View from the Observation Deck

Companies often return capital to their shareholders through dividend distributions. The practice is so common that 403 of the 503 constituents in the S&P 500 Index (“the Index”) distributed a cash dividend to their equity owners as of 11/14/24. In addition to acting as a conduit for the return of capital, dividend distributions account for a significant portion of the Index’s total return. According to data from Bloomberg, dividends contributed to over 37% of the total return of the Index over the 96-year period between December 30, 1927, and December 29, 2023.

• Dividend payments from S&P500 Index constituents totaled $70.91 per share (record high) in 2023, up from $67.57 (previous record high) in 2022. 
  
  
• As of 11/18/24, dividend payments are estimated to total $77.24 and $81.68 per share in 2024 and 2025, up from $74.54 and $79.66 per share in 2024 and 2025, respectively, on 1/31/24.
• Of the 11 major sectors that comprise the Index, eight of them had yields above the 1.26% generated by the Index over the period captured in the table. Financials, Information Technology, and Health Care contributed the most to the Index's dividend payout at 15.63%, 15.45% and 14.10%, respectively.
  
  
• The payout ratio for the S&P 500 Index stood at 36.43% on 11/18/24. A dividend payout ratio between 30% and 60% is typically a good sign that a dividend distribution is sustainable, according to Nasdaq.
  
  
• Many investors view changes in dividend distributions as an indication of strength and or weakness in the underlying company. For that reason, companies will often avoid decreasing or suspending their dividend payout. There were a total of 12 dividend cuts and two suspensions year-to-date through the end of October. For comparison, 22 dividends were cut and four were suspended over the same period last year.

Takeaway: Dividend distributions continue to be one of the most efficient methods by which companies can return capital to their shareholders. As such, investors often view consistent dividend payments and dividend increases as indications of strength. In the 96-year period between December 30, 1927, and December 29, 2023, more than 37% of the total return of the Index came from dividends. Remarkably, dividend growth estimates for the Index have increased since the start of the year. The Index’s 2024 dividend payments were forecast to total a record $77.24 per share on 11/18/24, up from $74.54 per share on 1/31/24. Furthermore, dividend sustainability appears to have improved since 2023. Just 12 dividends were cut and two were suspended this year (through 10/31), down from 22 cuts and four suspensions through October 2023.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is a capitalization-weighted index comprised of 500 companies used to measure large-cap U.S. stock market performance, while the 11 major S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector. 

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The next blog will be posted on 11/26.

View from the Observation Deck

Tracking the direction of worldwide semiconductor sales can provide investors with additional insight into the potential demand for tech-oriented products and the overall climate for technology stocks, in our opinion. As evidenced by recent developments in artificial intelligence (AI) and robotics, as well as the vast market for smartphones, tablets, and wearables, we continue to find creative and innovative ways to integrate semiconductors into our everyday lives.

Semiconductor sales appear to lag fluctuations in the valuations of technology stocks.

As today’s chart reveals, changes in semiconductor sales typically occur after changes in the performance of the S&P 500 Technology Index. This phenomenon continues to be true as of today’s update to this post. Case in point, the S&P 500 Technology Index increased to its third consecutive quarterly all time high at the end of September 2024. By contrast, prior to the most recent quarter, semiconductor sales hadn’t posted a quarterly record since Q4’21.

Worldwide sales of semiconductors totaled a record $166.0 billion in Q3’24, an increase of 23.2% from Q3’23.

Amidst unprecedented demand, the Semiconductor Industry Association reported that worldwide semiconductor sales surged by 26.2% to a record $555.9 billion in 2021. In 2022, sales increased to another record  ($574.1 billion), but had begun to stagnate in the second half of the year. In 2023, worldwide sales of semiconductors declined by 8.2% year-over-year to $526.8 billion. Since then, as evidenced by the third quarter’s record, sales of semiconductors increased dramatically. Aggregate semiconductor sales totaled $456.7 billion year-to-date through 9/30/24, putting them within reach of 2022’s record tally.

The technology sector continues to be a top performing sector compared to its peers.

