2Q24 Letter: "Head Fakes"

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Business Update

During the first half of 2024, Evolve Investing continued its growth trajectory. Our assets under management are up 24% year to date, driven by the addition of several new clients and solid performance across our managed portfolios.

Rate Cut Expectations Have Shifted

In June, Federal Reserve officials laid out projections for just one interest rate cut in 2024, well below March forecasts for three interest rate cuts. While inflation has moderated meaningfully from its 2022 peak, it has proved stickier than Fed economists expected. As a result of continued strong economic growth, Fed officials and investors have been questioning whether rate cuts are appropriate this year.      

Consumer Price Index (CPI) and Core CPI, Last 5 Years

Generally, the Fed tends to focus on the job market when considering the health of the overall economy. And for several quarters, U.S. job market has proved more resilient than anticipated. However, last week’s report from the Labor Department indicated some cooling. Specifically, for June the unemployment rate ticked up to 4.1%, compared to 4.0% the prior month and 3.6% a year ago. Average hourly earnings were up 3.9% y/y, the smallest gain since 2021. 

These data support the narrative that the economy is slowing, but not enough to justify the aggressive rate cutting path that was forecasted earlier this year. They also support the expectation for “soft landing” or “no landing” scenarios. Based on 30-Day Fed Funds futures pricing data, investors expect a 25bp rate cut in September, followed by the same in December.

Earnings Season in Focus

With Federal Reserve officials in “wait-and-see” mode, I expect corporate earnings to be the primary driver of stock market gains throughout the balance of the year. Earnings season kicks off this week, and companies in the S&P 500 are expected to report 8.8% y/y growth in profits, the largest increase since 1Q22.

Similar to the last several quarters, the Communication Services and Information Technology sectors – which include megacap technology companies such as Apple, Microsoft, Nvidia, Alphabet, and Meta – are expected to demonstrate outsized growth in profits. Nvidia, which is the third largest company in the S&P 500 by market cap, is expected to grow 2Q24 earnings by 132% y/y.

With the top 10 companies in the S&P 500 accounting for 37% of its market capitalization, an increasing focus is placed on a small group of companies to drive market returns. Valuations remain stretched, with S&P 500 stocks trading at 21.4x their projected earnings over the next 12 months, compared with the five-year average of 19.7x. It is more important than ever for these companies to deliver with respect to earnings growth and forecasts.

How We’re Positioning

As I look toward the back half of 2024, I am focused on earnings growth and actions of the Federal Reserve. Generally, I expect the larger S&P 500 companies to meet earnings expectations, and will be paying close attention to longer-term forecasts. While the Federal Reserve has delayed its original rate-cutting path, I expect interest rates to trend downward in the near-term.

Liquidity in the financial system remains abundant. Specifically, money-market fund balances increased to over $6 trillion for the first time in February, and have remained at that level. With rates expected to decline in the near-term, it’s possible that this sidelined money could be deployed into equities or higher-yielding fixed income.

Money-market Fund Balances, Year to Date

My equity portfolios include exposure to the Information Technology and Communication Services sectors, and I expect the lower rate path to benefit fixed income over a longer-term time horizon. In addition to equities, several of my portfolios contain investment grade and high yield corporate bonds as well as venture debt, asset classes that would benefit from a rate-cutting cycle, in my view.  

Please reach out anytime to discuss any of the above themes and how your portfolio is positioned. And as always, thank you for your continued support and confidence in Evolve Investing.

Best,

Peter Hughes, CFA, CEPA®