Solid business fundamentals continued to support a positive equity environment during Q2. After a strong first quarter, most stocks saw modest gains in Q2 while a handful of large-cap technology stocks pushed the overall S&P500 index returns up above 4% for the quarter. Some investors have been repositioning portfolios to reflect the opportunities expected to be realized from the widespread adoption of artificial intelligence technologies. So far, this has been primarily reflected in the returns for the so called “Magnificent 7” stocks including NVIDIA, Microsoft, Alphabet, Amazon, Apple, Meta and Tesla. Going forward, we believe that the strength of this secular growth phenomena may overwhelm other market factors in the near term; and may ultimately be the determining factor driving the strength of a potential multi-year bull market.
On the economic front, overall growth in the US has been relatively stable but seems to reflect a modest slowdown across several economic indicators. Manufacturing improved during Q1 but fell back some during Q2. The stronger Services economy softened in Q2. Unemployment continues to be historically low but has risen to 4.1% from 3.7% earlier in the year. Still, the US economy has done a better job balancing inflation, higher interest rates and growth than other large economies. Most of Europe and Asia are seeing lower growth rates. Combined with a strong US dollar, weaker global growth has a disinflationary impact on the US. Investors are rightly focused on potential interest rate cuts as a result of a weaker US economy and remain positive about equities.
Publicly traded companies are in good shape. Infrastructure spending for semiconductor, industrial and electrification goals will add to an already solid baseline economy. Analysts expect mid-single digit revenue growth and double-digit EPS growth for the S&P500 in 2024 and 2025. Free cash flow growth is expected to be near 10%, giving management teams the financial flexibility to continue to invest in their businesses, raise dividends, repurchase stock or pay down debt (or all-of-the-above). Artificial intelligence is expected to result in substantial technology investment in the near term with the longer-term benefit coming from higher productivity and profit margins.
As a caveat, some fear the current AI buildout may result in overcapacity if adoption rates are less than expected. We view this not likely near term but something to watch. Geopolitical issues are also of concern, especially market-impacting topics like potential changes to taxes and fiscal spending or increases in trade tariffs. It is helpful to recognize that while near-term political volatility can push markets lower, long-term impacts are typically muted.
Our client holdings are positioned to do well over time. We remind clients that patience is the key to a successful long-term investment strategy. SFE continues to invest in companies that have demonstrated success; and offer solid management, competitive advantages, strong balance sheets, profitable businesses, strong free cash generation and dividends. The current bull market is less than two years old and may have several years left, especially if the excitement generated by artificial intelligence continues. If AI provides the productivity improvements that many foresee, such a future could indeed be beneficial for our investors.
Disclosure Statement
SFE Investment Counsel is a Registered Investment Adviser. This presentation is solely for informational purposes and not a solicitation to invest. The results reflect the deduction of fees and the reinvestment of dividends and other earnings. Advisory services are only offered to clients or prospective clients where SFE and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by SFE unless a client service agreement is in place. Please contact a financial advisory professional before making any investment.
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