Financial Markets Review

August 2024 marked another month of gains for the major U.S. indices, with the S&P 500 rising 2.28%, securing its fourth consecutive monthly advance. Meanwhile, the Nasdaq Composite lagged, posting a modest gain of 0.65%, and small-cap stocks, as measured by the Russell 2000, declined 1.63%. Notably, the equal-weighted S&P 500 set a record high and outpaced the traditional market cap-weighted index, driven by strength in defensive sectors, such as consumer staples, healthcare and utilities.

The month began with significant volatility and a sharp selloff, largely influenced by disappointing economic data. July nonfarm payrolls came in significantly below expectations at 114,000 versus the consensus of 175,000, raising concerns that the Federal Reserve might be behind the curve in addressing economic slowdown risks. The unemployment rate also ticked up to 4.3%, triggering recession fears. The Magnificent Seven stocks were hit particularly hard, falling nearly 10% in the first week of August, while the S&P 500 shed nearly 6% within the first three trading days of the month.

However, the markets quickly found their footing, rebounding from early-month lows. As the month progressed, sentiment improved as the odds of a soft landing increased, and the Federal Reserve signaled a likely rate cut in September. July’s core CPI data, which showed a three-month annualized core inflation rate of 1.57%—the slowest pace since February 2021—further supported the case for a rate cut. Fed Chair Jerome Powell, speaking at the Jackson Hole symposium, confirmed the Fed’s shift in focus toward the labor market, noting that upside risks to inflation had diminished.

Despite the generally positive performance in August, there are looming concerns as we head into September. Historically, September has been a challenging month for the markets, with Goldman Sachs noting that the second half of the month is typically the worst two-week trading period of the year. JPMorgan echoed these sentiments, highlighting that September has averaged a 1.7% decline over the past century, with even more pronounced losses in recent years, as the S&P 500 has averaged a 4.2% decline over the last five years.

The seasonal headwinds managed to show up early this year, with the S&P 500 falling 4.3% in the first week of September, posting its worst week in 18 months. Much of the most recent weakness was due to economic growth worries, a repricing of the impending Fed rate cut later this month and a shift toward “bad news is bad news” on soft economic data. The truth is the market is just getting whipsawed on a daily basis due to growing uncertainty surrounding the economy, geopolitical tensions and the U.S. Presidential election. Months ago, we highlighted these risks, but at the time they were pushed aside as the mega cap technology stocks dominated the market narrative. Nothing has changed since then, except investors are now recognizing the actual risks that markets face.

The uncertainty in markets is unlikely to abate in the coming weeks, which should lead to a continuation of the volatility we’ve witnessed since mid-July. However, as we have already seen, equity market volatility doesn’t just mean everything goes down. Volatility should really be synonymous with opportunity. There will be opportunities to put cash to work and there will be opportunities to de-risk overvalued stocks or get out of positions that no longer meet your intended strategy. It also doesn’t mean that every stock within the market will move in unison. For much of the year, as the S&P 500 was grinding higher, the average stock woefully underperformed the headline index’s return. That script has flipped over the past couple of months, as the average stock has more recently been outperforming the handful of companies that drove the index higher earlier in the year. As the rotation under the hood continues, it’s important to take note of what you own, since the volatility at the index level can be quite distracting. After all, for better or worse, your intended investment strategy might perform nothing like what you might be subjected to by the financial news media.

Tandem Strategy Update*

It was a busy month at the strategy level in August. As markets rebounded from a sharp decline to start the month, we were given several opportunities to begin the liquidation process or eliminate our exposure entirely in a handful of core positions.

As a reminder, there are two main reasons why we might sell a stock. First, we will trim a position based on valuation. If our quantitative model signals a company is unsustainably overvalued, we sell a portion of our position. Since it fundamentally meets our criteria, we will continue to hold the stock, albeit at a smaller weighting with the intention to add back to our position at a more favorable valuation. Second, we will liquidate a position if it ceases to quantitatively meet our criteria of consistent growth through any economic cycle or qualitatively fails to hire and promote executives from within. Once a company is marked for liquidation, the process of selling the entire position takes time, as we try to identify the most opportune times to incrementally exit.

In last month’s edition of Observations, we highlighted the fundamental sales of Check Point Software Technologies (CHKP) in our Equity and Mid Cap Core strategies and Nike (NKE) in our Large Cap Core strategy. Over the course of August, we completed the liquidation of both companies. In addition to the liquidation of these core holdings, we exited our position of Five Below (FIVE) in our Equity and Mid Cap Core strategies. FIVE has struggled mightily over the past several quarters as retail spending amongst lower-income consumers has pulled back significantly. The rapid deterioration in FIVE’s business has caused the company to no longer pass through our screen of consistent fundamental growth.

In addition, we have begun the process of liquidating Henry Schein (HSIC) in our Equity and Mid Cap Core strategies and MarketAxess Holdings (MKTX) across all strategies. Both companies have failed to jump start growth since the Covid pandemic and no longer fundamentally pass through our quantitative screen. Each company has had fits and starts to only go on and disappoint, which has led HSIC and MKTX to fail at sustaining consistent growth in revenues, earnings and cash flows.

If the next couple of months are anything like what we’ve experienced in the first week of September, it is safe to assume transaction activity at the strategy level will remain elevated. With volatility in equity markets expected to remain heightened for the foreseeable future, we plan to remain prudent and steadfast in our discipline to deploy cash as opportunities arise.

*The transition level activity taken by Tandem is applicable to new accounts and new money, not the composite or firm-wide level. New accounts and new money are not automatically invested on the first day. Rather, they are transitioned into our strategy over a longer time period that is dependent upon market conditions. Strategy level activity is applicable to the composite and action is taken at the firm-wide level.

Source: Source of all data is FactSet, unless otherwise noted.

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Disclaimer: Tandem Investment Advisors, Inc. is an SEC registered investment advisor.

This audio/writing is for informational purposes only and shall not constitute or be considered financial, tax or investment advice, or an offer to sell, or a solicitation of an offer to buy any product, service, or security. Tandem Investment Advisors, Inc. does not represent that the securities, products, or services discussed in this writing are suitable for any particular investor. Indices are unmanaged and not available for direct investment. Please consult your financial advisor before making any investment decisions. Past performance is no guarantee of future results. All past portfolio purchases and sales are available upon request.

All performance figures, data points, charts and graphs contained in this report are derived from publicly available sources believed to be reliable. Tandem makes no representation as to the accuracy of these numbers, nor should they be construed as any representation of past or future performance.​