This past week, I had a number of people ask me how much longer the stock market can continue to climb. From the outside looking in, this year’s rally must seem pretty curious. I have news for you; it appears that way from the inside looking out, too.
After all, the economic data has been mostly so-so thus far in 2024.
- Loan growth on bank balance sheets has been anemic.
- Not surprisingly, so has deposit and money supply growth.
- Housing affordability is a thing of the past, and small business owner optimism remains, well, kind of pessimistic.
In truth, there are a fair amount of headwinds.
Even so:
- The economy has continued to add jobs and growth through the first two quarters of the year.
- Corporations have been able to growth their earnings, and there is hope the Federal Reserve will eventually start cutting the overnight right.
- Further, innovation and technological advancement has been through the roof, as is evidenced by companies like NVIDIA, changing the world and biting off huge chunks of revenue.
So, there are also some tailwinds.
However, it would be a little nebulous to say the ‘market’ has soared this year, maybe even spurious. A better way of describing what has happened this year is: “huge tech companies have absolutely crushed it. Everyone else? Meh.”
What’s Happening in the Stock Market
Through the end of June,
- The S&P 500 Growth Index was up a staggering 23.56% in 2024, led by the tech sector which returned in excess of 28%.
- By comparison, the S&P 500 Value Index returned 5.79% for the same time period.
- Small-cap stocks? Please. They were up only 1.73%, and mid-caps were up a decent, but still far distant, 6.15%.
If you want to nerd out even more, “S&P 500 Semiconductor & Semiconductor Equipment Industry Group GICS 2 Index” soared (an apt word this time) 68.23% during the first two quarters of 2024. Over the last 2-years ending last month, this subsector index was up 218.42%, or 78.30% on an annualized basis.
As such, it is fair to say recent stock returns have been a little, shall we say, uneven. Then, something changed with the recent Consumer Price Index (CPI) report, which showed that inflation is slowing down at a faster pace.
This realization dispelled any doubt the Fed would cut the overnight rate this year. Cutting rates would make money cheaper, which has always led to more borrowing and lending in the past. Intuitively, that spurs money supply growth and economic activity. Further, cheaper money is great for small companies, who are traditionally more reliant on bank debt, usually floating, than larger ones (who can use the secondary markets).
Essentially, every rate cut results in lower debt service costs and higher profits for small cap stocks. Voila. What is not to like? In truth, a lot of people have been waiting for this trade, this asset class rotation, to happen. However, the speed with which it did has been spectacular.
The Tech Sector
For the 5-day trading period which ended on Wednesday, a full calendar week after the CPI announcement, those index returns which I listed above were as follows:
- S&P 500 Info Tech Industry, (5.47%)
- S&P 500 Growth Index, (3.95%)
- Semiconductors & Semiconductor Equipment, (10.86%)
- Large Cap Value + 3.80%; Mid-caps, (5.07%)
- Small Caps (as defined by the Russell 2000 Index), +9.17%
That is over a 1300 basis point swing from large-cap growth to small-cap core in 5 trading sessions. To say this is unusual would be an understatement. To that end, I can’t remember another asset class rotation this profound in such a short period of time.
But, how much longer will this continue? Further, does it mean now is the time to liquidate your tech holdings? Especially your semiconductor stocks and others associated with Artificial Intelligence (AI)? As Lee Corso might say: “not so fast, my friend.”
Do you remember the so-called “tech bubble” from 2000-2002, when the tech sector was down an eye-watering 68%, or thereabouts? That hurt, didn’t it? However, even with that bloodbath, from December 31, 1999 through June 30, 2024, the S&P 500 Info Tech Index was up 583.31%, or 8.16% when annualized. Compare this to the entire S&P 500’s 488.13%, or 7.50%, over that same time frame.
In essence, if you had taken your lumps in tech from 2000-2002 and ridden it out, you would still have done better than “the market” as a whole over the last 24.5 years. This by almost 17.5%, in aggregate. For anyone who remembers just how bad those days were, that seems crazy.
The reason for it is simple. Investors go to where the growth is.