Propelled forward by promising developments in AI and an easing in the global chip shortage, the S&P 500 Information Technology Index increased by 57.84% in 2023. In our view, these factors remain relevant today, and continue to entice investors to the sector. Year-to-date through 11/12/24, the S&P 500 Information Technology Index posted a total return of 36.34%, second only to the S&P 500 Communication Services Index which increased by 37.41% on a total return basis over the same time frame. Despite surging valuations, recent cuts to the federal funds rate appear to have made competing sectors more attractive to investors. Tellingly, the S&P 500 Information Technology Index increased by just 1.58% since 7/9/24, the day Jerome Powell testified that the U.S. economy was no longer overheated, making it the worst performing of all 11 subsectors that comprise the broader S&P 500 Index over the period (7/9 thru 11/12).

Takeaway: It is nearly impossible to discuss semiconductors and technology stocks without mentioning developments in AI, and rightly so. One forecast suggests the global AI market could grow to nearly $600 billion by 2026 and $1.8 trillion by 2030, according to Ryan Issakainen, ETF Strategist at First Trust Portfolios L.P. These estimates, coupled with resilient U.S. consumer spending, and increasing demand for semiconductors have served as potent catalysts to technology stocks over the past several years. Despite record technology sector valuations, global semiconductor sales remain below their all-time yearly high set in 2022. That said, increased demand for AI-related chips resulted in record semiconductor sales in Q3’24. Should that trend continue, 2024 could be a record setting year for sales in the space.

This chart is for illustrative purposes only and not indicative of any actual investment. There can be no assurance that any of the projections cited will occur. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Information Technology Index is capitalization-weighted and comprised of S&P 500 constituents representing the technology sector. The S&P 500 Communication Services Index is capitalization-weighted and comprised of S&P 500 constituents representing the communication services sector.

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View from the Observation Deck
With the U.S. Presidential election officially behind us, we thought it would be timely to provide an update regarding estimated 2024 and 2025 earnings and revenue growth rates for the companies that comprise the S&P 500 Index (“Index”). On November 11, 2024, the Index closed at a record 6,001.35, representing an increase of 25.82% on a price-only basis from when it closed at 4,769.83 on December 29, 2023, according to data from Bloomberg. For comparison, from 1928-2023 (96 years) the Index posted an average annual total return of 9.56%. In our post on this topic from October 2023 (click here), we wrote that increased revenues could boost earnings and provide the catalyst for higher equity valuations going forward. We believe that the Index’s year-to-date price improvement is reflective, in part, of that scenario playing out.

The most recent estimates reveal favorable earnings growth expectations.

As today’s table shows, earnings for the companies that comprise the Index are estimated to increase by a combined 9.7% and 12.8%, respectively, year-over-year (y-o-y) in 2024 and 2025. These figures are mixed from when they stood at 9.5% and 14.5%, respectively, the last time we posted on this topic (click here). Keep in mind that estimates for 2024 reflect favorable comparisons to 2023’s earnings which declined by 0.9% in 2023 (not in table). In 2024, earnings are now estimated to decline in three of the eleven sectors that comprise the Index (Energy, Industrials, and Materials), up from just two in our last post. The Energy sector’s 2024 earnings estimates continued to decline, falling from -12.6% in our last post to -19.0%. From our perspective, the decline in earnings estimates is likely reflective of plummeting oil and gas prices. The price of WTI crude oil stood at $68.04 per barrel on November 11, 2024, down 11.83% y-o-y, according to data from Bloomberg. The price of natural gas stood at $2.92 per million BTUs as of the same date, down 3.73% y-o-y.

Revenue growth rate estimates for 2024 and 2025 remain favorable.

As of November 8, the estimated revenue growth rate for companies in the Index stood at 5.2% and 5.5%, respectively in 2024 and 2025. These figures are mixed since our last post when they stood at 4.9% and 6.0%, respectively, in 2024 and 2025. Nine of the eleven sectors that comprise the S&P 500 Index reflect positive y-o-y revenue growth rate estimates for 2024 with five of them estimated to surpass 5.0%. For comparison, ten of the eleven sectors are estimated to see revenue growth in 2025.

Takeaway: In our view, the Index’s year-to-date total return of 25.82% can be explained, in part, by the estimated earnings and revenue growth rates revealed in today’s table. Since our last post on this topic, six of the 11 sectors that comprise the Index saw their 2024 earnings and revenue estimates increase. With the U.S. Presidential election behind us, and the Federal Reserve having announced its second rate cut of the year, we believe investors would be well-served to retrain their focus on these two driving forces of equity valuations. Time will ultimately reveal the accuracy of these estimates, but we maintain that higher revenues could be the best catalyst for growing earnings, and in turn, drive equity valuations higher.

