View from the Observation Deck

We update this post on an ongoing basis to provide investors with insight into the earnings beat rate for the companies that comprise the S&P 500 Index (“Index”). Equity analysts adjust their corporate earnings estimates higher or lower on an ongoing basis. While these estimates may provide a view into the expected financial performance of a given company, they are not guarantees. From Q2’20 through Q2'24 (the 17 quarters in today’s chart), the average earnings beat rate for the companies that comprise the Index was 78.2%.

As of 8/30/24, the sectors with the highest earnings beat rates and their percentages were as follows: Financials (87.1%); Health Care (85.7%); and Industrials (81.8%), according to S&P Dow Jones Indices. Real Estate had the lowest beat rate at 67.7%. The Real Estate sector also had the highest earnings miss rate (29.0% during the quarter).

As indicated in today’s chart, the percentage of companies in the Index that reported higher than expected earnings in Q2’24 stood 0.5 percentage points above the 4-year average of 78.2%.

The Index’s earnings beat rate outpaced the average in eight of the 17 quarters. More recently, the Index’s beat rate outpaced the average in just two of the past eight consecutive quarters. Keep in mind that the Q2’24 data in the chart reflects earnings results for 494 of the 503 companies that comprise the Index and is unlikely to change substantially in the coming weeks. 

FactSet reported that the blended, year-over-year (y-o-y) earnings growth rate for the Index stood at 10.9% as of 8/16/24. 

If the metric remains at that level, it will mark the highest y-o-y earnings growth rate for the Index since Q4’21 (+31.4%). Keep in mind, the Q4’21 results reflect favorable comparisons resulting from COVID lockdowns in 2020. For comparison, the five-year and ten-year average earnings growth rates for the Index were 9.4% and 8.4%, respectively. 

Takeaway: While earnings beats are generally viewed as positive for the overall market, they represent just one piece of an intricate puzzle. As today’s chart reveals, the earnings beat rate for the companies that comprise the S&P 500 Index has been below the average in many of the time frames presented. Despite this fact, the S&P 500 Index closed at 5,528.93 on 9/3/24, representing an increase of 54.57% on a price only basis from its most recent low of 3,577.03 (10/12/22). Notably, the Information Technology Sector’s earnings beat rate declined from 87.7% in Q1’24 to 78.5% in Q2’24. A higher percentage of companies in the sector missed their estimates as well. The sector’s earnings misses increased to 15.4% in Q2’24 from 9.2% in Q1’24. These factors likely contributed to the sector’s recent lackluster performance. From 7/31/24 to 9/3/24, the S&P Information Technology Index fell by 3.23% on a total return basis. Only Energy fared worse, declining by 4.07% over the time frame. For comparison, Financials, Health Care, and Industrials (the three sectors with the largest percentage of earnings beats this quarter) increased by 3.78%, 4.88%, and 0.56%, respectively, over the period.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry.

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View from the Observation Deck

Today’s blog post offers a visual representation of trends in money market fund assets over time. As the chart reveals, it appears that investors tend to increasingly utilize money market funds during times of turmoil such as the financial crisis in 2008 – 2009 and the COVID-19 pandemic of 2020. Recently, however, investors have been piling cash into money market accounts (see chart) despite compelling returns in the U.S. equity markets. A note about the chart: we use the federal funds target rate (upper bound) as a proxy for short-term interest rates, such as those offered by taxable money market funds and other savings vehicles. In our opinion, this proxy may offer insights into the potential effect of short-term rates on investor behavior.

• U.S. money market fund assets stood at a record $6.24 trillion on 8/21/24 (most recent weekly data), an increase of 5.9% from $5.89 trillion on 12/27/23.
  
• The S&P 500 Index increased by 19.20% on a total return basis between 12/29/23 and 8/23/24.

Below are several noteworthy points:

• Beginning in March 2022, the Federal Reserve (“Fed”) initiated eleven increases to the federal funds target rate (upper bound), raising it from 0.25% to 5.50% where it remains today.
  
