Market Commentary
“I’m sorry, Dave, I’m afraid I can’t do that.” The famous quote comes from the film 2001: Space Odyssey. The villain in the film is a malevolent talking computer named HAL who attempts to kill the crew of a spaceship. While thankfully, we do not have psychopathic talking computers today, advancements in generative AI are driving a new tech spending cycle with its promise of increased automation and improved productivity. Companies in all industries appear to be embracing the new technology to improve sales, lower costs, and get a leg up on their competition. This secular growth has caused the market’s returns to be concentrated in companies driving the AI transformation. This is illustrated by the widening performance gap between the S&P 500®, which is market cap weighted, versus the S&P 500®, Equal Weighted Index. The performance gap expanded from 300 basis points (bp) to over 1000 bp as the Equal Weighted S&P 500® Index declined 3.1% in Q2 while the S&P 500® rose 3.9% despite lowered expectations for the number of potential rate cuts by the Fed this year. While Inflation continues to moderate, expectations for rate cuts have again been pushed out, from June to September. That said, cooling inflation as measured by the Personal Consumption Expenditure Price Index (PCE) reading of 2.6% year-over-year (y/y) for May, along with slowing economic growth (1.4% Q1 GDP) has increased the odds of a 25 bp cut in the Fed Funds rate in September. Meanwhile, the yield on 10-year Treasuries spiked 50 bp from the end of March until late April as investors digested the likelihood of fewer rate cuts this year before declining to end the quarter at 4.4%, up 18 bp.
The broadening market participation that occurred in the second half of last year and continued through Q1 and reversed in Q2 as a decreased likelihood of rate cuts and scarcity of growth led to outsized returns for Megacap stocks, particularly the Magnificent Seven,which as a group outperformed the S&P 500® by 1100 bp in the second quarter. Nvidia alone was up nearly 37% during the quarter following a better-than-expected earnings report and expectation of a smooth transition to its new Blackwell GPU platform. As a result, the Technology Sector and Communication Services were the two top-performing sectors, up 13.6% and 9.1%, respectively. Meanwhile, cyclical sectors ex-Technology underperformed the market with Materials (-4.9%), Industrials (-3.3%), Energy (-3.2%), and Financials (-2.4%) all down for the quarter. Defensives such as Healthcare (-1.4%), Consumer Staples (0.7%), and Utilities (3.9%) were mixed with Healthcare down and Staples and Utilities up. Inflation, as measured by the Consumer Price Index (CPI), continues to abate at a measured pace, coming in at 3.3% y/y, but was flat on a m/m basis, which is the lowest reading since July 2022. One segment of the CPI that remains stubbornly elevated is housing, which came in at 5.4% y/y. This comes as a result of low supply and higher mortgage rates. Following the rally in Q2, while we could see some consolidation, particularly in outperforming stocks, we believe that market participation could broaden again, particularly if moderating inflation enables the Fed to begin cutting rates in September.
Portfolio Equity Positioning
We adjusted the portfolio to further participate in the secular growth themes showing exceptional earnings power. After trimming Apple in January, we re-established it as our top portfolio weight this quarter before the company gave more clarity into its AI initiatives with the expectations for re-accelerating revenue growth from the integration of AI into Siri. Clearly, the anticipation for a refresh cycle within its iPhone segment is the driver of performance. The company also recently authorized an additional $110 billion in share repurchases and increased its dividend by 4%. ServiceNow (NOW) was purchased because of its ability to leverage its generative AI solutions and automation capabilities and has become the de facto AI solution for business transformation. The company recently reported a 24.5% year-over-year growth in subscription revenue, which was above previous guidance and indicated strong demand going forward. In terms of existing positions, we added to Advanced Micro Devices (AMD) given the exceptional growth and future opportunities within its data center segment. In fact, this segment grew 80% year-over-year through the first quarter, and the company has guided the segment to almost double revenues by year-end.
As previously mentioned, cooling inflation numbers and slowing GDP growth raise the odds for a possible rate cut as soon as September. Regardless as to whether this were to happen in September or later in the year, we believe that a most anticipated broadening out into cyclical and economically sensitive stocks (similar to the first quarter) could re-emerge and drive market returns in the 2nd half. As such, we added to Lowes (LOW) and will wait for the recovery in housing demand and related do-it-yourself project demand as rates possibly fall into year-end. The company is also advancing its Pro segment for professional contractor relationships and sees solid growth with small and medium-sized pros going into year-end. Within our non-cyclical holdings, we added to Thermo Fischer (TMO) after they raised 2024 guidance and increased dividends by 11%. The company is further expanding its footprint with strategic acquisitions and partnerships and has a positive outlook on the biotech funding environment going forward.
Purchases were funded with the sales proceeds from Salesforce (CRM), McDonald’s (MCD), and Adobe (ADBE). We exited Salesforce mainly due to concerns about moderating bookings and elongated deal cycles. Furthermore, management was not building AI revenue contributions into the current year’s guidance, although they did voice a more positive outlook further out into 2025. Essentially, we exchanged this position for ServiceNow as we felt management was more confident in its guidance and bookings for the current year and going forward. McDonald’s was sold due to concerns over the pressured consumers that refuses to absorb additional price increases. McDonald’s seems to have lost its value proposition to the consumer is having to reinstate affordability combo deals to reengage with the weakening consumer, thereby pressuring margins for the foreseeable future. Adobe was sold in response to mounting lower-cost competition for its Creative Cloud Suite product portfolio. Concerns related to potential market share losses and margin sustainability ultimately led to the sell decision.
Outlook
Despite strong year-to-date market performance, with the S&P 500® up 14.5% through June, we believe that the market could see further upside in 2024 if inflation continues to moderate and expectations for Fed rate cuts increase. We believe that while AI will continue to be a significant market driver, market participation could broaden again in the second half, and we could see a rotation back into cyclical sectors as well as individual equities that have underperformed on a relative basis. Rate-sensitive industries such as housing would greatly benefit from any potential rate cuts or declines in the 10-year Treasury rate. Financials with capital markets exposure should benefit from increased advisory and M&A business along with greater fee generation due to higher AUM in businesses such as asset and wealth management. We continue to manage a core portfolio of both secular growers and more value-oriented cyclicals. We look for opportunities to enhance the portfolio and will look to add to positions on any pullbacks.
Important Disclosures
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Connors Investor Services, Inc. “Connors”), or any non-investment related content made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Connors. Please remember to contact Connors in writing if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services or if you would like to impose, add, or modify any reasonable restrictions to our investment advisory services. Unless and until you notify us in writing, to the contrary, we shall continue to provide services as we do currently. Connors is neither a law firm nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. A copy of the Connors’ current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request. Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Connors account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Connors accounts; and (3) a description of each comparative benchmark/index is available upon request.