Market Commentary

In the 1967 movie The Graduate, Dustin Hoffman’s character Benjamin is taken aside by a family friend at his graduation party and is told that he has one word of advice for him: “plastics.” While S&P returns in Q2 were primarily driven by a narrow set of stocks that benefit from a new technology spending cycle driven by artificial intelligence or AI, Q3 returns were driven by cyclical industries, including chemical companies that manufacture plastic. During the third quarter, the S&P 500® Index returned 5.5%, but unlike in Q2, the Equal-weighted S&P 500® outperformed its market-cap-weighted brethren by returning 9.1% as the market broadened. The Magnificent 7 had mixed returns for the quarter as investors reallocated dollars into traditional cyclical sectors as expectations for Fed rate cuts increased. Inflation, as measured by the CPI for August, decelerated to 2.5% year-over-year, the smallest increase since February 2021. Following weakening employment numbers and moderating inflation, the Fed initiated a rate cut program by cutting its Federal Funds rate by 50 basis points (bp) to 4.75% to 5.0%. The yield curve, which became inverted in 2022, steepened with the 2/10 Treasury curve, ending the quarter at +15 bp.

The market set all-time highs in July before experiencing a pullback following weaker-than-expected non-farm payroll numbers in July. The Federal Reserve’s language became more dovish leading up to Powell’s speech in Jackson Hole in August, where the Fed Chairman signaled that the Fed’s policy would become more accommodative. The increased likelihood for rate cuts led to outperformance for traditional cyclical and higher yielding sectors, including Utilities (+18.5%), Real Estate (+16.3%), Industrials (+11.2%), Financials (+ 10.2%), and Materials (+9.2%). Many of the Magnificent Seven, which as a group outperformed the S&P 500® by 1100 bp in the second quarter, were down in the third quarter, including Google (-9.0%), Microsoft (-3.8%), Amazon (-3.6%) and Nvidia (-1.7%). As a result, the Technology Sector and Communication Services were two of the worst-performing sectors, each up only 1.4% versus 5.5% for the S&P. Energy (-3.1%) was the worst-performing sector as global GDP growth concerns, particularly in China and increased production negatively impacted oil prices with WTI prices dropping 16.4% in Q3. Following the broadening of the market in Q3, we believe the market rally could continue if inflation continues to moderate.

Portfolio Equity Positioning

Consistent with our 2^nd quarter outlook for broadening participation in the year's second half, we focused on increasing portfolio exposure within cyclical recovery themes, such as housing, while maintaining our secular growth exposure (technology) for further appreciation into 2025. Stanley Black and Decker (SWK) provides hand and power tools utilized in housing construction and do-it-yourself home projects. The company raised guidance for the full year and increased free cash flow and gross margin projections by focusing on better capital management and supply chain efficiencies. Organic growth also inflected positively as demand strengthened for the DeWalt brand even in a still challenging macro housing environment. Broadcom (AVGO) designs, develops, and supplies semiconductor and software solutions for AI, wireless, and enterprise applications. The company reported significant year-over-year revenue growth of 47% in the fiscal third quarter of 2024, driven by growth in AI revenue, accelerated bookings in VMware, and stabilization in non-AI (cyclical) semiconductor revenue.

In addition to new purchases, we added to existing positions, including Dupont (DD) and Meta (META). Dupont exceeded guidance, mostly driven by a strong recovery in its electronics unit, which saw significant growth with its AI applications and new wins in the consumer electronics market, resulting in guidance being raised for the full year 2024. Meta was weighted up while Alphabet (GOOGL) was trimmed due to Meta’s ability to monetize its AI applications across a swath of services, which is driving strong user engagement and user growth. Meta saw a 22% increase in total revenues with a solid 38% operating margin.

Purchases were funded with the sales proceeds from Pepsi (PEP), Honeywell (HON), and Emerson (EMR). We exited Pepsi due to concerns about pricing power within the Frito-Lay snacks division and the effects of trade down from an increasingly budget-conscious consumer, especially within the domestic market. Honeywell was sold due to the difficult environment within the short-cycle product portfolio, which led to effects on margins from mix impacts vs long-cycle products. Emerson was sold due to the drag on performance from its National Instruments Corp acquisition and generally better opportunities elsewhere within the industrial sector. Lastly, we trimmed Welltower (WELL) on the run-up through the 3rd quarter. The company posted net operating income growth in excess of 20% for the seventh consecutive quarter and deservedly trades at a Price to Funds from Operation (P/FFO) premium to the group and its historical average. We thought it was prudent to modestly trim the position at this point.

Outlook

While the S&P 500® is up 20.8% through September, we see potential for the market to participate in further upside in the fourth quarter if inflation continues to moderate and the Fed rate cut cycle continues. We believe that the key to further upside is earnings growth (versus multiple valuation expansion), which could continue to surprise to the upside if earnings from cyclical stocks improve. We believe that Technology companies could do well in the fourth quarter, particularly those that can utilize AI to drive additional revenue growth and reduce costs. The Consumer Discretionary, Industrials, and Financial sectors could continue to perform well in the fourth quarter if the likelihood for a soft landing remains high. We continue to manage a barbell portfolio of both secular growers and value-oriented cyclicals. We remain diligent in our search for under-appreciated growth and value stocks and will trim positions that appear extended as well as add to positions on retracements.

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.