• The Fed’s tighter monetary policy set the stage for disinflation, with the trailing 12-month rate of change in the Consumer Price Index declining from 9.1% in June 2022 to 2.9% in July 2024.
  
• Consumer expectations regarding the Fed’s policy rate changed dramatically over the last few months. As of 4/30/24, the federal funds rate futures market was pricing in just one rate cut totaling 28 basis points (bps) in 2024. For comparison, the same market projected four rate cuts totaling 103 bps on 8/23/24.

Takeaway: In previous posts on this topic, we wrote that tighter monetary policy and disinflation had benefitted money market investors by ushering in a period of positive real yields. While we maintain this stance, we also believe that the increased likelihood of near-term rate cuts could be fueling increased demand for money market products. In short, investors are locking in higher rates before they are gone. While we think it is healthy to take advantage of positive yield spreads, investors should be aware that allocations to less-risky assets may come at a cost. Money market funds offer principal stability and income, but their total return has lagged the S&P 500 Index, which surged by 26.26% on a total return basis in 2023, and 19.20% year-to-date through 8/23/24. We believe that an allocation to equities will continue to generate a higher return on capital than cash over time.

This chart is for illustrative purposes only and not indicative of any actual investment.

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The next blog post will be on Tuesday, September 5th.

View from the Observation Deck

Today’s blog post is intended to provide insight into the movement of bond prices relative to changes in interest rates. For comparative purposes, the dates in the chart are from prior posts we’ve written on this topic. Click here to view our last post.

Valuations for seven of the eight bond indices in today’s chart have improved since our last post, and all eight are significantly above their time series lows from October 2023.

In our last post on this topic, we wrote that the increased likelihood of cuts to the federal funds target rate led to a surge in fixed income valuations (fixed income yields and prices generally move in opposite directions). As indicated in today’s chart, that trend has continued in the months since, albeit with a few headwinds along the way. Notably, the start of the third quarter ushered in renewed concerns that the U.S. could fall into an economic recession. In the past two weeks economic reports have included a decline in construction, slower job growth, and mixed ISM indexes, according to Brian Wesbury, Chief Economist at First Trust Portfolios, LP. Should a recession become a reality, we expect the Federal Reserve would have no choice but to lower interest rates, which could increase fixed income valuations further.

The trailing 12-month rate of change in the Consumer Price Index (CPI) stood at 2.9% as of 7/31/24, down significantly from its most recent peak of 9.1% on 6/30/22.

The decrease in the rate of the CPI continues to be a welcome relief to bond investors and consumers alike. In fact, July’s CPI reading marks the lowest level for the metric since 3/31/21. Following their policy meeting in July 2024, the Fed voted to keep the federal funds target rate unchanged, marking the eighth consecutive meeting with no changes. Inflation’s non-linear decline, combined with mixed economic data has made predicting the timing of the Fed’s cuts incredibly difficult. At the close of 2023, the federal funds rate futures market was pricing in an 84.3% chance that the Fed would cut rates at its policy meeting in March 2024. As we now know, those cuts never materialized. Months later, on 8/13/24, that same market is predicting at least four cuts totaling 108 bps are likely by the Fed’s December 2024 meeting.

