The Great Rotation Continues — Putting the Current Market Sell-Off in Context: Insights From Our CIO

The past several trading sessions have witnessed a significant sell-off in U.S. equities, especially U.S. large cap technology stocks. At the time of writing, the sell-off has accelerated into today’s session, prompting a number of talking heads to point fingers at the Fed for “failing” to cut interest rates at their July meeting last week. However, before we explore the relative merits (if any) of such claims, let’s first put the current market decline in some context.

• The Dow Jones closed down 1,034 points or -2.6% today (August 5). To put this in context: While the press has been quick to point out that this was the “15^th largest point decline in Dow history,” it is actually the 432^nd largest percentage decline in the Dow’s history.
• The S&P 500 finished the day down 3%. NASDAQ Composite was down 3.43%.
• Inside the market, we’ve seen the steepest sell-offs within megacap tech and growthier names; the sell-off is “less bad” in value names. For example, today the Russell 1000 Growth was down 3.52% versus 2.4% for the Russell 1000 Value. Big names like NVDA and TSLA were down 6.36% and 4.23%, respectively.

Putting 2024 Returns in Context

Through Friday’s close, the S&P 500 Index has returned 12.99% for the year — that’s even after Friday’s sell-off. Said differently, the market has delivered above-average gains thus far for 2024 with relatively minimal intra-year volatility.

Exhibit A: S&P 500 Intra-year declines versus calendar year returns. Despite an average intra-year decline of 14.2% (since 1980), annual returns were positive in 33 out of 44 years. Source: JP Morgan Guide to the Markets, slide 16, August 5, 2024.

Returns are based on price index only and do not include dividends. Intra-year drops refers to the largest market drops from a peak to a trough during the year. For illustrative purposes only. Returns shown are calendar year returns from 1980 to 2023, over which time period the average annual return was 10.3%.

What’s Driving the Current Sell-Off

A number of pundits claim the current sell-off is a result of the Fed’s decision last Wednesday to hold rates steady. However, if this were true, the market likely would’ve sold off significantly when news of their decision was first announced — yet it didn’t. In fact, the S&P 500 Index closed up 1.58% on the Fed’s increasingly dovish statements that suggest a September rate cut is likely. The Fed actually delivered the exact decision that markets were then expecting — to hold steady at the July meeting and hint heavily at a rate cut in September. The market got exactly what it was expecting.

A more likely explanation for current market volatility includes a combination of macroeconomic trends — a slowing U.S. economy (that still grew at a 2.8% annualized rate in Q2), declining inflation (but at 3%, still above the Fed’s 2% target), and a deteriorating jobs outlook (only 114,000 jobs added in June, though in an economy that still boasts low unemployment by historical standards). To be fair, all of these metrics are trending in directions that suggest the Fed will most certainly cut rates at some point in the very near future — but it’s far from clear that the Fed should’ve cut rates last week.

The “Magnificent 7”

The deteriorating economic backdrop comes at a time when U.S. equity markets have been propelled ever higher by a small handful of large capitalization technology stocks. Today, only seven technology stocks — dubbed the “Magnificent Seven” (Tesla, Nvidia, Alphabet, Meta (Facebook), Microsoft, Apple, and Amazon) — make up nearly one-third of the S&P 500 Index. Today the Magnificent Seven trade at high, frothy valuations — they collectively trade at more than 34 times next year’s earnings — and at a time when their collective earnings growth is declining and falling in-line with that of the broad market. Such high levels of concentration, combined with arguably deteriorating growth prospects, poses significant risk. This underscores how imperative it is for investors to diversify beyond the Magnificent Seven and the S&P 500 Index.

The Great Rotation Continues

As we discussed in a previous market communication and again on last week’s Quarterly Capital Markets call, since July 11 (when the BLS released the Consumer Price Index inflation numbers for June) markets have been undergoing a powerful rotation out of the Magnificent Seven and into less expensive value and small capitalization companies. That rotation has continued into the first trading days of August, with returns on value, small cap, and non-US stock indices continuing to outperform the Magnificent Seven, the tech-heavy NASDAQ, and S&P 500 index. Exposures to these asset classes has helped more diversified, multifactor portfolios since mid-July.

Exhibit B: Market Returns and Valuations by Index versus the Magnificent 7 (source: FactSet, Inc. as of August 5, 2024)

For informational purposes only. Past performance is not a guarantee of future results. Indices are not available for direct investment.

Mercer Advisors’ Global Multifactor Equity Portfolio and the “Magnificent 7”

It’s during significant market sell-offs that we most often appreciate the value of a broadly diversified, risk-managed, global multifactor portfolio. As you can see from the nearby table, our multifactor model portfolio is underweight the Magnificent 7 relatively to the S&P 500 index and we have instead diversified across small cap, value, and non-us stocks. This is what we believe a diversified, risk-managed portfolio should look like — it should minimize the impact of any single company or individual asset class on your portfolio.

Exhibit C: Mercer Advisors’ Global Multifactor Portfolio is underweight the Magnificent 7 relative to the S&P 500 Index (Source: FactSet, Inc. Data as of August 5, 2024)

For informational purposes only, not intended as a solicitation or recommendation for any individual to implement any investment strategy or invest in any underlying holdings.

Takeaways for Investors

None of the above commentary is to suggest that market sell-offs aren’t worrisome and discomforting; they certainly can be, even for the most seasoned, time-tested investors. The purpose of the above commentary is to provide context and insight into current market events. With that said, we believe there are three important takeaways for investors from today’s current market volatility.

First, markets are complex. Rather than simplistically attributing any specific market decline to one singular event or data point (e.g., the Fed’s decision to leave rates unchanged), we should recognize financial markets for what they are: a means for global investors to digest massive quantities of new information in real time. Today’s market continues to incorporate new information related to the economy, markets, and individual companies in asset prices — everything from new information on GDP growth, job creation, inflation, interest rates, company valuations, expected earnings growth, and more.

Second, the best way to help protect our portfolios against the outsized impact of any particular company, set of companies, or singular asset class is through broad global diversification across many countries, asset classes, and companies. By definition, this means a diversified portfolio will need to underweight the biggest names in the S&P 500 Index. That hurts when those names perform well; it helps when they don’t.

Finally, and most importantly, we should all resist the urge to emotionally respond to dramatic headlines or short-term market events. Impulsiveness is an investor’s worst enemy. This can be quite hard; it’s precisely during these moments of market decline that we most feel the urge “to do something” when it’s — against our instincts — typically best to do nothing. To paraphrase Warren Buffett, it’s during such times when significant investor wealth is transferred from the impatient and to the patient. Sitting tight isn’t easy, but we know from decades of experience and academic research that having a trusted advisor, a well-crafted plan, and a diversified portfolio can all work wonders to help keep our emotions in check and our portfolio on track.

Your advisor can help determine how best to diversify your portfolio to suit your needs and goals in addition to answering your questions about the current market rotation and sell-off. Not a Mercer Advisors client but interested in more information? Let’s talk.

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