Stembrook Market Review - Second Quarter 2024

Following a strong start to the year, stock market indices continued to advance in the second quarter. Despite the S&P 500 being up 4.3%, this price appreciation has been concentrated in a few mega-cap, technology stocks that have been driven by exposure to artificial intelligence, most notably NVIDIA and Microsoft.¹ If we study the same group of 500 stocks on an equal weighted basis, the index was actually down -2.6% in the quarter.² This is also true for global stocks. The global market cap weighted benchmark was up 2.4%,³ while the equal weighted index fell -1.7% in the second quarter.⁴ This type of divergence has only happened 5 times in the past 30 years.⁵

The US economy remains on solid footing, despite recent weakness in employment. The unemployment rate increased from 4.1% to 4.3% in July, though this is primarily attributable to an increase in the participation rate and not a loss of jobs.⁶ This follows a pattern of weaker jobs data for the past few months, which has weighed on the minds of investors. This led to a selloff in equity markets that began in the US, and spread abroad. This selloff was amplified by positions that had been levered in Japanese Yen. Due to the recent weakness in the Yen, investors had borrowed the currency to make investments both in the country and in markets abroad, such as the US equity market. On July 31^st the Bank of Japan announced that they would be raising short-term interest rates from 0.1% to 0.25%. This caused demand for the Yen to surge, pushing up exchange rates. Borrowers were forced to exit positions, which amplified the selloff across global markets. Highly valued technology stocks bore the brunt of the selloff, but stocks across the board suffered losses. U.S. markets remain up by nearly 11% for the year, but we did experience a rather dramatic selloff in a short period of time. It is worth noting that this -8.5% drawdown took place over a period of just over 2 weeks.⁷ The VIX index, a measurement of fear among investors, spiked to its highest level since March of 2020. Since this spike, market volatility has eased and stocks have rallied. Going forward all eyes will be on the U.S. Federal Reserve's next announcement. Market participants expect the Fed to lower rates by 0.25% at the very least following their meeting in mid-September. Many are calling for a 0.50% cut due to signs of weakness in employment and fear of a recession.

Historical Drawdowns

Large cap U.S. stocks tend to experience an average drawdown of 15% over the course of a calendar year.

Our proprietary models forecast long-term, pre-tax returns ranging from 3% to 5% for fixed income-like asset classes and 9% to 10% for equity-like asset classes (see Expected Market Returns and Risks table). We maintain target-weight allocations to equities and fixed income. Our more detailed observations and current portfolio positioning are outlined in the following comments.

Expected Market Returns and Risks 7-10 Year Horizon

A sampling of return expectations produced by our models. Expected returns are projections and are not guaranteed.

Historical Market Returns

Historical market returns as of June 30th 2024. Note that looking backwards at recent returns is not a reliable method of predicting future returns.

Yields Across Asset Classes

Yields are an indicator of future returns. Orange dots show current yields, blue bars show historical ranges.

Economic Backdrop

In their most recent April 2024 release, the IMF projected that global economies would grow at a 3.2% rate adjusted for inflation in both 2024 and 2025. This forecast is consistent with the 3.2% growth rate in 2023.⁸
Economic growth is expected to decelerate slightly over the next two years from 4.3% in 2023 to 4.2% in 2024 and 2025. The Indian economy remains the leader of this group, economists expect the economy to grow by 6.8% this year and 6.5% next year.⁸
Inflation is beginning to cool on a global level as most central banks have enacted tighter monetary policies. Economists expect the period of high inflation to be behind us. Global inflation is expected to fall to 2.3% this year from a level of 3.1% in 2023.⁸
The pattern of disinflation continued in the US. Through June, the rate of inflation has been 2.4% year-to-date. Prices have increased by 3% over the last 4 quarters, only slightly above the 10-year average.⁹

Currencies

The U.S. Dollar was relatively unchanged in the second quarter, up less than 1%.¹⁰

Equities

Stocks continued to rally after a very strong start to the year.
Growth-oriented technology stocks in the U.S. continued to build on previous gains, with the NASDAQ up 11.3%.¹¹
Non-U.S developed stocks were up by 5.2% over the course of the quarter.¹²
Emerging markets stocks were among the weakest relative performers of the quarter, but still finished up 4.8%.¹³
Small cap stocks in the U.S. had the strongest performance for the quarter, returning over 13.7%.¹⁴

Fixed Income

For the most part, bond prices in the U.S. remained unchanged in the quarter, with investment grade bond prices increasing by 0.07%.¹⁵
Municipal bonds outperformed the broad index, up 4.3% in the quarter.¹⁶

High yield bonds continued to deliver above average returns, up 4% in the quarter.¹⁷
Non-U.S bonds also continued to rally, up 3.4% in the quarter.¹⁸

^{Global Asset Class Returns}

Returns are arranged in columns, by year. Each color represents a different asset class. Each year, the leaders and laggards tend to shift. Diversification across a range of asset classes can smooth returns and enhance growth.

