It’s hard to complain about the performance of the first half of the stock market and how it sets investors up for the rest of 2024 – hard, but not impossible. A 15% year-to-date total return in the S&P 500 is the 21st best run through June since 1900, according to Goldman Sachs. Among the years when the index was at least that much at this point, the rest of the year rose 72% of the time for a further average gain of nearly 9%. The reward collected by investors in US large-cap stocks per unit of risk has been extraordinary, the 12-month Sharpe ratio for the S&P 500 (return versus statistical volatility) more than three times the long-term average. The S&P 500 since the October 2023 correction low is up 33% for an annualized total return rate of 56%. Not only has the index’s smooth climb allowed its owners to sleep well at night, but the extreme calm has made it safe to snooze along with the market during the day. The S&P has gone eight sessions without a move of up to half a percent. Its worst daily decline during June was a paltry 0.4%. The CBOE Volatility Index is near a multi-year low of around 12, yet it looks positively rich compared to the S&P’s realized volatility over the past 30 days: just above 7, in VIX terms. There’s not much on the surface to dislike here, but that shouldn’t stop us from watching. Market Concerns The most popular objection to this happy story went this way from being the most obvious: Stellar returns have come mostly from a handful of large-cap companies, with typical companies lagging far behind. True to size: The market-cap S&P 500 has outperformed its equivalent version by more than ten percentage points this year. Without Nvidia’s accumulation of an additional $1.8 trillion in market value since January 1st, we wouldn’t have so many superlatives for the rare and rosy market performance of 2024. I’ve long argued that tighter rallies are still to come. legitimate, that money is chasing a scarce supply of high-conviction secular growth that is landing disproportionately on fundamentally stronger, insulated companies. I have also argued that the prevailing tone of frustration and complaint among investors toward this phase of high growth has in some ways helped maintain a useful wall of concern that would otherwise not exist in a market that is making record more than 30 in six months. What’s more, the equal-weight S&P is running at a 9% annual rate of return this year — not stellar, but not weak either. It would be more worrying if traditionally defensive sectors started to outperform to give a sobering economic signal. Credit conditions have grown slightly less steadily in recent weeks, albeit from extremely strong levels. Jeff deGraaf, founder of Renaissance Macro, has argued that the “strong effort” of the fourth-quarter rally brought with it positive implications for 3-, 6- and 12-month earnings. The three- and six-month forecasts were met, which leaves it expected to persist – with hiccups along the way – in the fourth quarter of this year. All this remains, perhaps the most plausible base case in fact – and yet, the perverse internal dynamics in this market may be building to more dangerous extremes that could make the bar more fragile under a period of stress. Not only have the past few days not been broadly inclusive, the direction of the S&P 500 has been the opposite of the daily breadth over the past month. Of course, this is partly a feature of the index concentration we’ve already noted (three stocks worth 20% of the S&P), but it still shows a certain sub-surface dissonance. The extreme tendency of individual stocks to go their own way often independent of the S&P is illustrated by the CBOE Implied Correlation Index here. It measures the expected market-based volatility of the major index members against that of the S&P 500 itself. This is both an observed pattern and an active tactical strategy. The so-called spread trade—shortening the volatility of an index while owning the volatility of a stock usually through options—has become popular. It goes without saying that a burst of market stress would overturn such trades, with unknown effect. Impeding Momentum A separate but weather-related piece has been the high-momentum stock’s recent sprint-and-stalling performance, which peaked more than a week ago as Nvidia hit a buying crescendo. This disruption of the step in the “momentum factor” resembles, in some respects, what happened in early March with a very similar change at Nvidia. That month, the market was held near the highs for a while through some useful rotations between the Magnificent Seven and the rest of the market. Until the end of March (the end of the previous quarter), when the broad bar peaked and the 5% S&P 500 pullback ensued—the only notable pullback in eight months. This setback in an overbought market at the end of the quarter coincided, of course, with a macro scare. Treasury yields edged higher by a range, the 10-year race toward 4.5% as tepid inflation readings forced a review of the Federal Reserve’s rate-cutting path and stark questions about whether the economy can afford “higher” rates. higher for longer”. Last Friday, as the quarter closed at a fresh intraday high, the index edged lower for the day despite a friendly PCE inflation report, while Treasury yields returned above 4.3%. If the election hurdle traders again became aware of the fiscal structure of whether the Trump tax cuts would be extended or what, the interaction remains to be seen. More broadly, of course, macro inputs have been softer but largely benign, consistent with an economy slowing toward a version of a soft recession, with oil prices in check, earnings forecasts hitting highs and inflation low enough to give the Fed some data-dependent flexibility. Investors still can’t be sure whether the Fed’s patience in holding rates at cycle highs since last July will outlast the market’s ability to wait for an “insurance” rather than an easing move. emergency”. Other niggling items to think about: Wall Street strategists have been scrambling to hit their year-end S&P targets (though they generally remain subdued), depleting the reservoir of skepticism that has fueled this bull market. Extreme hostile reactions to earnings disappointments in large-cap stocks hint at pockets of unreasonable expectations (Micron) and reflexive spring-loaded selling in fallen bellwethers (Walgreens, Nike). That’s because second-quarter consensus estimates haven’t been reduced to lower drag over the course of the quarter, as they usually are. The heavy but justified attention to mechanical and structural machinations hints at a market that is, in a sense, outgrowing its shell. We’ve spent weeks being treated to intense analysis and heated chatter about the massive options-expiration impacts due to the rapid growth of retail call purchases in the technology. How big is the dispersion trade? The long-short momentum “factor” has beaten the bar by itself some days. Not to mention the large index rebalancing and distorting effects of the diversification rules, which require a large swing in the weightings of Apple vs. Nvidia in the Technology SPDR. In 2018, Standard & Poor’s felt compelled to revamp the Communications Services sector to accommodate some of the big names fueling the technology sector (Meta, Alphabet, Netflix). Tech was cut back to 20% of the index from 26%; today it is at 32.5%. None of this is predictive of direction for stocks, and should never be “machines” or “quants” for what is ultimately an asset market price in economic reality. However, it is easy to observe greater friction these days between the underlying market and the vehicles used to drive it.
The S&P 500 returns 15% in the first half in a remarkably smooth ride