This chart is for illustrative purposes only and not indicative of any actual investment. There can be no assurance that any of the projections cited will occur. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The respective S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector. 

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View from the Observation Deck

Today's blog post is for those investors who want to drill down below the sector level to see what is not performing well in the stock market. The S&P 500 Index was comprised of 11 sectors and 126 subsectors as of 11/1/24, according to S&P Dow Jones Indices. The 15 worst-performing subsectors in today’s chart posted total returns ranging from -6.64% (Health Care Services) to -61.30% (Drug Retail) over the period. Click here to view our last post on the worst performing subsectors.

• As indicated in the chart above, five of the 15 worst-performing subsectors came from the  S&P 500 Index Consumer Discretionary sector, followed by three subsectors from the Consumer Staples sector. Drug Retail, a subsector of the Consumer Staples sector was the worst performer, posting a total return of -61.30% for the period. 
• Each of the 11 sectors that comprise the Index were positive on a year-to-date (YTD) basis through 11/5/24. Information Technology was the top performer, with a total return of 31.57% over the period. The Health Care sector was the worst performer, posting a total return of 9.78% over the time frame. For comparison, the broader S&P 500 Index posted a total return of 22.61% during the period.
• As of 11/1/24, the most heavily weighted sector in the S&P 500 Index was Information Technology at 31.75%, according to S&P Dow Jones Indices. For comparison, the Financials and Health Care sectors were the next-largest with weightings of 13.33% and 11.18%, respectively.

Takeaway: As we enter the final months of the year, the S&P 500 Index looks poised to register back-to-back years of positive total returns. Notably, each of the S&P 500 Index’s 11 major sectors are positive YTD (thru 11/5). For comparison, the Real Estate, Consumer Staples, Health Care, and Utilities sectors all suffered negative total returns over the same period in 2023. In our view, the Utilities sector stands out among its peers in this regard. After posting a total return of -7.08% (the worst performer) in 2023, the sector has enjoyed a stunning turnaround, notching a total return of 26.72% YTD thru 11/5, making it the third-best performing sector in the broader Index. Click here to read our recent commentary on the Utilities space. As always, there are no guarantees, but there could be some potential deep value opportunities in this group of subsectors. For those investors who have interest, there are a growing number of packaged products, such as exchange-traded funds, that feature S&P 500 Index subsectors.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry. 

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View from the Observation Deck

Today's blog post is for those investors who want to drill down below the sector level to see what is performing well in the stock market. The S&P 500 Index was comprised of 11 sectors and 126 subsectors on 11/1/24, according to S&P Dow Jones Indices. The 15 top-performing subsectors in the chart posted total returns ranging from 80.93% (Semiconductors) to 32.45% (Trading Companies). Click here to view our last post on the top performing subsectors.

• As indicated in the chart above, the Industrials sector had the most subsectors (3) represented in the top 15 performers on a year-to-date (YTD) basis.
  
  
• With respect to the 11 major sectors that comprise the S&P 500 Index, Communication Services posted the highest total return for the period captured in the chart, increasing by 31.22%. The second and third-best performers were Information Technology and Utilities, with total returns of 29.83% and 26.40%, respectively. The S&P 500 Index posted a total return of 21.46% over the period.
  
  
• As of 11/1/24, the most heavily weighted sector in the S&P 500 Index was Information Technology at 31.75%, according to S&P Dow Jones Indices. For comparison, the Financials and Health Care sectors were the next-largest with weightings of 13.33% and 11.18%, respectively.
  
  
• Using 2024 consensus earnings estimates, the Information Technology and Energy sectors had the highest and lowest price-to-earnings (P/E) ratios at 35.16 and 13.95, respectively, as of 11/4/24 (excluding Real Estate). For comparison, the S&P 500 Index had a P/E ratio of 24.44 as of the same date.

