Continued High Equity Markets
Equities continued to reach record level highs driven by investor optimism. During the third quarter of 2024, the Russell 3000 Index gained 6.2%. Large cap stocks, as measured by the Russell 1000 Index, gained 6.1%. Small cap stocks outperformed large caps, gaining 9.3%.
On a style-orientated basis, small cap stocks outpaced mid and large cap stocks for the quarter, with small cap Value stocks in particular the best performing style/size category. The outperformance by small caps occurred solely during the month of July, significantly outpacing large cap stocks for the month (+10.2% versus +1.5% as measured by the Russell 2000 and 1000 indices, respectively). Throughout July, investors temporarily rotated out of large caps and into small caps, however, this rally was short lived as large caps outperformed small caps in August and September. On a year-to-date basis, large cap stocks have outperformed small cap stocks.
During the third quarter, the group of stocks known as the Magnificent 7 performed in line with the S&P 500, a departure from previous periods. Only three of the Magnificent 7 stocks (Tesla, Meta and Apple) had positive returns on the quarter, with the remaining four stocks experiencing negative returns. Despite the relative lackluster performance of the mega cap tech stocks, the equity market experienced a more broad-based rally during the third quarter. Currently, 77% of stocks in the S&P 500 are trading above their 150-day moving average, a high not seen since May 2024.
Foreign developed markets gained 7.8% for the quarter. Foreign emerging markets outperformed developed markets, gaining 8.7% for the quarter. China’s Hang Seng Index reached a 52-week high during the quarter as government stimulus measures were initiated in an attempt to mute a slowdown in that country’s economy.
The second quarter of 2024 earnings results for the S&P 500 came in relatively strong, posting a 13% year-over-year earnings growth rate, higher
than the 10.5% growth rate expected earlier in the year. Almost 80% of companies reported earnings that beat analysts’ expectations, with all sectors posting relatively solid results.
Recent Inflation Metrics Abating Favoring Long-term Duration Stocks
Recently released inflation metrics have abated from their previous relatively high levels. In combination with other recent economic releases, the market is anticipating two further rate cuts by the Federal Reserve in 2024 and three to four rate cuts in 2025. This prospective interest rate environment bodes well for longer-term duration stocks, particularly from relatively lower interest rates. Additionally, those companies who require borrowing to fund their capital expenditure programs will also stand to benefit in a relatively lower interest rate environment.
Near-term Opportunities
We continue to remain cautiously optimistic regarding United States equities into the latter part of 2024 and into 2025. Forecasted earnings growth for large cap stocks continues to drive stock market gains as the mega cap companies have been able to deliver on expected earnings growth and have generally provided guidance for future years that this will continue. The S&P 500 is currently trading at a relatively high 21.4X for the next 12 months price-to-earnings ratio (NTM P/E), which is at the high end of its historical range. However, when looking at valuations via earnings growth metrics, the S&P 500 is trading in the midrange of its long-term price/earnings-to-growth (PEG ratio) average. The Information Technology sector, which may appear expensive strictly on a P/E basis, is forecasted to deliver a higher rate of earnings growth than the broad index, and yet, trades at a slight discount to the broad index on a PEG ratio basis. Other sectors, which may appear relatively cheaper on a P/E basis such as Consumer Discretionary and Consumer Staples, are expected to deliver lower earnings growth than the broad index, yet trade at a higher PEG ratio than the index.
Calendar Year (CY) 2024 year-over-year earnings growth for the S&P 500 has been lowered slightly since earlier in the year but is expected to be approximately 10%, which is more in line with long-term earnings growth average. Sectors expected to lead earnings growth include Information Technology and Communication Services. CY 2025 year-over-year earnings growth is expected to be 15%, outpacing the CY 2024 growth forecast. Small cap stocks have seen their earnings forecast recently lowered, however, positive earnings growth is still expected in 2024. We continue to favorably view United States large cap earnings stocks based upon analysts’ earnings growth forecasts.
Valuations in foreign developed markets are currently relatively lower. The MSCI EAFE Index (EAFE) is currently trading at 14.0X NTM P/E. However, earnings growth forecasts for international stocks trail the United States Analysts and are currently forecasting 8% year-over-year earnings growth for EAFE for CY 2024. The P/E discount versus the United States indicates that investors are willing to pay a premium for higher forecasted earnings growth.
Consistent Earnings Growth at Reasonable Valuations
While there is some uncertainty regarding future economic trends both in the United States and overseas, as well as divergent views on the future interest rate environment, we continue to adhere to our proprietary process regarding stock selection. Sustainable earnings growth, above average returns on invested capital and reasonable valuations continue to be our chief tenets in company selection in our portfolio construction process. We strive to capture upside returns in the market while managing portfolio risk. By adhering to this proven process, we are confident in our long-term ability to produce consistent risk-adjusted returns.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.