Takeaway: Echoing our findings in our last post on this topic, bond valuations have improved dramatically over the past six months. From our perspective, soaring bond prices can be attributed to surging expectations that the Fed could announce multiple interest rate cuts in the near-term. That said, timing the Fed can prove to be a fruitless endeavor, and markets react quickly to ever-changing data. Case-in-point, on 7/31/24, the federal funds rate futures market indicated less than three rate cuts totaling 73 bps were anticipated in 2024. On 8/13/24, not even two weeks later, data showed that more than four cuts totaling 108 bps were expected by year’s end. What should investors make of this data? In our opinion, these short-term fluctuations mask the bigger picture. Over the 30-year period ended 7/31/24, the federal funds target rate (upper bound) averaged 2.57% on a monthly basis, while the CPI averaged 2.5%. Should inflation remain subdued and economic data soften further, the Fed may have significant justification for normalizing the spread between interest rates and inflation over the coming months.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The Morningstar LSTA U.S. Leveraged Loan 100 Index is a market value-weighted index designed to measure the performance of the largest segment of the U.S. syndicated leveraged loan market. The ICE BofA U.S. High Yield Constrained Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA 22+ Year U.S. Municipal Securities Index tracks the performance of U.S. dollar denominated investment grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions with a remaining term to maturity greater than or equal to 22 years. The ICE BofA Fixed Rate Preferred Securities Index tracks the performance of investment grade fixed rate U.S. dollar denominated preferred securities issued in the U.S. domestic market. The ICE BofA 7-10 Year U.S. Treasury Index tracks the performance of U.S. dollar denominated sovereign debt publicly issued by the U.S. government with a remaining term to maturity between 7 to 10 years. The ICE BofA U.S. Mortgage Backed Securities Index tracks the performance of U.S. dollar denominated fixed rate and hybrid residential mortgage pass-through securities publicly issued by U.S. agencies in the U.S. domestic market. The ICE BofA U.S. Corporate Index tracks the performance of U.S. dollar denominated investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA Global Corporate Index tracks the performance of investment grade corporate debt publicly issued in the major domestic and Eurobond markets.

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The next blog post will be on Tuesday, August 27th

View from the Observation Deck

We update today’s table on a regular basis to provide insight into the variability of sector performance by market capitalization. As of the close on 8/9/24, the S&P 500 Index stood at 5,344.16, 5.70% below its all-time closing high of 5,667.20 set on 7/16/24, according to data from Bloomberg. The S&P MidCap 400 and S&P SmallCap 600 Indices stood 5.76% and 8.85% below their respective all-time highs as of the same date.

• Large-cap stocks, as represented by the S&P 500 Index, posted total returns of 12.96% on a year-to-date (YTD) basis thru 8/9/24, outperforming the S&P MidCap 400 and S&P SmallCap 600 indices, with total returns of 6.45% and 2.40%, respectively, over the period (see table).
  
  
• •    Both the S&P 500 and S&P MidCap 400 Indices crested to new all-time highs in 2024. The S&P SmallCap 600 Index has yet to recapture its pre-COVID high of 1,466.02 set on 11/8/21.
  
  
• Sector performance can vary widely by market cap and have a significant impact on overall index returns. Two of the more extreme cases in 2023 were the Communication Services and Technology sectors. In 2024, the Communication Services, Information Technology, and Utilities sectors all exhibit significant variability in performance across market capitalizations.
• Communication Services and Information Technology stocks, the two top-performing sectors in the S&P 500 Index YTD, represented 8.9% and 31.4%, respectively, of the weight of the S&P 500 Index on 7/31/24. By comparison, those sectors represented 1.5% and 8.9% of the S&P MidCap 400 Index, and 2.9% and 12.2% of the S&P SmallCap 600 Index, respectively, as of the same date.
  
  
• As of the close on 8/9/24, the trailing 12-month price-to-earnings (P/E) ratios of the three indices in today’s table were as follows: S&P 500 Index P/E: 25.00; S&P MidCap 400 Index P/E: 18.91; S&P SmallCap 600 Index P/E: 19.10.

Takeaway: Both the broader S&P 500 and S&P MidCap 400 Indices reached new all-time highs in July 2024, while the record high for the S&P SmallCap 600 Index occurred nearly three years ago on 11/8/21. Combined, the SmallCap and MidCap Indices comprised just 8.3% of the total market capitalization of the S&P 1500 Index as of 7/31/24. The last time (pre-COVID) that small and mid-sized companies accounted for 8.3% or less of the S&P 1500 Index’s market capitalization was on 4/28/00. Since then, the S&P MidCap 400 and S&P SmallCap 600 Indices notched average annual total returns of 9.25% and 9.32% respectivey (4/28/00 thru 8/09/24). For comparison, the average annual total return of the S&P 500 Index was 7.51% over the same period. While past performance is no guarantee of future results, it is our opinion that there may be potential benefits from exposure to small and mid-sized companies going forward.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. stocks with a small market capitalization. The S&P 500 Equal Weighted Index is the equal-weight version of the S&P 500 Index. The 11 major sector indices are capitalization-weighted and comprised of S&P 500, S&P MidCap 400 and S&P SmallCap 600 constituents representing a specific sector.

