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Market Commentary

Monthly Financial Markets Commentary — August 31, 2024

Stocks advanced in the month of August, but there was a rotation into small caps and other value plays. It remains to be seen whether this is a durable rotation. The consensus on Wall Street remains that the Federal Reserve Bank has engineered a soft landing, with little chance of a recession. However, recent data that indicates soft hiring and sales, particularly in the retail and consumer spaces, gives some investors pause. There are also indications that notwithstanding tremendous investment, A.I. is yielding very little in the way of revenue, and even less in terms of profits. This has caused many of the A.I. stock plays to move sideways in the last month.

Breadth in the market has improved somewhat but still remains narrow with the "Magnificent Seven" accounting for most of the recent gains in the indices. Too much attention is probably being paid to these seven stocks, however, as there are many other stocks that are also quite expensive by historical standards. These stocks are outside the technology area, but have been dubbed "quality" stocks, for consistent earnings, dividends, etc. They retain the moniker of "quality" investments regardless of the price to which they have risen.

By traditiional measures stocks are overvalued but investors view them as safe, since they have risen the most and not endured significant long-term losses. The equal-weighted S&P 500 Index has returned far less than the cap-weighted S&P 500 Index, demonstrating the disproportionate effect of these stocks. By historical measures, such as price-earnings, price-to-sales, market-cap-to-GDP, Schiller CAPE Ratio, stocks are significantly overalued.

For 2024 the S&P 500 Index, the capitalization-weighted broadest measure of U.S. stock market performance, has returned 19.41%. The Nasdaq Composite Index, another capitalization-weighted index, but more reflective of growth stocks, has returned 18.43%. Finally, the Dow Jones Industrial Average, a price-weighted index, has returned 11.61%. All returns are on a total return basis in that they include dividends.

The Morningstar U.S. Aggregate Bond Index, a broad measure of the U.S. bond market, has returned 3.16% for the year, as interest rates have fallen since the start of the year. Investors have cheared falling inflation and believe the Fed will cut short-term rates 100 basis points by the end of the year. But there are several trends that do not auger well for longer-term interest rates. The government is running gargantuan deficits and it is unclear who the buyers of all this newly issued debt will be (probably not China or Japan, the traditional buyers of U.S. government debt). Investors have largely attributed falling short-term interest rates to positive factors such as falling inflation; however, an alternate interpretation is that rates are falling due to decelerating economic activity, stretched consumer and corporate balance sheets and woes in commercial real estate.

The sectors in the equity market that have performed the best in 2024 are Communications Services, Financials and Information Technology at 21.9%, 20.5% and 26.1%, respectively. Energy, Real Estate and Consumer Discretionary have fared the worst at 8.0%, 8.3% and 5.8%, respectively. The softness in Real Estate is over concerns of credit and financing, particularly with respect to the office properties. It is surprising that regional banks have risen given that they are at the epicenter of likely problems in commercial real estate loans.

The comparison of current price/earnings ratios and dividend yields as of August 31, 2024 to those of the prior year is as follows.

* based on 12-month trailing data

It is to be noted that much of the advance in markets so far is due to multiple expansion rather than fundamental factors such as increasing earnings.

Gold and crude oil most recently traded at $2.515.75 and $73.50, respectively, compared to $1,975.55 and $82.75 one year earlier. Gold has risen in reaction to global political instability and increased holdings by all central banks; crude oil has fallen recently due to softness in the global economy. Year to date Gold has outperformed the S&P 500 index.