Highlights:
The S&P 500 rose 3.6% in June, with a year-to-date return of 15.3%, driven by mega-cap stocks.
Over 30% of the S&P 500 is concentrated in "the Magnificent Seven" stocks, influencing index performance.
Weakening economic indicators such as manufacturing data and consumer confidence underscore the disconnect between stock market performance and economic realities.
Looking at just the headline indices, June was another stellar month for stock investors. The S&P 500 Index was up 3.6% for the month, bringing the year-to-date return to 15.3%. But underneath this banner was a different story. The equal-weighted S&P was down for the month, as were the major mid-cap and small-cap indices. So, too, for the value indices. For the month, only three sectors, Technology, Consumer Discretionary, and Communication Services, beat the overall index. Six of the 11 S&P sectors were negative. More than 100% of the month's gains were concentrated in that coterie of mega-caps christened "the Magnificent Seven."
Today, a buyer of the S&P 500 is placing more than 30% of that investment in these seven stocks, so index investing alone provides inherent momentum behind their pricing. But the rise of these stocks, closely linked to the AI boom, is fundamentally an earnings story. This has been the case for some time. For instance, in the first quarter of this year, the blended earnings rate of the companies in the S&P 500 was 0.5%; without the Mag7, this dropped to -6.0%.* The equal-weighted S&P 500 has a forward price-to-earnings (P/E) of 16x; the Mag7's is 30x.
This bifurcation of earnings and stock returns suggests that the overall economy may not be as hot as the stock market, an intuition that has plenty of real evidence. Manufacturing continues to be soft, with the Purchasing Managers’ Index (PMI) dipping again in May, well below the 50 threshold, indicating contraction. Consumer confidence slipped in June, although not as much as feared in the face of persistent higher prices. The consumer is as bifurcated as the market, with affluent households buoyed by the rising stock market and cushioned by the relatively small percentage of income spent on goods. Meanwhile, wage gains at the lower end of the income spectrum have not been sufficient to cover the increased cost of goods and services, and these households are increasingly stressed. Small business sentiment confirms the division, with half of owners in the latest survey projecting conditions to worsen for the remainder of the year. Meanwhile, GDP is still expanding, albeit at a slowing rate, and the employment environment remains healthy, with the standard unemployment measure hovering near historic lows.
Persistent inflation and solid employment have conspired to keep hoped-for Federal Reserve cuts on hold. The rate of inflation dropped in June, but it did so at a pace that was uninspiring. While the consensus still points towards a quarter-point Fed cut in September, this minor shift seems unlikely to spark much change. High mortgage rates continue to throttle the housing market, and the yield curve seems stuck in its inversion.
Given the gap between stock market index returns and the underlying realities, we are discomforted with the animal spirits calling for a continued piling on to current market winners. We continue to seek ways to participate in the rally while moderating the risk we believe is inherent in extremely narrow markets.