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View from the Observation Deck

Today's blog post is for those investors who want to drill down below the sector level to see what is not performing well in the stock market. The S&P 500 Index (“Index”) was comprised of 11 sectors and 126 subsectors as of 8/2/24, according to S&P Dow Jones Indices. The 15 worst-performing subsectors in today’s chart posted total returns ranging from -10.57% (Brewers) to -57.15% (Drug Retail) over the period. Click here to view our last post on the worst performing subsectors.

• As indicated in the chart above, 10 of the 15 worst-performing subsectors came from the S&P 500 Index Consumer Discretionary and Consumer Staples sectors (5 subsectors from each sector), followed by two subsectors from the Industrials sector. Drug Retail, a subsector of the Consumer staples sector was the worst performer, posting a total return of -57.15% for the period.
  
  
• Ten of the 11 sectors that comprise the Index were positive on a year-to-date (YTD) basis through 8/6/24. Consumer Discretionary was the only sector with a negative total return (-1.91%). The second and third-worst performers were Materials and Real Estate, with total returns of 4.35% and 5.62%, respectively. For comparison, the Index posted a total return of 10.74% during the period.
  
  
• The most heavily weighted sector in the Index was Information Technology at 30.71% as of 8/2/24, according to S&P Dow Jones Indices. For comparison, the Financials sector was second highest with a weighting of 12.97%.

Takeaway: Since the start of August, the S&P 500 Index has declined by 5.83% on a total return basis (thru 8/7). The sharp selloff stands in stark contrast to the first seven months of the year when the Index delivered a total return of 16.69%. Several sectors have sold off substantially more than others. Since the start of August (thru 8/7), the Consumer Discretionary, Information Technology, and Energy sectors declined by 9.99%, 9.11%, and 5.81%, respectively. For comparison, those same sectors had increased by 7.41%, 25.57%, and 13.27% on a total return basis, respectively, during the first seven months of the year. The Consumer Discretionary and Consumer Staples sectors combined account for 10 of the 15 worst-performing subsectors in today’s chart. As always, there are no guarantees, but there could be some potential deep value opportunities in this group of subsectors. For those investors who have interest, there are a growing number of packaged products, such as exchange-traded funds, that feature S&P 500 Index subsectors.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry. 

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View from the Observation Deck

In September 2018, the Telecommunications sector was renamed the Communication Services sector as part of a broad reconstitution of the S&P 500 Index. The number of constituents in this sector expanded from just a handful of telecom carriers to 22 companies today. The new members have brought more diversification to the sector via exposure to the internet, media, and entertainment industries (see subsectors in chart above). These companies were formerly members of the Information Technology and Consumer Discretionary sectors. Click here to view our last post on this topic.

As indicated in the chart above, the S&P 500 Communication Services Index (Communication Services Index) has significantly underperformed the S&P 500 Information Technology Index (Information Technology Index) and fallen short of the broader S&P 500 Index since its inception.

Of the eleven sectors that comprise the S&P 500 Index, the Communication Services Index was the worst performer in 2022, posting a total return of -39.89%. In 2023, the sector experienced a significant turnaround, posting a total return of 55.80%, second only to the Information Technology Index which boasted a total return of 57.84% during the year.

With a total return of 20.33% on a year-to-date (YTD) basis through 8/2/24, the Communication Services Index is the best performing sector so far this year. The S&P 500 Utilities and the S&P 500 Information Technology Indices were the second and third-best performers with total returns of 19.24% and 18.93%, respectively, over the same period.

From a valuations and earnings perspective, the outlook for the Communication Services Index appears more optimistic than the broader market, in our opinion.

