value Index. Valuations reflect the trailing 12m P/E ratio. Data from Jan 2001 through June 2024.
Decades of academic and practitioner research suggest smaller, more value-tilted companies tend to outperform over time. Taking advantage of these higher expected returns is not easy, however, because the strategy of tilting towards small-caps and value does not work all the time. It certainly has not benefited investors over the last 18 months.
When outperformance does arrive, it often comes in dramatic fashion and without warning. To ensure you capture those higher returns, it’s important to be in your seat already. There will never be a signal for investors to reposition their portfolios in advance. Instead, investors should maintain a disciplined and diversified approach that incorporates these portfolio tilts over the long term.
Week in Review
- Recent manufacturing data in the US has shown signs of picking up as industrial production advanced .6% in June, beating the consensus forecast of .3%. This was the second straight month of solid gains in industrial production. Meanwhile, the Philadelphia Fed released its July Manufacturing survey, a gauge for regional business activity, which showed that the index for future manufacturing activity jumped to the highest level in three years. Market participants will be focused on the ISM manufacturing reading on August 1st for further confirmation of improving manufacturing activity.
- The 30-year mortgage fell to 6.77% for the week ending July 18th, the lowest level in nearly four months. This has occurred as the market has priced in a 95% probability of a September rate cut.
- According to FactSet, 14% of the S&P 500 reported Q2 results as of last Friday, July 19th. The earnings growth rate, blended between companies that have already reported with the estimates for those that have yet to report, is at 9.7% year-over-year, which is above analyst expectations of 8.9%. Analysts will pay particular attention to the earnings results of AMZN, GOOGL, NVDA, and META as these four companies together have year-over-year earnings growth estimates of 56.4%, compared to a 5.7% aggregate growth rate for the other 496 companies. GOOGL earnings will be released after the close today, July 23rd, with META and AMZN reporting next week.
Hot Reads
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Markets at a Glance
Source: Morningstar Direct.
Source: Morningstar Direct.
Source: Treasury.gov
Source: Treasury.gov
Source: FRED Database & ICE Benchmark Administration Limited (IBA)
Source: FRED Database & ICE Benchmark Administration Limited (IBA)
Economic Calendar
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