Current Positioning

Out of an abundance of caution, we shifted our cash in traded money market funds from a prime fund (holds a combination of commercial paper, repurchase agreements, CDs and Treasuries) to one that holds only Treasuries, backed by the full faith and credit of the U.S. government. We sacrificed very little in yield by making this transition.
We have sold our inflation-linked bond positions for taxable and tax-deferred investors as the yields have become less attractive than nominal Treasuries on a relative basis.
We maintain our neutral duration position in fixed income portfolio as interest rates have risen to levels that are closer to historical averages.
We maintain our overweight to developed non-U.S. and emerging market equities, where valuations and long-term return potential remain attractive.
We also maintain our underweight to large cap U.S. equities.
We favor lower priced, value-oriented equities, both in the U.S. and abroad, which tend to outperform the broad market over time, with less volatility. While these stocks did not keep pace with some of the tech oriented growth names in the first half of 2024, we are excited about the return potential going forward.

We continue to focus our efforts on helping you meet your financial objectives by following our disciplined investment approach. Our approach uses return and risk models, incorporating fundamental valuations and tax-efficient strategies. This investment discipline is tailored to your individual situation in our continuing effort to craft and implement your customized investment solution.

We are keeping an eye on legislation regarding the tax cuts related to The Tax Cuts and Jobs Act that are scheduled to sunset at the end of 2025, most notably the potential reduction in the estate and gift tax exemption. We will continue to keep you informed as we learn more about this.

As always, we thank you for placing your trust in our investment management and advice and welcome your questions and comments at any time.

Peter & Tom

Endnotes and Sources:

Text:

Morningstar: S&P 500 Total Return. 3/31/24-6/30/24.
Morningstar: S&P 500 Equal Weight Total Return. 3/31/24-6/30/24.
Morningstar: MSCI ACWI All Cap NR USD. 3/31/24-6/30/24.
Morningstar: MSCI ACWI All Cap Equal Weight NR USD. 3/31/24-6/30/24.
Charles Schwab Investment Management.
Bureau of Labor Statistic: Unemployment Rate as of 7/30/24.
Morningstar: S&P500. As of 8/6/24.
IMF World Economic Outlook: April 2024.
Bureau of Labor Statistics: CPI For All Urban Consumers. 6/30/24.
Barchart: $DXY—U.S. Dollar Index. 3/31/24-6/30/24.
Morningstar: NASDAQ 100 TR. 3/31/24-6/30/24.
Morningstar: MSCIE EAFE NR USD. 3/31/24-6/30/24.
Morningstar: MSCI EM NR USD. 3/31/24-6/30/24.
Morningstar:: S&P 600 Total Return. 3/31/24-6/30/24.
Morningstar: Bloomberg US Aggregate Bond Total Return. 3/31/24-6/30/24.
Morningstar: S&P Intermediate Term National AMT Free Municipal Bond Index Total Return. 3/31/24-6/30/24.
Morningstar: Bloomberg US Corporate High Yield TR USD. 3/31/24-6/30/24.
Morningstar: FTSE WGBI Non-USD. 3/31/24-6/30/24.

Charts:

Historical Drawdowns: As of 8/6/24.

Source: Morningstar, JP Morgan Research, Stembrook Research.

Expected Market Returns and Risks, 7-10 Year Horizon: As of 6/30/24.

Source: Stembrook Research.

(1) Volatility is measured in terms of Standard Deviation. Standard deviation is the statistical measurement of dispersion about an average, which depicts how widely a stock or portfolio’s returns varied over a certain period of time. Investors use the standard deviation of historical performance to try to predict the range of returns that is most likely for a given investment. When an investment has a high standard deviation, the predicted range of performance is wide, implying greater volatility. If an investment’s returns follow a normal distribution, then approximately 68 percent of the time they will fall within one standard deviation of the mean return of the investment, and 95 percent of the time within two standard deviations. For example, for a portfolio with a mean annual return of 10 percent and a standard deviation of two percent, you would expect the return to be between 8 and 12 percent about 68 percent of the time, and between 6 and 14 percent about 95 percent of the time. Source: Morningstar.