Takeaway: The Information Technology, Financials, and Communication Services sectors accounted for 41.34%, 14.91%, and 12.95%, respectively, of the total return of the S&P 500 Index YTD through 10/31/24, according to data from S&P Dow Jones Indices. With a total return of 31.22%, communication services stocks are the top-performer in the S&P 500 Index YTD through 11/1, followed by technology companies (+29.83%). Surprisingly, none of the 15 subsectors in today’s chart come from the S&P 500 Utilities sector, which happens to be the third-best performer with a total return of 26.40% YTD. For those investors who may have an interest, there are a growing number of packaged products, such as exchange-traded funds, that feature S&P 500 Index subsectors.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance, while the S&P sector and subsector indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector or industry.

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View from the Observation Deck

For today’s post, we compare the cumulative total returns of several utility and infrastructure-related indices to that of the S&P 500 Index between 10/12/22 (the start of the current bull market) and 10/29/24. As revealed in the chart, when it comes to an investment in infrastructure stocks, water stands out above them all. Water plays a critical role in socio-economic development, the production of food and energy, and crucially, human survival itself. The United Nations reported that 2.2 billion people around the world lacked access to safely managed drinking water, and 3.5 billion did not have access to safely managed sanitation in 2022. We discuss what we believe have been catalysts to growth for the companies involved in water utility, infrastructure, materials, and equipment below.

• In the U.S., an estimated 2 million people currently live without running water inside their homes. While most U.S. citizens have access to clean water and sanitation, the infrastructure that provides these services is aging. The pipe that makes up the U.S. water network is 45 years old, on average. Some of the oldest cast iron pipes still in use were put in service more than 100 years ago, according to McKinsey & Company.
  
  
• The U.S. drinking water infrastructure is comprised of 2.2 million miles of underground pipe, according to the American Society of Civil Engineers (ASCE). The ASCE noted that an estimated 6 billion gallons of treated potable water is lost through leaks in this piping infrastructure each day. The U.S. Environmental Protection Agency (EPA) expects water-pipe replacement rates to peak in 2035, with somewhere between 16,000 to 20,000 miles of piping being replaced per year.
  
  
• We’ve written about estimated impact of artificial intelligence (AI) on the energy grid in previous posts (click here), but AI’s demand for water cannot be understated. A recent report by J.P. Morgan revealed that large data centers use as much as 5 million gallons of water per day to effectively cool the chipsets that process AI intensive workloads. Notably, the U.S. was home to 5,381 data centers at the end of March 2024. For comparison, Germany, the U.K., and China were home to just 1,484 data centers combined as of the same date.
  
  
• Funding for updated water infrastructure has accelerated in recent years. In 2021, the U.S. government revealed legislation that designated $55 billion toward water infrastructure improvements. Fifteen billion dollars of that funding was set aside to replace each of the 9.2 million lead service lines still in use, by 2031. In October 2024, the EPA announced $6.2 billion in additional funding to upgrade U.S. water infrastructure.
  
  
• The cumulative total returns of each of the indices in today’s chart were as follows: S&P 500 Index (68.23%), S&P Global Water Index (47.27%), S&P Global Infrastructure Index (42.96%), ISE Global Wind Energy Index (21.60%), S&P Global Clean Energy Index (-24.08%), and the MAC Global Solar Energy Index (-42.27%).

Takeaway: From our perspective, the results in today’s chart can be explained by the crucial role that access to clean water and proper sanitation play in developed and developing nations around the world. Globally, an estimated $1.37 trillion of additional water infrastructure investments are required to provide clean water to the 2.2 billion people currently in need of it by 2030. In the U.S., our aging water infrastructure is in dire need of repair and replacement, with 6 billion gallons of treated water being lost each day to leaks in the current framework (approximately 14%-18% of U.S. daily water usage). Additionally, data centers are estimated to use an increasing share of available water to cool the chipsets that process AI workloads, which stands to stress these systems even further. Given the critical nature of the water ecosystem in comparison to the other infrastructure investments shown in today’s chart, we do not find the sector’s outperformance overly surprising. While there is no way to be certain, we expect these companies will continue to benefit from the global construction and domestic modernization of water infrastructure.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P Global Water Index is comprised of approximately 50 companies from around the world that are involved in water related businesses. The Global Infrastructure Index is comprised of 75 companies from three distinct infrastructure clusters: Utilities, Transportation, and Energy. The ISE Global Wind Energy Index is a quintile-based modified capitalization weighted index tracking public companies that are active in the wind energy industry. The S&P Global Clean Energy Index is an index of approximately 100 companies involved in global clean energy-related businesses. The MAC Global Solar Energy Index tracks globally-listed public companies that specialize in providing solar energy products and services.

