Mid-Year Report

July 1, 2024

Stocks Score Record Highs; Fed Disappoints, But AI Doesn’t

John Bonnanzio

"Market Outlook" and "Fund Commentary" have been combined to provide a more seamless overview of the markets and Fidelity’s fund performance at mid-year.

Thank you, NVIDIA! Thank you, because it wasn’t all that long ago that stock (and bond) investors were counting their chickens well before they hatched. In the fourth quarter, talk was pervasive that 2024 would see four and maybe six interest-rate cuts. Perhaps not in the first half of this year, but certainly by the end of it.

Though it’s unclear what will unfold in the next six months, the odds of four cuts this year are now about zero, NVIDIA can’t fuel investor euphoria forever, consumer spending is slowing, and control of Congress and the presidency are on the line. Will the markets climb this wall of worry? Please read on...

Rate Cuts Must Wait

To recap, Jerome Powell & Co. haven’t made progress. Lest we forget, in the immediate aftermath of Covid shutdowns, inflation neared 9%. Now down to 3.3%, the road to the Fed’s 2% long-term target seems fanciful unless, of course, there’s a recession.

Slow Growth, But Growth
Among the reasons why its goal may be unattainable is Washington’s unconstrained spending. Then again, if $1.2 trillion in deficit spending so far this year has an upside it’s this: since November 2023, federal money has started to pour into 40,000 (yes 40,000!) infrastructure projects of every imaginable (and unimaginable) variety. From bridge repairs, to rural high-speed internet service and electric recharging stations, long-neglected repairs are both growing the economy and pushing up prices.

On that score, the economy held another big surprise for investors in the first half: there was no recession. In fact, real GDP grew at an annualized rate of 1.4% in the first quarter. And if the Conference Board estimates hold, inflation and higher interest rates could restrain second- and third-quarter growth to about 1% apiece. Though hardly blowout growth, it’s better here than elsewhere. Notably, the World Bank projects the U.S. economy to grow 2.5% this year versus 2023, whereas the Euro region and Japan are both facing real GDP growth of 0.7%.

The Bad News
While record-high stock and home prices and the associated "wealth effect" that trickle down to other parts of the economy is real and beneficial, there are signs of Main Street’s fortunes slowing.

That small uptick in the nation’s unemployment rate, from 3.7% at the start of the year to 4.0% in May, translates into an estimated 1.5 million lost jobs. And even as inflation has recently moderated, pocketbooks continue to be squeezed by an economy that has seen inflation remain above 3% for 38 continuous months.

Food prices are up 20% since 2020, and "shelter" is in a state of crisis — if you don’t already own a home. Nationally, rents are up 24% during that same period. Meanwhile, record-high home prices, 7% mortgage rates (a 20-year high) and elevated construction costs are keeping the American dream out of reach for millions. According to the National Association of Home builders, only 37.7% of new and existing homes are affordable to families with the national medium annual income of $96,300. That sets its affordability index at a 12-year low.

Another pocket of worry is consumer spending. While wage growth has been good owing to the tight labor market, it has also been uneven.

Consumer spending should grow 1.5% on an annualized basis in the first half. But with the Fed Funds rate at a restrictive 5.25-5.50%, that will be hard to match in the second half. Indeed, loan delinquencies on cars and credit cards, especially among lower-income families, is on the rise. And with pandemic-era personal “savings” depleted, consumer optimism fell in the second quarter. Spending habits are changing, including a shift away from name-brand goods to generic store brands.

(This month we downgraded Select Consumer Staples from OK to Buy to Hold.) Discretionary spending on travel and leisure may also slow.

Against that backdrop, the first half of 2024 was remarkably strong for share prices. Granted, the AI mania had a lot to do with market bullishness generally, though specifically, NVIDIA’s rising prospects were especially beneficial.

Nevertheless, the market’s gains weren’t fueled by unbridled optimism. The practical rationale for higher stock prices was future earnings growth.

On that score, year-over- year earnings growth in 2023 was a meager 1% (though that didn’t keep the S&P 500 from surging 26%!). Stocks rose in large part over expectations that lower interest rates would fuel bigger profits down the road. And that may yet happen.

FactSet’s aggregation of analysts’ estimates suggest S&P 500 earnings will grow 11.3% this year and 14.4% in 2025. Moreover, growth should be widespread by sector, though information technology and health care are likely to fare especially well. Indeed, the five best-performing Select funds this year are in those two arenas.

