Summer Rally
Stocks had another solid week, and the S&P 500 is now up more than 5% in May with a few days to go. The mild pullback in April is behind us, and the summer rally we’ve been expecting is likely taking place. As we show below, the usually weak months of June and August tend to be quite strong in an election year, so be open to potential strength as we head into fall.
- The summer rally has likely started. The S&P 500 is up more than 5% so far in May.
- This is one of the best starts ever in an election year, which could bode well for more strength over the rest of 2024.
- U.S. small-caps and international stocks continue to appear inexpensive historically, although valuations aren’t a timing mechanism.
- Even adjusting for the sector mix, U.S. stocks are expensive.
It is quite normal to see jitters in the months leading up to a presidential election, and we expect this year to be the same. In 2016 and 2020, stocks were weak and volatile ahead of the election, but they soared after the election was over. Similar patterns may play out once again.
One hundred trading days into 2024 (the 100th day was last Thursday), this year is the strongest election year ever, up 10.4%, topping the previous best of 10.3% in 1976. Most election years tend to be weak early, but they do better as the year progresses. So, what does a good first 100 days tell us? We found 20 other times the S&P 500 was up double digits as of day 100, and the rest of the year was higher 85% of the time and up close to 9% on average, with the median return even better. In fact, eight of the last nine times, stocks rose by double digits the rest of the year. The bottom line is a big start tends to see the bulls in control for the remainder of the year.
A Glance at Global Valuations
In May, value investors from around the world came to Omaha for the “Woodstock of Capitalism,” a chance to listen to Warren Buffett opine on life and his latest investments. The event serves as a good reminder to step back and look at the long term. After an April swoon, a May rebound, and a nearly complete earnings season, now is as good a time as any to review the current valuation picture.
Resurgent interest rates have not been enough to slow the equity rally in 2024, as growth stocks have led the way once again, building on strength in 2023 on the back of artificial intelligence hype and strong earnings results. Beneath the surface are signs of waning strength in growth stocks and broadening participation in value stocks. This strength in the top growth names is nothing new, but it has pushed valuations to new highs relative to the rest of the market, where we see several attractive opportunities.
Below is a look at the valuations of the major equity asset classes around the world relative to the entire global stock market. As a reminder, we use a composite of metrics to measure valuations and then review the difference to their own history by displaying it in units of standard deviations (called a z-score). The narrative here has been similar for several years. (We talk about valuations not being a timing mechanism for a reason!) U.S. large-cap stocks, dominated by large growth names, command a higher valuation relative to the global market than they normally have. On the flip side, the remainder of the U.S. market — value stocks, mid-caps, and small-caps — are all trading cheaper than they have historically, in some cases meaningfully so. U.S. small-caps are trading nearly two standard deviations below where they have traded historically (on average). Put another way, U.S. small-caps have been cheaper than they are today only 6% of the time! Developed international markets also look attractive using this metric. We have seen some positive momentum in areas such as Japan, but we remain neutral as we observe the relative economic and price performance of these markets.
U.S. vs International: Comparing Apples to Apples
This comparison uses as much history and as many valuation metrics as we can find to provide an unbiased view on where markets currently trade. As country, sector, and security weights change over time, they will have an impact on these indices. But history should still be a reliable guide for comparison. With that being said, we are often asked whether comparing domestic to foreign markets is “apples to apples” given the differences in sector and style weights, especially with technology’s prominence in U.S. large-cap indices. 
There are several ways to explore this idea, but one is to reweight domestic and international indices based on the other’s sector composition. For example, in the chart on the left, if we look at the S&P 500, but with the same sector weights as the MSCI EAFE, a widely used index of developed market stocks outside the U.S., the forward price-to-earnings ratio drops from 26.6 to 24.9. That’s a smaller drop than might be expected given the large differences in technology sector weights.
Looked at another way on the right-side chart, if we reweight the MSCI EAFE with S&P 500 sector weightings (i.e., more technology), price-to-earnings rises by roughly three points. That is meaningful but not extreme. The larger changes for both indices come into play when we look at equal-weighted price-to-earnings ratios. Both indices see a large drop in valuations — attributable to less expensive mid-cap stocks — but remain separated by a wide margin. We believe the U.S. market deserves its premium to international markets, but when that premium becomes too high relative to historical data (as shown in the previous chart), we want to be thoughtful about what those extremes can mean going forward. Still, even in the U.S., we see opportunity to diversify out of the relatively higher-valued areas, such as growth stocks, and into lower-valued pockets, such as mid-cap and small-cap stocks.
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This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Small-cap stocks – shares of companies with total market capitalization in the range of about $300 million to $2 billion.
Mid-Cap Stocks – shares of companies with total market capitalization in the range of about $2 billion to $10 billion.
Large-cap Stocks – share of a company with a market capitalization value of more than $10 billion.
Growth Stocks – shares in a company that is anticipated to grow at a rate significantly above the average growth for the market.
MSCI EAFE – Designed to measure the equity market performance of developed markets (Europe, Australasia, Far East) excluding the U.S. and Canada. The Index is market-capitalization weighted.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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