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View from the Observation Deck

In a previous post on this topic (click here), we noted that Jerome Powell’s July commentary to the Financial Services Committee on 7/10/24 appeared to have set the stage for a dramatic shift in the performance of small cap stocks relative to their large cap counterparts. Today’s post serves as an update to our previous observations. The chart above includes the price-only returns of the largest 100 stocks in the S&P 500 Index (the S&P 100 Index), the S&P 500 Index, and the S&P Small Cap 600 Index normalized to a factor of 100.

• On 7/8/24, prior to Powell’s address, the federal funds rate futures market indicated there was a 72.0% chance that the Fed would cut its policy rate at its September meeting. That expectation surged following his remarks, rising to 98.0% on 7/23/24.
  
  
• As we now know, the Fed cut its policy rate by 50 basis points in September, lowering the federal funds target rate (upper bound) from 5.50% to 5.00%.
  
  
• Historically, the Fed’s policy rate has nearly matched the rate of inflation.
   
  
  • Over the 30-year period ended 9/30/24, the federal funds target rate (upper bound) averaged 2.58% on a monthly basis. Inflation, as measured by the 12-month change in the consumer price index (CPI) averaged 2.5% over the same time frame.
    
    
  • The federal funds target rate (upper bound) stood at 5.00% at the end of September, well above September’s CPI reading of 2.4%.
    
    
• Valuations for small cap stocks appear to be more attractive than their large cap counterparts. In fact, the price to earnings (P/E) ratio of the S&P Small Cap 600 Index currently sits at 16.80 compared to its 10-year average of 24.63 (as of 10/28). For comparison, the P/E ratios of the S&P 100 and S&P 500 Indices stood at 26.41 and 24.97, above their 10-year monthly averages of 21.09 and 21.36 as of the same date. Notably, year-over-year earnings for the S&P Small Cap 600 Index are estimated to decline by 8.53% in 2024 before becoming increasingly favorable the following year. In 2025, earnings are estimated to increase by 16.99% for the S&P Small Cap 600 Index, compared to 13.38% and 13.62%, respectively, for the S&P 100 and S&P 500 Indices.
  
  
• For reference, the price only returns for the indices in today’s chart were as follows (7/10/24 – 10/25/24): S&P Small Cap 600 Index (7.35%), S&P 500 Index (3.09%), S&P 100 Index (1.89%).

Takeaway: As noted in our previous post on this topic, smaller companies are often more reliant on outside capital than their larger counterparts, who generally operate in a state of going concern. Given that equity valuations can vary based on the cost of raising said capital (internally or externally), we expect further easing in monetary policy to have an outsized impact on small cap valuations relative to other market capitalizations. Another noteworthy point is that the spread between the federal funds target rate (upper bound) and the CPI remains well-above historical norms. We anticipate small cap valuations could benefit from a narrowing of that spread, over time. That said, there are mounting concerns that the Fed’s initial cut may have been too deep. Case-in-point: the Bureau of Labor Statistics announced that non-farm payrolls increased by 254,000 in September, well above the consensus expected 150,000. In the U.S., real GDP growth was unrevised at 3.0% in Q2’24, but Gross Domestic Income, an alternative measure of economic activity, was revised upward from 1.3% to 3.4%. Given the Fed’s data-dependency, a strong U.S. economic outlook may prove to be a headwind to small cap valuations.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 100 Index is a capitalization-weighted index based on 100 highly-capitalized stocks selected from the S&P 500 Index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P SmallCap 600 Index is an unmanaged index of 600 companies used to measure small-cap U.S. stock market performance.

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View from the Observation Deck  

Today's charts are intended to give investors a visual perspective on where equity analysts think earnings are headed. The charts cover the quarterly earnings per share (EPS) for 2023 and the first half of 2024, as well as Bloomberg’s estimated EPS for the next several quarters. For comparison, we included results and estimates from the S&P 500 Index (“LargeCap Index”), the S&P MidCap 400 Index (“MidCap Index”) and the S&P SmallCap 600 Index (“SmallCap Index”).

