By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors

As we enter the second half of the year, 2024 has continued to be very rewarding for investors in risk assets. The S&P 500 returned 15.3% through the end of June, primarily driven by the largest technology and communications stocks. Although bonds gained some ground in the second quarter, they were negative over the first half with a return of -0.7% as the 10-Year Treasury Rate rose from 3.9% to 4.4%.

For many months we have been in a state of holding our breath for what comes next. The election in November will have considerable global ramifications, the Federal Reserve seems intent on not acting on rates until at least September, and our economy is yet to show any major cracks. During this waiting phase, strong earnings and the artificial intelligence (AI) hype have kept stocks continually moving higher with relatively low volatility. Part of this resilience can be attributed to government intervention, however. Its exact effect is difficult to quantify, but ever since the pandemic, the government has used a wide array of tools to bolster economic activity and liquidity. Such a degree of priming is expected in a re-election year, but it does make one wonder how sustainable our economic strength is under the surface. All these factors make it almost impossible to be bearish in the near term, but it is also difficult not to harbor some skepticism.

One area of weakness has been housing, with activity essentially frozen, record high prices, and slumping building sentiment. Until rates begin to fall, it is unlikely to see demand or supply increase significantly. There has also been some minor weakness for consumers in areas like retail, but the consumer and labor markets are still quite robust.

As of the end of June, markets are assigning a roughly 60% probability to the Fed cutting rates in September, and they are also pricing in a second cut by the end of the year. Given unemployment below 4% and the stickiness of inflation, we think the market might be too optimistic on rate cut expectations, and we think we could be in a higher-for-longer regime. We are still experiencing the longest yield curve inversion in history, so if short rates don’t come down, we are cautious of the push higher in long rates that could come from an attempt at normalization.

Additionally, it is worth noting that over one third of U.S. outstanding marketable debt is maturing in the next year, meaning that interest expenses will likely continue to climb. As shown in the chart below, net interest cost as a percentage of tax revenues has been increasing significantly as rates have gone up. On our current trajectory, net interest expense is set to exceed both Medicare spending and defense spending in 2025.

2025 will also be a tremendously consequential year for tax policy due to expiring tax cuts from the Tax Cuts and Jobs Act, along with potential changes in Affordable Care Act subsidies, Inflation Reduction Act provisions, and more. It is too early to tell what will happen to these expiring tax cuts at this point, but we doubt that taxes will return to pre-Trump levels even if they are higher.

The election continues to be a source of uncertainty since the U.S. is essentially a 50/50 country. As mentioned in prior commentaries, the S&P 500 has performed similarly under both parties historically and has done well in re-election years, but some heightened volatility leading up to the election would not be surprising. The results of the last debate also introduced the possibility of Democrats replacing Biden on the ticket, although that still seems unlikely since they don’t have many strong alternatives at this time.

Investment Allocation

Our concerns about market concentration have only been exacerbated as the year has gone on. The 10 largest stocks in the S&P 500 have quickly climbed to make up 37% of its market cap, the highest level ever seen.

The main culprit has been NVIDIA, which returned 150% in the first half of the year and briefly became the world’s largest company in June. Even if the lofty valuations of NVIDIA and the mega-cap technology names are completely justified, their heightened exposure in market-cap weighted investing is concerning from a risk standpoint. Consequently, we are inclined to have a quality and value tilt compared to the index, with a particular focus on dividend growers. We are also exploring opportunities to benefit from the effects of AI on the economy without taking imprudent risks.

We continue to be attracted by the valuations of small and mid-cap stocks, although we are hesitant to be overexposed in the case that inflation gets a large second wind. Similarly, we like international valuations but are very aware of the potential headwinds of geopolitical tension, deglobalization, war, and fragile energy policies.

We have not made significant changes to our bond portfolio over the year, and we remain underweight in duration and overweight in quality versus the benchmark due to the attractive risk/reward profile of the short end of the Treasury curve. We are willing to extend duration if the yield curve steepens and add credit exposure if spreads widen.

In this environment, we also continue to see the benefit of alternative asset classes with low correlation to stocks and bonds, such as gold or managed futures. Stock and bond correlations have increased, and the diversification provided by alternatives can be valuable to reduce volatility.

Charts provided by Strategas Research Partners, LLC and J.P. Morgan Asset Management, Inc.

Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.


Daniel McGarvey, Porfolio AnalystDaniel is a Senior Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.