Market Update

Volatility is back in equity markets.

• A decline in megacap tech stocks Thursday
• The first day in the last five where small caps have underperformed large caps
• The CBOE Volatility Index (VIX) at its highest level since April

Markets are feeling like a … market.

The S&P 500 (-0.8%) had a broad pullback with 10 of the 11 sectors in the red. Small caps fell nearly -2% in their worst day since April, but are still up more than 7% this month.

Yields were higher across the curve, but markets are still pricing a 95% chance of a September cut.

As markets digest the speed of the equity rotation, we give our interpretation below.

Small caps are shining

Through the first half of this year, large caps carried the market. The S&P 500 and Nasdaq 100 outperformed small caps (Solactive 2000) by more than 16% and 18%, respectively. Since the midpoint, however, the tables have turned. Small caps have rallied over 9%, compared to just over 2% for the S&P 500 and less than 1% for the Nasdaq 100.

The returns in the first half of the year were top-heavy. Just four stocks (Nvidia, Microsoft, Alphabet and Amazon) contributed more than half of the S&P 500’s gain, while nearly 40% of the index was negative. In the second half of the year, only 20% of the index has a negative return, including all four companies listed above.

Performance is broadening across the equity market. As we argued last week, we think that can continue.

1) The fundamentals. We are moving into a “Goldilocks” scenario for the Federal Reserve. Inflation is coming down and growth is moderating, but not stalling. The inflation data continues to give us more confidence that inflation is no longer threatening. Last week’s Consumer Price Index (CPI) report showed the first month-over-month decrease since 2020, and Bank of America’s (BofA) institutional fund manager survey showed that higher inflation is no longer investor’s number one tail risk.

The consumer is still strong. Retail sales in the all-important control group for the month of June were more than four times Street expectations, and the Atlanta Fed’s GDPNow forecast is for the economy to grow 2.7% in the second quarter. At the same time, according to a Bank of America survey, almost 40% of investors think that monetary policy is too restrictive – the highest since 2008. That backdrop of decent growth with fading inflation pressures and room to cut rates is compelling for risk assets.

That’s the macro setup. On the micro, nearly 40% of the Solactive 2000 (small caps) are unprofitable, which means they are more dependent on capital markets for financing than large caps who can fund operations through cash flow. Thus, lower rates have an outsized impact on small caps relative to large caps.

2) The technicals. Given the smaller size and relatively less liquidity of the small cap market, technicals also play a bigger role. Hedge funds came into the month with a near-record short position in small caps. When positioning is that stretched, it only takes a small spark to ignite a powerful rotation.

It wasn’t just short covering. For the week ending July 12, equity exchange-traded funds (ETFs) had their second-highest flows of 2024. Most of the dollars on a nominal basis went to large-cap ETFs. But relative to size, small caps were the big winner. The iShares Russell 2000 ETF recorded an inflow of $3.7 billion, which is more than 6% of its market cap, compared to the 2.4% market cap inflow for the SPDR S&P 500.

3) The political landscape. Per PredictIt, there is a 63% chance that a Republican will win the presidential election, up eight percentage points from just a month ago. As we noted in our Mid-year Outlook, small-cap equities would likely benefit from the prospect of lower taxes and less onerous regulations. For only the second time in the index’s history, the Solactive 2000 rallied to a new 52-week high after a five-day 10% rally. The only other instance? November 11, 2016, the business day after national election polls closed and Donald Trump became president-elect. The index rallied a further 7% over the next month and was 14% higher a year later.

Past performance is no guarantee of future results. It is not possible to invest directly in an index.

Assess portfolio positioning and consider an allocation to Small and Mid-cap (SMID) stocks. We think outperformance in the style factor can continue as several of the tailwinds we mentioned have long runways. For those portfolios where an allocation make sense, we think the best way to access the factor is through active management. Skilled managers can find quality companies in the space, producing cash flows that trade at a discount.

As always, reach out to your J.P. Morgan advisor, who is here to help.

All market and economic data as of 07/19/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

DISCLOSURES

The Chicago Board Option Exchange(CBOE) Volatility Index (VIX), is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index.

The Solactive United States 2000 Index intends to track the performance of the largest 1001 to 3000 companies from the United States stock market. Constituents are selected based on company market capitalization and weighted by free float market capitalization.

The iShares Russell 2000 ETF seeks to track the investment results of an index composed of small-capitalization U.S. equities.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

Investing in equities involves risk. The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only – they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The outputs of the assumptions are provided for illustration/discussion purposes only and are subject to significant limitations.

“Expected” or “alpha” return estimates are subject to uncertainty and error. For example, changes in the historical data from which it is estimated will result in different implications for asset class returns. Expected returns for each asset class are conditional on an economic scenario; actual returns in the event the scenario comes to pass could be higher or lower, as they have been in the past, so an investor should not expect to achieve returns similar to the outputs shown herein. References to future returns for either asset allocation strategies or asset classes are not promises of actual returns a client portfolio may achieve. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making a decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future returns. The model assumptions are passive only – they do not consider the impact of active management. A manager’s ability to achieve similar outcomes is subject to risk factors over which the manager may have no or limited control.

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit and accounting implications and determine, together with their own financial professional, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield are not a reliable indicator of current and future results.

Index definitions:

The Russell 3000 Index is a capitalization-weighted stock market index that seeks to be a benchmark of the entire U.S. stock market. It measures the performance of the largest 3,000 U.S. companies representing approximately 96% of the investable U.S. equity market.

The S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight of the index total at each quarterly rebalance.

The Bloomberg U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

The S&P 500 Equal Weighted Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight – or 0.2% of the index total at each quarterly rebalance.

The Magnificent Seven stocks are a group of influential companies in the U.S. stock market: Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla.

The Magnificent 7 Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, Tesla) classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System (BICS).

The S&P Midcap 400 Index is a capitalization-weighted index which measures the performance of the mid-range sector of the U.S. stock market.

The S&P 500 index is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The Russell 2000 Index measures small company stock market performance. The index does not include fees or expenses.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

The views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. Information presented on these webpages is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.

RISK CONSIDERATIONS

• Past performance is not indicative of future results. You may not invest directly in an index.
• The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time.
• Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.
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• As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
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• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.