Mitchell Anthony
Mag 7 Stocks Boom in 2nd Quarter Despite Higher Rates
Mag 7 Stocks Boom in 2nd Quarter Despite Higher Rates Magnificent Seven stocks gain 17% in 2nd Quarter! The US economy finally seems to be on a path of slower growth; however, interest rates still remain quite high, causing investors to ponder why. At the same time, earnings growth for corporate America is waning as higher inflation has pushed wages up and corporate margins down. The areas of the US economy that are growing are narrow and centered on very strong secular consumption themes of artificial intelligence, web computing, cybersecurity, digital devices, and obesity. The broader part of the US economy is not benefiting from these consumption themes, and it is mostly benefiting the magnificent seven and a few other mega-cap names. The long-awaited decline in interest rates that investors have been anticipating has been hampered by growing US debt. US government debt is now over $36 trillion and has grown from $12 trillion since 2010, and from $25 trillion to $36 trillion just over the last four years. As a result of this alarming acceleration in debt, investors are demanding higher returns on US treasury debt. The spread that US treasury debt pays over inflation is in excess of 200 basis points, which is close to a historic high. (Figure 1) Normally, US treasuries yield approximately 1% more than the inflation rate. That would put treasury rates at 3.6%, but they are currently yielding 4.6%. Economic Review Q2 2024 Work from Home There are several economic themes at play in the US economy. Working from home has been adopted and pushed by employees of corporate America and began during COVID. US employees have become comfortable with the unaccountability of working from home and many have refused to come back to the workplace. Tight employment has allowed these themes to continue. Employers want control back and have been monitoring the work that is being done at home by their employees. Employees have been found cheating and using keyboard software to imitate work while they leave their homes and do personal errands. Wells Fargo fired dozens of those employees last month who were caught with this software on their workstations at home. Employers are partially winning the battle, and it seems like we have a hybrid model that is being embraced where employees are required to be in the office at least 2 to 3 days per week. Regardless, this has been a headwind for productivity, but fortunately, it has been offset by artificial intelligence that is allowing employers to do work without as many employees. US Debt at Troubling Levels As noted above, US debt is rising as budget deficits get worse, compounded by a decline in perceived credit quality for US treasuries. (figure 2) US debt service relative to GDP is at an all-time high, further stretching deficits. It is uncertain what the endgame will be and could be drastically different given a Trump victory versus a Biden victory. Economic Growth The growth rate of the US economy is slowing, and GDP last quarter was only 1.4%. (figure 3) At the same time, corporate profits have gone flat for most of corporate America. Margins are eroding with higher costs of wages. The number of companies with strong earnings growth is a short list and seems to be related to the consumption themes noted above. US Consumer The status of the US consumer is difficult to pin down. On one hand, the US consumer is enjoying wages that are growing above the inflation rate, while on the other hand, consumers seem to be at the end of reasonable capacity to consume. The amount of debt they have accumulated does not seem excessive yet with what is measurable, although there is phantom debt in the US economy related to buy-now and pay-later type terms being offered by many retailers across corporate America. It is estimated that phantom debt is currently over $300 billion. Consumer sentiment has fallen, as has consumer confidence. Personal income and personal consumption are showing modest growth, but only because of population growth, and actual per capita consumption is in decline. Nominal retail sales are flat, and inflation-adjusted retail sales are in significant decline. Existing home sales have been flat and are now turning lower, and new home sales are starting to break to the downside a bit as well. Mortgage delinquencies are trending higher but still at very low levels. The industrial and manufacturing side of our economy remains in a modest decline that began more than a year ago. Durable goods have declined, and only consumer services have tilted upward. Inflation Data The inflation picture is improving steadily as both CPI and PPI have trended lower and are getting closer to the Fed's targets. This is occurring alongside steady but slower growth. Housing and insurance are still rising and are the strongest part of the inflation report. While inflation is trending lower, US debt is rising exponentially, keeping yields up despite lower levels of inflation. Financial