As we cross the halfway mark of 2024, investors are witnessing bifurcated results for the various stock market indices. The S&P 500 index has registered mid-teen percentage returns, led by a handful of large technology companies. The extent of the enthusiasm over the future of artificial intelligence is reflected in the fact that market darling Nvidia is nearing the top of the leader board in terms of largest global companies measured by its stock market capitalization of over $3 trillion. In fact, Apollo Chief Economist Torsten Slok recently noted that the gains in shares of Nvidia this year accounted for over one-third of the 500 stock average.
The problem is that many of the other 499 stocks in the S&P 500 are severely lagging the leadership stocks. Evidence of this is reflected in the much weaker performance in the equal-weighted S&P 500 index and the Russell 2000 index of small capitalization stocks. Thus, one could argue that more broadly, the equity markets are struggling. One could attribute this to the slowing of the economy, relatively high interest rates and the lack of a growth catalyst.
Because of the underperformance of so many companies and sectors this year, we have no intention to reduce allocation to equities, despite record highs in the S&P 500 index. In our judgment, many laggards are poised for improvement in the second half and into 2025. We note that in the last presidential election year of 2020, broad market performance lagged the large cap stocks for most of the year. But the Russell 2000 index saw stellar returns of over 31% in the fourth quarter of 2020 versus the 12.1% return for the S&P 500. The Russell 2000 index ended 2020 with higher returns than the S&P 500 despite trailing badly for most of the year.
Of course, stock market performance in the second half will likely depend on the direction of the Federal Reserve and the prospects of interest rate cuts that nearly every pundit had expected at the beginning of the year. Signs of increased stickiness in inflation will likely cause the Fed to remain cautious and to keep short-term interest rates at the current 5%+ level. In that case, all bets are off.
Deficits Don’t Matter! Or Do They?
Back in 2002, when the Bush Administration was considering ways to stimulate economic growth, Treasury Secretary Paul O’Neill pushed back on the idea of a second round of tax cuts, saying that the country was headed for a “fiscal crisis.” At that time, the country was running an annual deficit of about $158 billion, or less than 1/10th the size of our current annual deficit. Vice President Dick Cheney retorted that “deficits don’t matter.” O’Neill was fired and the Bush administration continued to rack up deficits.
What is interesting is that Federal fiscal deficits have been growing during every administration since the turn of the century. Yet the Federal government has been able to finance its burgeoning debt. So was Cheney correct that “deficits don’t matter?”
We are becoming increasingly concerned about the deficits which show no signs of abating. Fiscal deficits were historically relegated to weak economic periods when the economy needed stimulus. Yet, our fiscal deficit will be about $2 trillion even as the economy remains in growth mode. In the meantime, interest rates have risen and financing that debt will become increasingly costly to finance.
While we do not believe that deficits matter in the short term, there are no signs that the U.S. economy can withstand fiscal irresponsibility forever. We will be closely monitoring the patience of Treasury security investors to finance the growing deficits without a further rise in interest rates and a potential cost to economic performance. While we are not suggesting that “the sky is falling,” we believe that politicians could very well discover that deficits do indeed matter.
This article is provided for informational and educational purposes only. The information contained herein is not intended and should not be construed as individualized advice or recommendation of any kind. Where specific advice is necessary or appropriate, individuals should contact their professional tax, legal, and investment advisors or other professionals regarding their circumstances and needs.
Any opinions and forward-looking statements expressed herein are subject to change without notice. The information provided herein is believed to be reliable, but we do not guarantee accuracy, timeliness, or completeness. It is provided “as is” without any express or implied warranties.
There is no assurance that any investment, plan, or strategy will be successful. Investing involves risk, including the possible loss of principal. Nothing herein should be interpreted as an indication of future performance.
Index definitions: The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. The S&P 500 Equal Weighted Index is the equal-weight version of the S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company is allocated a fixed weight and rebalanced quarterly. The Russell 2000 is an index that tracks the performance of the Russell 3000’s 2000 smallest firms.
The indexes are unmanaged and cannot be directly invested in. Past performance is no indication of future results.
Investment Advisory Services are offered through Mariner Independent Advisor Network (MIAN), an SEC Registered Investment Adviser. Caplan Capital and MIAN are not affiliated entities.