As anticipated in our previous post on this topic (click here to view), each of the Indices in today’s charts saw earnings decline on a quarter-over-quarter basis in Q1 and Q2 of 2024. That said, the early year contraction is expected to be short-lived, with year-over-year (y-o-y) comparisons reflecting favorably for each of the three Indices in Q1’25.

SmallCap Index earnings declined by 9.91% y-o-y in Q1’24 but are estimated to increase by 3.53% y-o-y in Q1’25. Earnings for the MidCap Index declined by 5.15% y-o-y in Q4’23 but are expected to increase by 0.94% y-o-y in Q1’25. For comparison, the broader S&P 500 Index is estimated to see earnings increase by 11.09% y-o-y in Q1’25.

Yearly EPS estimates for each of the Indices for the 2024 and 2025 calendar years and their respective totals are as follows (not in the charts): S&P 500 Index ($241.35 and $274.53); S&P MidCap 400 Index ($175.23 and $201.61); S&P SmallCap 600 Index ($81.86 and $96.25). 

Earnings per share for the LargeCap Index are estimated to increase to record-highs in 2024 and 2025 consecutively, while the MidCap Index is expected to see record EPS in 2025. Full-year EPS estimates for the SmallCap Index total $96.25 in 2025, just below its record high of $97.53 set in 2022.

Takeaway: In our September post on earnings and revenue growth (click here to view it), we voiced our opinion that the recent surge in the S&P 500 Index can be attributed, in part, to expected earnings growth for the companies that comprise the Index. For today’s publication, we wanted to provide an alternative look at the data that informs this thought process, as well as an extended view into the mid and small-cap segments of the market. We believe that corporate earnings drive the direction of stock prices over time, especially when the major indices are trading at or near record highs. As the data shows, EPS are expected to trend higher across each of these indices over the next several quarters, with full year estimates reaching record-highs for the LargeCap and MidCap Indices in 2025. As always, these are estimates and are subject to change (and have changed since our last post). That said, we trust today’s publication provides a unique perspective on what we view as a major catalyst of the recent surge in equity valuations.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. stocks with a small market capitalization. The S&P 500 Equal Weighted Index is the equal-weight version of the S&P 500 Index. The 11 major sector indices are capitalization-weighted and comprised of S&P 500, S&P MidCap 400 and S&P SmallCap 600 constituents representing a specific sector.

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View from the Observation Deck

Investors directing capital into U.S. mutual funds and exchange traded funds (ETFs) continued to favor passive investing over active management for the 12-month period ended 9/30/24.

Passive mutual funds and ETFs reported estimated net inflows totaling $754.18 billion for the 12-month period ended 9/30/24, while active funds reported estimated net outflows totaling $298.05 billion over the same period. The top three active categories with net inflows over the past 12 months were Taxable Bonds, Nontraditional Equity, and Alternatives, with inflows of $150.45 billion, $20.94 billion, and $15.36 billion, respectively (see table above). For comparison, the top three passive categories were U.S. Equity, Taxable Bond, and International Equity, with inflows of $407.11 billion, $238.26 billion, and $77.21 billion, respectively.

Despite compelling total returns in the broader equity markets, equity mutual funds and ETFs saw much lower inflows than their fixed income counterparts over the trailing 12-month period.

Combined, the active and passive equity categories experienced inflows of $6.87 billion for the 12-month period ended 9/30/24. For comparison, the Taxable and Municipal Bond categories reported net inflows totaling $416.19 billion over the same time frame. The S&P 500, S&P MidCap 400, and S&P SmallCap 600 Indices posted total returns of 36.33%, 26.76%, and 25.76%, respectively, for the 12-month period ended 9/30/24, according to data from Bloomberg. With respect to foreign equities, the MSCI Emerging Net Total Return and MSCI Daily Total Return Net World (ex U.S.) Indices posted total returns of 26.05% and 24.98%, respectively, over the same time frame.