Ask yourself this question: “over the next decade, will the U.S. and global economies spend more on technology or, say, soft drinks in both absolute and relative terms?” You shouldn’t have thought very long or hard on that. But why? The reason being is most products assume a consumer demand which is ultimately finite. There are only so many people in the world. They will only drink so much soda or eat so many hamburgers. They can only keep their lights burning 24-hours a day, max, or drive so many cars.
To be sure, there might still be a gracious amount of room to run before the markets become fully saturated with a finite product. But technology? What is finite about what is happening now? Further, what does the future hold?
In 1984, if you were alive, how many of you had ever had a Pepsi? Pretty much everyone, right? It tastes basically the same today, doesn’t it? Now, how many had an email address? A personal computer? A cellphone? A smartphone? A tablet? Used the Internet? Shopped online? Heard of cryptocurrencies? Made a reservation at a restaurant without talking to someone? Booked a flight the same way? Ever heard of accelerated computing, or what we call AI?
Shoot, I recently told my son I will be able to make economic presentations to his grandchildren and great-grandchildren long after I am dead. That may sound incredible, but it isn’t crazy…assuming someone would actually want to use my avatar and everything I will have loaded into AI (to enable the technology to think, talk and act like I do).
40 years is a blip of the smallest magnitude in the history of mankind, let alone the world. Imagine what the future holds! However, that doesn’t mean tech stocks will outperform over every abbreviated period. A 3-month span here of a 12-month one there. They won’t. However, consider the following list of companies:
| The American Cotton Oil Company |
| Distilling & Feeding Company |
| North American Company |
| The American Sugar Refining Company |
| General Electric Company |
| Tennessee Coal, Iron and Railroad Company |
| American Tobacco Company |
| The Laclede Company |
| The United States Leather Company |
| Chicago Gas Light and Coke Company |
| National Lead Company |
| United States Rubber Company |
Are you familiar with this list of companies? Do you know what its historical significance is?
Okay, I will cut the suspense. That is the very first Dow Jones Industrial Average, listed on May 26, 1896. They are all mostly finite companies producing finite products for a finite number of potential clients, regardless of the potential for growth.
Now, how about the following table? What make you of these names? I bet they are a little more familiar for many of you.
| Allied Chemical Corporation |
| Aluminum Company of America |
| American Can Company |
| American Express Company |
| American Telephone & Telegraph Company |
| American Tobacco Company |
| Bethlehem Steel Corporation |
| EI du Pont de Nemours & Company |
| Eastman Kodak |
| Exxon Corporation |
| General Electric |
| General Foods Corporation |
| General Motors Corporation |
| Goodyear Tire & Rubber Company |
| Inco Limited |
| International Business Machines Corporation |
| International Harvester Company |
| International Paper Company |
| Merck & Co. Inc. |
| 3M Company |
| Owens-Illinois, Inc. |
| The Proctor & Gamble Company |
| Sears Roebuck & Company |
| Standard Oil Co. of California |
| Texaco Incorporated |
| Union Carbide Corporation |
| United States Steel Corporation |
| United Technologies Corporation |
| F.W. Woolworth Company |
Okay, you probably guessed this is the Dow Jones Industrial Average from 1984, since I had used that year in an earlier example. Hmm. A lot of those companies simply aren’t around any longer, are they? If still around, they certainly aren’t as economically important or as relevant as they once were.
This has a point.
The sector rotation the markets have experienced over the last week, or so, has been tremendous. Frankly, it was arguably a little overdue. Fortunately, we had been anticipating it, and had positioned our strategies to outperform (at least on a relative basis) once the first of the rate cuts was a fait accompli.
However, longer-term? You, we, all of us want to be where the growth is. We want to skate to where the puck will be. So, will it be in cotton oil? Sugar refining? Lead? I am sure plenty of folks thought so in 1896.
Or will it be in photographic film? Steel? Nickel? Glass containers? Tires? Tobacco? Cans? Again, I am certain more than a fistful of investors in 1984 believed this to be true.
Now? The future is in the infinite. The products and services which we currently don’t know exist. That are merely science-fiction today. That is where you want to invest long-term. However, in the short-term, when those long-term dreams get a little too expensive for their own good, it is okay to buy some of that old, finite stuff.
Just don’t make a long-term portfolio out of inherent obsolescence. That is where the true headwinds are and will be. The tailwinds? That is where you will make your money, and they are infinite and ever changing.
Have a great weekend.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.