Executive Summary
- During the quarter, the Lazard Global Managed Volatility (MUTF:MEVIX) Equity Portfolio underperformed the MSCI World Index (net of fees).
- Stock selection and sector allocation both detracted.
- Stock selection was strongest in consumer staples and consumer discretionary.
- Information technology and communication services holdings lagged.
- Sector positioning helped, as the underweight to consumer discretionary and energy proved beneficial.
- The underweight to information technology detracted. Regionally, selection was strongest in Canada and Switzerland and weakest in the United States and Japan.
- Alpha was positive for the quarter, with the most strength in April.
- Sentiment factors remained effective and consistently contributed to returns in 2024.
- Value measures were strong in April but declined sharply in subsequent months, especially in the US.
- Growth and quality measures recovered in June, contributing positively overall.
Market Review
The rally in global equity markets continued in the second quarter with a 2.2% quarterly gain, marking the third straight positive quarter. The market has now rebounded nearly 25% from September’s lows (MSCI AC World Index in USD).
Gains have been driven by several forces: strong corporate earnings, subsiding inflationary pressures, and anticipated artificial intelligence productivity enhancements. The United States continues to dominate the global equity landscape, and the Magnificent Seven, led by Nvidia (NVDA, 149% year to date), now accounts for more than 60% of the US market’s gains. Spending on AI continues to drive earnings for all related companies, including utilities, due to the high electricity demand. This has created a bifurcated market, with the average US stock underperforming the broad cap-weighted index by nearly 10% year to date, a level not seen in over 35 years.
Asian markets boasted a strong quarter, but still lagged the United States. Taiwan, with its dominant technology exposure, was the leading market in the region, rising over 15% in the quarter. India recovered in June after the surprise election results, which may temper Prime Minister Modi’s political powers. Despite losing 2% in June, China rose more than 7% in the quarter as the government took stimulus actions to address its real estate overhang and weak consumer spending. Japan managed a gain in local currency terms, but the Bank of Japan’s interest rate policy continues to weigh on the yen, which depreciated another 7% in the quarter.
European stocks delivered a positive quarter as the eurozone continues to deal with inflation that remains well above the European Central Bank’s (ECB) 2% target. Wage pressures continue to drive inflation fears as labor shortages and low unemployment persist. Despite the inflation news, the ECB cut its interest rates from 4% to 3.75%, arguing that it was still far from a neutral rate and needed to spur the economy. The political implications of the French elections will likely add to market volatility in the third quarter.
Sector performance reflected the narrow market, as only five sectors finished with a positive return in the quarter. Information technology and communication services stocks dominated the market with returns of 11% and 8%, respectively. Real estate and materials stocks lagged.
Factor effectiveness was muted in the second quarter, especially in comparison to the strong first quarter. Sentiment was the most consistent factor for the quarter, adding modest value in each month. Value measures worked well in April but trailed off in the later part of the quarter. Growth worked well in June but detracted in the first half of the quarter. Quality provided incremental return in the first half and again in the final week of the quarter, but was the weakest factor overall.
What Helped
Roche (OTCQX:RHHBY), which has a 1.8% weighting in the Portfolio. The company’s pharmaceutical and diagnostics divisions each achieved a 2% growth rate at constant currency following the first-quarter results. The underlying constant-currency growth was a robust 7% when excluding the impact of reduced COVID-related antibody and diagnostic sales. Management has reaffirmed its guidance, anticipating mid-single-digit constant-currency sales growth and core earnings per share growth for the full year. Walmart (WMT, 1.5% weighting in the Portfolio) delivered impressive first-quarter results, driven by its competitive pricing and strategic digital investments, which continue to attract a diverse consumer base. Total revenue grew by 6%, with gains seen across both domestic and international segments. The retailer is well-positioned to continue capturing market share across various income groups.
What Hurt
Bristol-Myers Squibb (BMY), which has a 1.2% weighting in the Portfolio. The company’s first-quarter results were mixed, with new- product sales falling short of market expectations. Despite Revlimid’s strong performance, its impact on the stock’s valuation was limited due to the anticipated rapid sales decline as it faces increasing generic competition over the next few years. CVS Health (CVS, 0.6% weighting in the Portfolio) reported weak first-quarter results, primarily due to reduced profits in its Medicare Advantage (‘MA’) segment. Increased medical utilization and mispriced plans led to a decline in insurance segment profits, while the pharmacy benefit management business was impacted by the loss of the Centene (CNC) contract. Consequently, management lowered its 2024 guidance, citing the ongoing challenges in the MA segment.
Market Outlook
Investors have continued to benefit from strong equity market returns in the first half of 2024, creating an increasing disparity in stock valuations within and across markets. Despite generally improving economic conditions, neither emerging market nor small cap stocks have enjoyed a return premium befitting their risk profile. As we look forward to the balance of 2024, we expect that US inflation will continue to ease and the strength of the dollar will take a greater toll on corporate profits. This should allow the US Federal Reserve to cut rates at year-end providing a lift to equity investors. The November election will certainly raise investor anxiety and add to market volatility. The outcome will likely have a profound influence on the market direction in the following months. Conditions in Europe should favor further central bank easing and economic growth. China’s government continues its desire to stimulate its economy. We expect more specific stimulus to be announced during the Third Plenum in July, which may provide reasons for optimism over the latter half of 2024. Japan also appears to be on a path to balancing growth and inflation, and we see an end to its zero interest policies finally supporting the yen. In sum, we expect that US election uncertainty and geopolitical tensions will elevate market volatility despite a favorable trend in corporate profits. We believe that segments of the equity markets that have been out of favor will revert in the second half with the US dollar weakening, specifically small cap and emerging market stocks.
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