Using 2024 consensus earnings estimates, the Communication Services Index had an estimated price-to-earnings (P/E) ratio of 18.87 as of 8/2/24. For comparison, the S&P 500 Index had an estimated P/E ratio of 22.25 as of the same date.

Bloomberg's consensus 2024 earnings growth rate estimate for the Communication Services Index stood at 23.42% as of 8/2/24, representing the highest estimated earnings growth rate of all eleven sectors that comprise the S&P 500 Index. For comparative purposes, the 2024 estimate for the S&P 500 Index was 9.40% as of the same date.

Takeaway: Of the eleven major sectors that comprise the S&P 500 Index, the Communication Services Index posted the highest total return (+20.33%) on a YTD basis through 8/2/24. In our view, unprecedented interest in Artificial Intelligence (AI) continues to drive valuations within the sector. Since its inception in 2018, however, the Communication Services Index has underperformed both the S&P 500 Information Technology Index (another major benefactor of surging interest in AI) and the broader S&P 500 Index. That said, the recent performance of the Communication Services Index has been strong and could be reflective of market-topping earnings growth expectations in 2024. Revenue growth looks promising as well. The sector is forecast to produce revenue growth of 6.78% and 6.93% in 2024 and 2025, respectively, compared to 4.99% and 5.71% for the S&P 500 Index. In our view, if those expectations are met, the sector could continue to produce outsized returns.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry. 

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View from the Observation Deck

Investors directing capital into U.S. mutual funds and exchange traded funds (ETFs) continued to favor passive investing over active management for the 12-month period ended 6/30/24.

Passive mutual funds and ETFs reported estimated net inflows totaling $652.18 billion for the 12-month period ended 6/30/24, while active funds reported estimated net outflows totaling $358.44 billion over the same period. The top three active categories with net inflows over the past 12 months were Taxable Bonds, Nontraditional Equity, and Alternatives, with inflows of $100.10 billion, $21.36 billion, and $9.75 billion, respectively (see table above). For comparison, the top three passive categories were U.S. Equity, Taxable Bond, and International Equity, with inflows of $356.99 billion, $209.11 billion, and $78.45 billion, respectively.

Despite compelling total returns in the broader equity markets, equity mutual funds and ETFs suffered net outflows over the trailing 12-month period, while fixed income mutual funds and ETFs saw inflows.

Combined, the active and passive equity categories experienced outflows of $24.92 billion for the 12-month period ended 6/30/24. For comparison, the Taxable and Municipal Bond categories reported net inflows totaling $313.47 billion over the same time frame. The S&P 500, S&P MidCap 400, and S&P SmallCap 600 Indices posted total returns of 24.54%, 13.55%, and 8.58%, respectively, for the 12-month period ended 6/28/24, according to data from Bloomberg. With respect to foreign equities, the MSCI Daily Total Return Net World (ex U.S.) and MSCI Emerging Net Total Return Indices posted total returns of 11.22% and 12.55%, respectively, over the same time frame.

Takeaway: Passive mutual funds and ETFs saw inflows of $652.18 billion compared to outflows of $358.44 billion for active funds over the trailing 12-month period ended 6/30/24. In the table above, we observe that the U.S. Equity category experienced the largest disparity, with active shedding $290.53 billion compared to inflows of $356.99 billion for passive funds. Notably, despite compelling total returns in the broader equity markets, equity funds suffered net outflows of $24.92 billion over the trailing 12-month period. For comparison, fixed income saw combined net inflows of $313.47 billion over the same time frame. From our perspective, investor expectations of an impending rate cut could account for the recent surge in fixed income fund flows. Morningstar noted that flows into taxable-bond funds totaled $230 billion during the first half of 2024, representing nearly 87% of all U.S. fund flows over the period. Of that total, $112 billion was allocated to actively managed bond funds.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. companies with a small market capitalization. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI World (ex U.S.) Index is a free-float weighted index designed to measure the equity market performance of developed markets.

