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Quarterly Letter to Clients

July, 2024

Indices at quarter-end (June 30, 2024):

Dow Jones Industrials: 39,118.86 2Q'24 -1.73% YTD +3.79%

Standard & Poor's 500: 5,460.48 2Q'24 +3.92% YTD +14.48%

Lately, when people ask me how the market is doing on a given day, I often answer that stocks are "mixed." By that I mean that the Dow is down, while the S&P and NASDAQ are up. Sometimes it is the other way around.

In the quarter just past, the averages churned higher, not dramatically, but steadily. The indices continue to be led by a small handful of companies. Three stocks today account for almost 20% of the moves in the S&P, with four or five more doing much of the rest of the lifting. As for the other 492, well, they account for the "churn," not so much the "higher."

Of the three main indices, the Dow was left in the dust by the S&P 500 and the NASDAQ. These indices are constructed differently: the Dow Jones is equal-weighted, meaning that each of it's 30 component companies contributes equally to performance. In contrast, the S&P and NASDAQ are capitalization-weighted, meaning that the bigger the value of a given company, the more it will influence the index.

In order for the Dow to up (or down) most of its underlying 30 stocks must move in the same direction, while for the S&P to move it only takes perhaps seven stocks to move in tandem. So stocks with multi-trillion-dollar capitalizations (Microsoft, Apple, Nvidia) have an outsize influence on the index.

This is why the Dow Jones has not kept pace with the S&P or NASDAQ over the last couple of years.

But most people don't own stocks based upon capitalization. We own them, and track our holdings, based upon how much money we put into them; we selected them based upon how comfortable we are investing our hard-earned dollars in that particular business. We don't say, "I'm going to put 10 times more into Company A because it is 10 times bigger than Company B."

In fact, if a particular stock grows to 20% of our portfolio, we are wise to trim that holding back. And most professional money managers would do exactly that. I, for one, get nervous at 10%.

Is it accurate to view the market as going higher when only a handful of stocks are going up? Perhaps it is irrelevant. This is the world that we live in. We compare our performance to these averages notwithstanding their shortcomings.

The indices aren't human, they do not care whether you are 25 or 85, they don't care about risk, and are not influenced by how much income you might need to draw from your account, or how much risk you are able to bear. They are simply a mathematical construct.

The main topics of the day are threefold: interest rates, artificial intelligence (AI) and weight-loss drugs, GLP-1s.

In the third and fourth quarters of last year it was widely thought (or hoped) that 2024 would see 4 to 6 interest rate cuts. I was not so sanguine; today it is widely felt tht the Fed may institute only a single cut before the end of this year. Personally, I do not believe that they will make any significant rate cuts until inflation is closer to 2.5% than the current plus-or-minus 3.5%. I have moved to invest cash in short-term Treasury bills.

Artificial intelligence, or AI, is a rather vague term used to describe computers that will, hopefully, take much of the "grunt" out of work, from writing papers on subjects arcane to mundane and ranging all the way to doing things like developing new drugs. From chips (Nvidia) to software (Microsoft, etc.) it seems like every company that can be considered "tech" is trying to get on the AI bandwagon. And if there is a credible path for those companies, they are being rewarded.

In the healthcare sector are two companies that manufacture drugs initially intended to combat diabetes, but which have found enormous markets in weight-loss applications. The drugs are known as GLP-1s, and they are made primarily by two companies, Eli Lilly in the U.S. and Novo Nordisk in Europe. The implications range from health to clothing to foods.

The leading companies in AI and the two principal GLP-1 makers trade at very high multiples of earnings. Nvidia sells at 71 time it's earnings, Lilly at 120 times and Novo at 49 times. Some research services put "NM" (for Not Meaningful) in the slot where the P/E ratio should go.

While I always knew that I would grow older, it really didn't register that I would also grow that much more cautious. I just can't bring myself to buy companies selling at such elevated levels, regardless of their potential. I have always been a conservative investor, more interested in protecting and preserving my funds than in racing against the pack.

Jim Pappas