Historical Market Returns: As 6/30/24.

Source: Morningstar, Stembrook Research.

Indices: Bloomberg Barclays U.S Treasury Bills 1-3 Month Total Return, Bloomberg Barclays Municipal Bond 5 Year (4-6) Total Return, Bloomberg Barclays U.S. Aggregate Bond Total Return, Bloomberg Barclays U.S. Corporate High Yield Total Return, FTSE All Equity REIT Total Return, S&P 500 Composite Total Return, S&P SmallCap 600 Total Return, MSCI EAFE Total Return, MSCI EM (Emerging Markets) Total Return, Consumer Price Index – U.S., S&P 10 Year U.S. TIPS Total Return, Bloomberg Commodity (Total Return) Index.

Yields Across Asset Classes: As of 6/30/24.

Sources: Cash Equivalents Yields since March 1976. Ibbotson, Federal Reserve Bank, Thomson Reuters, Municipal Bond Yields since March 1988. Barclays Capital, Charles Schwab, BofA Merrill Lynch, Standard & Poor's/Investortools Municipal Bond Indices, Investment Grade Bond Yields since March 1976. Barclays Capital, High Yield since December 1984. BofA Merrill Lynch, Barclays Capital, Real Estate (Public) Earnings Yield since March 1976. NAREIT all Equity, Large Cap U.S. Equity Earnings Yield since March 1976. Standard & Poor's, BARRA, Mid Cap U.S. Equity Earnings Yield since June 1991. Standard & Poor's, BARRA, Small Cap U.S. Equity Earnings Yield since December 1993. Standard & Poor’s, BARRA, Developed Europe Equity Earnings Yield since March 1976. MSCI Europe, Standard & Poor's Europe 350, Developed Pacific Equity Earnings Yield since March 1976. MSCI Pacific, S&P/Citi PMI Asia Pacific, S&P Asia 50, Emerging Market Equity Earnings Yield since December 1998, Inflation-Linked Bond Real Yield to Maturity since March 1997. Citi Yield Book, Federal Reserve Bank. Note: Yields are not perfect predictors of future returns and should not be used in isolation.

Global Asset Class Returns: As of 12/31/23.

Source: Thomson Reuters, Bloomberg, Morningstar, Stembrook Research.

Indices: Consumer Price Index – US, U.S. 30-Day Treasury Bills, Bloomberg Barclays U.S. Treasury Bills: 1-3 Month Index, Citigroup Inflation-Linked Index, S&P 10 Year US TIPS Index, Bloomberg Barclays U.S. Aggregate Bond Index, BofA Merrill Lynch U.S. High Yield Cash Pay, Bloomberg Barclays U.S. Corporate High Yield Index, Dow Jones Wilshire REIT Index, FTSE All Equity REIT Index, S&P 500 Composite Total Return, S&P SmallCap 600 Total Return, MSCI EAFE Index, MSCI EM (Emerging Markets) Index, Dow Jones AIG Commodity (Totl Ret) Index, Bloomberg Commodity Index.

Disclosures

This material is intended to inform you of products and services offered by Stembrook Asset Management, LLC (“Stembrook”). Stembrook is a New Jersey Registered Investment Advisor.

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. The opinions, estimates, and investment strategies and views expressed in this document constitute the judgment of Stembrook, based on current market conditions and are subject to change without notice. The investment strategies stated here may differ from those expressed for other purposes or in other context.

Past performance is not indicative of future results.

The obligations and securities sold, offered, or recommended are not deposits and are not insured by the FDIC, the Federal Reserve Bank, or any governmental agency.

The views and strategies described herein may not be suitable for all investors. This material is presented with the understanding that it is not rendering accounting, legal or tax advice. Please consult your legal or tax adviser concerning such matters.

Important note regarding Stembrook’s capital market expectations.

The capital market expectations developed by Stembrook Asset Management are estimates of both a central tendency of asset class behavior and a probable range of asset class behavior over a long-term horizon. These estimates are one of many inputs used in the portfolio construction process, and should not be used independently. These expectations should not be construed as the returns that will be achieved, but merely those that may be achieved if certain assumptions hold true. Also note that each client's portfolio may differ given specific goals and constraints applied to the portfolio construction process.

Additional information is available upon request.