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View from the Observation Deck

While companies have a number of ways in which to return capital to shareholders, cash dividends and stock buybacks have been increasingly popular methods corporations have utilized in recent years. Apart from Q3’22, Q2’23, and now Q1’24, dividend distributions steadily increased over today’s set of observations. In contrast, share buybacks account for a larger share of total capital disbursements despite greater variance.

• Combined, stock dividends and share buybacks totaled $1.410 trillion (preliminary data) over the trailing 12-month period ended March 2024, down from $1.431 trillion over the same period last year.
  
  
• Dividend distributions totaled $151.6 billion in Q1’24, down from a record $154.1 billion in Q4’23. The Q1’24 result represents just the third quarter-over-quarter decline in total dividend distributions for the period presented in today’s chart. In total, the companies that comprise the S&P 500 Index (“Index”) distributed a record $593.1 billion as dividends over the trailing 12-month period ended in March 2024, up from $573.7 billion over the same period last year. For comparison, the previous record was $588.2 billion, which was distributed over the 2023 calendar year.
  
  
• Stock buybacks stood at $236.8 billion in Q1’24 (preliminary data), up from $219.1 billion in Q4’23. Stock buybacks totaled $816.5 billion over the trailing 12-month period ended in March 2024, down from $857.2 billion over the same period last year.
  
  
• In Q1’24, the S&P 500 Index sectors that were most aggressive in repurchasing their stock were as follows (% of all stocks repurchased): Information Technology (24.2%); Communication Services (19.1%); and Financials (18.2%), according to S&P Dow Jones Indices.

Takeaway: Despite a slight contraction in Q1’24, the Index’s trailing 12-month dividend distributions increased to a record $593.1 billion. Investors often view dividend increases and initiations as signs of financial strength, while cuts and suspensions can be viewed as signs of weakness. Year-to-date through 7/25, there have been nine dividend cuts and zero suspensions in the Index compared to 15 cuts and four suspensions from January through July of last year. Buybacks surged during the quarter, increasing to $236.8 billion, their highest total since the record $281.0 billion in Q1’22. When ranked by total buyback expenditures, the top 20 companies in the Index accounted for 50.9% of all share buybacks in Q1’24, down from 54.1% in the previous quarter. For comparison, the historical average for the metric is 47.5%.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. 

To Download a PDF of this post, please click here. 

View from the Observation Deck

As represented in the chart above, a seismic shift in the performance of small cap stocks relative to their large cap counterparts appears to be underway. In light of this, we set out to review several of the factors we think set the stage for this environment. Our data set covers just nine business days commencing with the final day of Federal Reserve (“Fed”) chairman Jerome Powell’s most recent testimony to the Financial Services Committee on 7/10/24. For reference, the chart above includes the price-only returns of the largest 100 stocks in the S&P 500 Index (the S&P 100 Index), the S&P 500 Index, and the S&P Small Cap 600 Index normalized to a factor of 100.

• On 7/8/24, prior to Powell’s address, the federal funds rate futures market indicated there was a 72.0% chance that the Fed would cut its policy rate at its September meeting. That expectation surged following his remarks, rising to 98.0% on 7/23/24.
  
  
• Historically, the Fed’s policy rate has nearly matched the rate of inflation.
  • Over the 30-year period ended 6/30/24, the federal funds target rate (upper bound) averaged 2.57% on a monthly basis. Inflation, as measured by the 12-month change in the consumer price index (CPI) averaged 2.5% over the same time frame.
  • Comparatively, the federal funds target rate (upper bound) stood at 5.50% at the end of June, well above June’s CPI reading of 3.0%.
    