Takeaway: Passive mutual funds and ETFs saw inflows of $754.18 billion compared to outflows of $298.05 billion for active funds over the trailing 12-month period ended 9/30/24. In the table above, we observe that the U.S. Equity category experienced the largest disparity, with active shedding $296.95 billion compared to inflows of $407.11 billion for passive funds. Notably, despite compelling total returns in the broader equity markets, equity funds saw net inflows of just $6.87 billion over the trailing 12-month period. For comparison, fixed income saw combined net inflows of $416.19 billion over the same time frame. We think that continued inflows into fixed income investments are reflective of investor’s expectations regarding interest rate policy. Morningstar noted that flows into taxable-bond ETFs totaled a record $93 billion during the third quarter and short-term bond funds saw quarterly inflows for the first time since Q3’21.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions and other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The S&P MidCap 400 Index is a capitalization-weighted index that tracks the mid-range sector of the U.S. stock market. The S&P SmallCap 600 Index is a capitalization-weighted index that tracks U.S. companies with a small market capitalization. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI World (ex U.S.) Index is a free-float weighted index designed to measure the equity market performance of developed markets.

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View from the Observation Deck

Given their non-cyclical nature, defensive sectors may offer better performance than their counterparts during periods of heightened volatility. For today’s post (and the previous posts in this series), we set out to determine if that outperformance also exists during periods of high inflation. To construct the table above, we started in 1990 and selected calendar years where inflation, as measured by the Consumer Price Index (CPI), increased by 3.0% or more on a trailing 12-month basis. We chose 3.0% as our baseline because the rate of change in the CPI averaged 3.0% from 1926-2023, according to data from the Bureau of Labor Statistics. We then selected three defensive sectors (Health Care, Consumer Staples, and Utilities) and compared their total returns to those of the S&P 500 Index over those periods.

• While the CPI remains above the Federal Reserve’s target rate of 2.0%, it has fallen below the target level of 3.0% we use for this post. Despite this, the S&P 500 Utilities Index has been the top performer year-to-date, outpacing the broader S&P 500 Index by 7.12 percentage points through 10/15/24.

One reason for Utilities’ continued outperformance in 2024 is the rise in global usage of Artificial Intelligence (AI). The International Energy Agency reported that the global electricity consumed by data centers, which typically house the servers that host AI graphics processing units, is forecast to surge from an estimated 460 terra-watt hours in 2022 to more than 1,000 terra-watt hours in 2026. For comparison, this demand is roughly equivalent to the electricity consumption of Japan. We have posted on this subject recently (click here to view “The Only Constant is Change”), but it warrants repeating that U.S. data centers are projected to use 8% of total power by 2030, up from just 3% in 2022.

• Of the eleven time frames in the table where inflation increased by 3.0% or more on a trailing 12-month basis, there were only two (2021 and 2023) where the S&P 500 Index outperformed each of the Health Care, Consumer Staples, and Utilities sectors.
  
  
• From 12/29/89 – 10/15/24 (period captured in the table above), the average annualized total returns posted by the four equity indices presented were as follows (best to worst): 11.66% (S&P 500 Health Care); 10.64% (S&P 500 Consumer Staples); 10.61% (S&P 500 Index); and 8.51% (S&P 500 Utilities), according to data from Bloomberg.

Takeaway: Despite recent disinflation, the S&P 500 Utilities Index continues to lead the broader S&P 500 Index by a significant margin YTD. We think improving earnings estimates, surging demand for electricity resulting from increased AI adoption, and recent economic volatility may account for the sector’s outperformance. On 10/11/24 data from Bloomberg revealed that earnings for S&P 500 Utilities companies are estimated to increase by 14.6% and 9.1% in 2024 and 2025, respectively. For comparison, those same estimates stood at 8.5% and 7.4%, respectively, on 12/29/23. While forecasts vary for the effect of AI on global electricity consumption, the impact is not likely to be subtle. We think the increase in earnings estimates reflect these expectations. Additionally, recent economic data and geopolitical strife may have prompted investors to utilize defensive sectors as a safe haven. In early October, concerns that the Federal Reserve had cut rates too deeply mounted when non-farm payrolls surpassed all expectations, increasing by 254,000 in September. Notably, the news came on the heels of an August report from the Bureau of Labor Statistics which revised payrolls downward by 818,000 over the 12-month period ended March 2024. From our perspective, investor interest in defensive sectors may remain strong in light of geopolitical strife, economic volatility, and the potential for a resurgence in the pace of rising prices.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. The respective S&P 500 Sector Indices are capitalization-weighted and comprised of S&P 500 constituents representing a specific sector.  

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