Market Review The financial markets have enjoyed three consecutive quarters of outstanding performance. The last quarter was again great for equities, but market leadership has narrowed with the magnificent seven far outperforming the S&P 500. The MAG 7 was up 17% vs. 4.3% for the S&P 500. MACM’s Dynamic Growth (DG) advanced 7.5%, 320 basis points more than the S&P 500. It was a difficult quarter for fixed income, whether you owned treasuries, corporate bonds, mortgage bonds, or municipal bonds. For the most part, they all lost money as interest rates tilted a bit higher during the quarter. Intermediate treasuries lost over 2%, while short-term treasuries and municipal bonds were mostly flat. As inflationary expectations subsided during the quarter, concerns built about the creditworthiness of the US government, and as a result, treasuries lost ground. The reckless spending by Congress and the current White House expanded government debt by over $10 trillion over the last four years. (figure1) Just not a great time to own fixed-income securities. Bitcoin and Alternatives Bitcoin lost ground, as did other alternative investments like real estate and commodities. Real estate investment trusts mostly fell, with the XLRE dropping 1.9% and the IYR declining a bit over 1%. Housing REITs did a bit better. Bitcoin declined by over 13%. In the equity arena, large-cap growth stocks continued to far outperform value stocks, as represented by IWF vs IWD. (figure 4) From a sector perspective, tech and communication services were the front runners, gaining 8.8% and 5.2% in the quarter, while materials, energy, and industrials lagged with losses of 2-4%. The secular growth theme that favors the magnificent seven is the wind at the back for growth. At the same time, the slow-growing global economy is a headwind for value-oriented industrials and financials. Foreign markets performed poorly, with both Europe and China producing returns half the amount of the US markets. These export-based economies are struggling in a world of slower growth and with no participation in innovation or technology-driven productivity enablers. Money has likewise stayed away from small-cap stocks that need stronger overall growth to thrive. Economic Outlook The global economy is growth-challenged despite employment being very strong, but this is being offset by higher costs of borrowing money and a consumer who remembers those 1% rates and thinks they’re coming back. Employers are unhappy that their employees want to work from home, and it is unclear how this will play out. It seems like employees will have their way until the economy busts. Employment is likely to weaken just a bit, but not enough to bring down rates. Possibly by the end of the year, but not likely. There is some slight weakness brewing from the consumer, and it will likely get a bit worse. It seems unlikely that the economy will grow through this inflation problem quickly. Either a bust or a long two-year period of soft growth would end the cycle for inflation, but it doesn’t seem like a bust is on the horizon. While new home sales have held up well, it seems like the recent trend of weakness is going to continue, and strength is not on the horizon. Higher prices and higher borrowing costs have hit spending on goods, and consumer services are now likely to follow with weakness for the same reasons. Manufacturing outside of technology will remain soft until the consumer is better. Corporate spending on web computing is the lone bright spot. Travel, web computing, high-density computers, leisure services, and digital devices are the best part of the economy, but eventually, even they can soften if the consumer does not get back on their feet again. Financial Market Outlook The return on non-risk assets (4%) is still quite low relative to people’s recent memory, and hence most investors are unwilling to leave risk assets for 4% returns. As a result, money continues to flow toward risk assets. Also, fixed-income investments like treasuries that were perceived as risk-free are now being perceived as having some credit risk. Treasury rates would seem to be range-bound between 4 to 4.5%. It would seem that money will continue to remain in risk assets. Equities seem better positioned than any other asset. There is still potential earnings growth to drive prices higher, and it is clear the magnificent seven are growing at a strong pace. These stocks will continue to lead the equity market higher, dragging along any companies associated with those same themes that are driving the magnificent seven. Secular growth stocks are the place to be for the foreseeable future. MACM’s equity strategies are loaded with secular growth stocks that are driving excess return in our managed portfolios over the S&P 500. We remain optimistic!
Figure 1 – Spread of Treasuries over Inflation over 10 years
Figure 2 – Total Outstanding Government Debt over 20 years.
Figure 3 – US GDP over last 5 years
Figure 4 Large Cap growth ETF vs Large Cap value ETF( +8% vs -2%)