Market Indexes
In the second quarter, the Nasdaq Composite soared 8.5% — nearly a typical year’s worth of equity gains! In June alone, it rose 6.0%, leaving it with a year-to-date return of 18.6%.

The more diversified (less-tech-rich) S&P 500 gained 3.6% in June, 4.3% in the second quarter, and a comparable 15.3% for the first half. As for the Dow Jones Industrial Average, its performance was saddled partly by Boeing, but its heavier exposure to economically sensitive cyclicals like autos and chemicals depleted its second quarter return to -1.3%, though it rose 4.8% for the first half of the year.

2024's Best & Worst Funds

Small cap stocks, which are particularly interest-rate sensitive, performed best early this year when it appeared that inflation was under better control. But the second quarter proved more difficult. Down 1% in June, the Russell 2000 retreated 3.3% over the past 91 days. Nevertheless, those earlier returns were enough to keep the index positive (up 1.7%) for the year-to-date.

Mid-cap shares performed much the same. Down 0.7% in June, the Russell Midcap fell 3.3% in the second quarter but managed a year-to-date gain of 5.0%.

Stock Funds
How important was NVIDIA to last month’s fund performance? As you’ll read — very. But with the stock also lifting the broader tech sector, large-cap growth funds fared extremely well. Indeed. Fidelity’s 14 offerings in that market segment rose 4.9% in June. The second quarter’s 6.5% gain was also impressive, while lifting the category to a 22.3% year-to-date return.

As for large-cap blend funds, which are more typically benchmarked against the less tech-dense S&P 500, 14 funds returned an average of 2.4% in June, and a more modest 3.3% for the second quarter. Again, if that doesn’t seem like much, their 15% return half way in the year eclipses an average year of gains.

Turning to large-cap value and everything else, negative returns for June and the quarter were pretty much the norm. That disconnect to larger-cap funds highlights the fact that while the Nasdaq and S&P 500 have enjoyed gargantuan returns this year (and last), gains have been concentrated in a narrow band of the market.

To that point, OTC and Large Cap Growth Index were June’s top performers with gains of 6.8% and 6.7%, respectively. As for Fidelity’s most widely held actively managed offerings, Contrafund rose 4.4% in June, though it was topped by Blue Chip Growth’s 5.7% return.

International Funds
Foreign developed markets haven’t held a candle to our own this year. International Index fell 2.1% in June, leaving it with a comparatively shabby (with emphasis on comparatively) year-to-date gain of 5.5%.

The same cannot be said of developing market funds. Using China Region (up 3.7% in June) as one proxy and Latin America (down 8.6%) for another, their diverging fortunes suggest that Emerging Markets (up 4.6%) and Emerging Markets Index (up 3.2%) wouldn’t have fared so well last month. In addition, the stronger U.S. dollar and high interest rates are two more negatives for the asset class. So why their relative strength? Some developing economies are enjoying GDP growth (thanks to improved productivity), while others stand to benefit from stronger-than-expected U.S. demand for their exports. And with our markets up sharply since 2023, investors’ assets have been flowing into these less liquid markets. Not to be overlooked, many emerging market economies issue dollar-denominated bonds, which make them sensitive to U.S. interest rates. In June, Treasury yields declined (see chart).

Fidelity’s 31 flavors of international funds rose, on average, a scant 0.l% June, but have gained 6.9% for the year-to-date (again, thanks largely to emerging market funds). Note: Worldwide, which is up 21.6% this year, is 68% weighted in U.S. stocks, while its largest holding at 7.6% is NVIDIA.

High Yield Bond Funds
Typically more sensitive to the economy (GDP) than to rate-risk, high-yield (junk) bonds rose fractionally in June. Capital & Income (which holds some stocks) and High Income both gained 0.8%. New Markets Income, which invests in emerging market debt, rose 0.6%.

Fixed-Income Funds
With scattered signs that inflation is easing, Treasury yields fell last month. Notes and Bonds maturing in five-plus years fared best as double-digit falling yields took hold. With bond prices moving inversely to their yields, the benchmark 10-year Treasury fell 15 basis points to 4.36%. As such. U.S. Bond Index gained 1.1% in June, though it’s still down slightly for the year (-0.6%).

Treasury Bond Yield Curve

As for Fidelity’s most interest-rate-sensitive bond fund, Long-Term Treasury Index, it gained 1.6% last month.

As for state-specific muni funds, which tend to have durations just above six years, most gained around 1.6% in June.

Finally, with the Fed still sitting on its hands this year, the yield on Gov’t Cash Reserves has been stuck at 4.99%; it has so far returned 2.5% this year.

— John Bonnanzio