    
• Valuations for small cap stocks appear to be more attractive than their large cap counterparts. In fact, the price to earnings (P/E) ratio of the S&P Small Cap 600 Index currently sits at 16.29 compared to its 10-year average of 24.75 (as of 7/24). For comparison, the P/E ratios of the S&P 100 and S&P 500 Indices stood at 25.57 and 23.90, above their 10-year monthly averages of 20.83 and 21.13 as of the same date. Notably, year-over-year earnings for the S&P Small Cap 600 Index are estimated to decline by 5.48% in 2024 before becoming increasingly favorable the following year. In 2025, earnings are estimated to increase by 19.46% for the S&P Small Cap 600 Index, compared to 13.69% and 13.66%, respectively, for the S&P 100 and S&P 500 Indices.
  
  
• For reference, the price only returns for the indices in today’s chart were as follows (7/10/24 – 7/23/24): S&P 100 Index (-2.51%), S&P 500 Index (-1.39%), S&P Small Cap 600 Index (+8.92%).

Takeaway: Perhaps unsurprisingly, smaller companies are often more dependent on outside capital than their larger counterparts, who generally operate in a state of going concern. Given that equity valuations can vary based on the cost of raising capital (internally or externally), an easing in monetary policy would likely have an outsized impact on small cap valuations relative to other market capitalizations. Will the Fed cut rates in September? We don’t know, but the market appears increasingly certain of that outcome. Another noteworthy point is that the spread between the federal funds target rate (upper bound) and the CPI remains well-above historical norms. We expect small cap valuations could benefit from a narrowing of that spread, over time. In addition, small cap stocks remain a relative value compared to their peers. The trailing 12-month P/E ratio for the S&P 100 and S&P 500 Indices stood at 25.57 and 23.90, respectively, as of 7/24/24, above their 10-year monthly averages of 20.83 and 21.13. The S&P Small Cap 600 Index had a P/E of 16.29 as of the same date, well below its 10-year average of 24.75.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 100 Index is a capitalization-weighted index based on 100 highly-capitalized stocks selected from the S&P 500 Index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P SmallCap 600 Index is an unmanaged index of 600 companies used to measure small-cap U.S. stock market performance.

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View from the Observation Deck

Today's blog post is for those investors who want to drill down below the sector level to see what is performing well in the stock market. The S&P 500 Index was comprised of 11 sectors and 126 subsectors on 7/19/24, according to S&P Dow Jones Indices. The 15 top-performing subsectors in the chart posted total returns ranging from 68.40% (Semiconductors) to 20.60% (Tobacco). Click here to view our last post on the top performing subsectors.

• As indicated in the chart above, the Financials sector had the most subsectors (4) represented in the top 15 performers on a year-to-date basis. Information Technology had three subsectors represented in the top 15 over the same time frame.
  
  
• With respect to the 11 major sectors that comprise the S&P 500 Index, Information Technology posted the highest total return for the period captured in the chart, increasing by 27.02%. The second and third-best performers were Communication Services and Financials, with total returns of 23.47% and 14.84%, respectively. The S&P 500 Index posted a total return of 16.30% over the period.
  
  
• As of 7/19/24, the most heavily weighted sector in the S&P 500 Index was Information Technology at 31.86%, according to S&P Dow Jones Indices. For comparison, the Communication Services and Financials sectors had weightings of 9.02% and 12.82%, respectively.
  
  
• Using 2024 consensus earnings estimates, the Information Technology and Energy sectors had the highest and lowest price-to-earnings (P/E) ratios at 36.68 and 12.74, respectively, as of 7/22/24 (excluding Real Estate). For comparison, the S&P 500 Index had a P/E ratio of 24.23 as of the same date.

Takeaway: The Information Technology, Communication Services, and Financial sectors accounted for 52.42%, 15.08%, and 9.20%, respectively, of the total return of the S&P 500 Index YTD through 6/28/24, according to data from S&P Dow Jones Indices. With a total return of 27.02%, technology stocks are the top-performer in the S&P 500 Index YTD through 7/19/24, followed closely by communication services companies (23.47%). Notably, four of the 15 subsectors in today’s chart come from the S&P 500 Financials sector, which happens to be the third-best performer YTD with a total return of 14.84%. For those investors who may have an interest, there are a growing number of packaged products, such as exchange-traded funds, that feature S&P 500 Index subsectors.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry.

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