Asset class recap for August
August was a good month for both stocks and bonds, continuing a multi-month strong price growth trend. In the table below, all of the high-level asset classes we track except Small Cap Stocks had a positive return in August. In the Year-to-Date column, we can see that all asset classes except Long Term Bonds are on track for an above average year.
The S&P 500 hit its all-time high closing price on 7/16/24 and has shown some choppiness since then, but remains near its high level. The first three business days of August had an eyebrow raising 6.1% drawdown in the S&P 500 index caused largely by a few disappointing macroeconomic readings and bad Intel earnings, but the market fully recovered within the next seven business days. This sort of heightened volatility is typical of stock markets when they cross new high levels. When prices appreciate sharply, it can take a while for earnings to catch up and for valuations to return to an equilibrium level.
Value stocks outperformed Growth stocks in July and August. Quarterly earnings and future revenue guidance from some companies that benefitted from the recent A.I. price run-up have not been quite as high as some investors were hoping and questions about just how profitable large investments in A.I. related projects might be have led some analysts to revisit their discounted cash flow models to make downward adjustments.
Small caps were our worst performing asset class in August, with price losses. Economic uncertainty impacts them more strongly than it impacts larger corporations – in particular, the looming threat of higher corporate tax rates, additional regulations, and less interest rate cuts for 2024 than expected at the start of the year have put pressure on Small Cap Stocks.
International Stocks are showing signs of life, as the MSCI EAFE index outperformed the S&P 500 index during July and August. The Euro strengthened versus the U.S. Dollar in July and August, with the Euro costing $1.071 at 6/30/24, but costing $1.108 at 8/31/24, for a drop of 3.5% in the Dollar’s purchasing power so far this quarter. This currency shift adds return to the MSCI EAFE for U.S. investors who are not employing a hedging strategy (which we feel is an unnecessary expense for long term diversified investors). As the U.S. Fed gets closer to cutting interest rates, the Dollar gets less attractive because bond investors may earn higher yield on bonds denominated in alternative currencies.
Bonds have enjoyed a solid run since 5/1/24, as the yield on the 10 Year Treasury Bond has been steadily dropping. 10 Year Treasury Bond yields dropped 0.17% in May, 0.17% in June, 0.23% in July, and 0.20% in August. Many investors have been exiting shorter term debt and CDs in favor of longer-term debt, to lock in rates at today’s levels for an extended time period in anticipation of U.S. Fed short term rate cuts. While recent bond returns look good from a short, one-year time frame, they still have a long way to go to fully recover from their 8/2020 to 10/2022 rising rate cycle induced drawdown.
Looking Forward
We have a solid Value overweight in the majority of our portfolios (we don’t implement Growth / Value tilting in portfolios with very low equity levels) that has been working out well. As Value stocks have outperformed Growth stocks in July and August, the gap between valuations for Growth and Value has started to shrink, but is still at historically wide levels. We will hold onto our Value overweight until we see the valuation gap shrink much further.
During mid-July, we made a slight shift away from international stocks and into large cap and small cap U.S. stocks. This shift has worked against us, but our rationale for the shift has not changed, so we are staying with this tilt. There has been a lot of discussion among politicians about adding tariffs, taxes, or other financial and non-financial burdens to non-U.S. corporations. If these changes come to pass, we expect these changes to be detrimental to non-U.S. stock returns.
Among bonds, we are continuing to maintain our duration underweight. The yield curve is starting to steepen, making longer term bond yields more attractive, but we feel that long bonds are not yet worth the duration risk that comes with owning them. When the Fed starts to lower their overnight lending rate, we expect our short-term bonds to appreciate in price as their fixed coupons are more attractive than lower yielding new issues with similar maturity dates.
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