Resources/Weekly Insights

Volume 13, Edition 21 | August 31 - September 6, 2024

No Dog Days for Diversification

Doug Walters, CFA

The dog days of summer may be over, but stocks are having their own summer doldrums. Diversification can help.

Contributed by Doug Walters, David Lemire, Max Berkovich

The kids are off to school, and the dog days of summer are behind us. The stock market experienced its own dog days this week, shedding about 4%. The S&P 500 is still up over 4% from the August lows, but with NVIDIA a key contributor to the downward move, it is a good time to remind investors of the benefits of evidence-based investing and diversification.

The Origin of “Dog Days”

Ever wonder why they are called the “dog days?” The constellation Canis Major (Great Dog) and the brightest star, Sirius, rise into view during the mid-summer months. Ancient civilizations, like the Greeks and Romans, associated the rise of Sirius with the elevated heat and humidity. They believed that the heat from Sirius contributed to the higher temperatures. This conclusion, of course, is not true. Correlation does not necessarily imply causation.

Correlation vs. Causation

As evidence-based investors, we think a lot about correlation and causation. Many spurious tales have arisen out of seeming correlation without causation:

Sell in May and go away
The Super Bowl indicator
The Santa Claus rally

Our job is to separate useless noise and data mining from genuine, proven relationships. “Factors” like High Quality, Good Value, Strong Momentum, and Small Size all fall into this category of “proven.” The benefits of diversification have also been proven to help investors in the long term. In fact, it is the one free lunch for investors. With smart diversification, investors can simultaneously increase or maintain returns and reduce overall portfolio risk. Magic!

Spotlight on NVIDIA

And that brings us back to NVIDIA. The mega-cap chip company has been a massive success story, benefiting from investment in artificial intelligence. Yet, its enormous size, along with its mega-cap peers (Alphabet, Microsoft, Amazon, Apple, etc.), has left many investors with less-diversified portfolios. For us, a well-diversified portfolio includes a healthy dose of small-cap stocks, international, emerging markets, gold, and fixed income.

NVIDIA is down around 24% from its July highs, and all the above diversifiers have outperformed it and its mega-cap peers during that period.

Looking Ahead

With the Fed set to lower rates for the first time in this cycle, geopolitical tensions high, and a close Presidential election approaching, uncertainty remains elevated. Investors should not be running for cover. Instead, a well-diversified portfolio is their best long-term defense.

-24%

Decline in NVIDIA from it’s July peak

NVIDIA stock has led a decline in Tech and its mega-cap peers. Diversification is always important, but perhaps more-so with concentration risk elevated by the rise (and fall) of the mega-caps.

Headline of the Week

Revisions

The August jobs report came in below expectations but not by too much. While technically a “miss,” the jobs report was an improvement over the previous report and gave comfort to the quarter point cut crowd. However, the latest revisions to previous reporting saw more reductions on top of the whopping +800K reduction dating back to April 2023. Markets seem to be adjusting to the scale of revisions but may still be digesting rate path scenarios. The September Fed meeting was always slated to be pivotal, and it is hard to believe the anticipatory fervor could get any higher.

The Week Ahead

Before we turn our eyes to the Federal Reserve, next week will be more internationally focused, with the Bank of England and European Central Bank kicking off the central bank parade. Domestically, an inflation report is the major event.

Hold On!

The Bank of England (BOE) was quicker to hike rates in 2021 but is expected to trim rates more slowly than its peers.

When the BOE cut rates in August, it was under the cloud of rate watchers who were not expecting another trim until November.
Has economic data warranted an earlier trim? Wages rose slower than anticipated in June, and the unemployment rate dropped unexpectedly as well.
So, that leaves the BOE watching the September 10th wages report and looking at Gross Domestic Product, but overwhelming expectations are for them to hold steady.

The 2nd Cut

The European Central Bank (ECB) will decide its next move on Thursday, and the market is predicting another cut.

Headline inflation dropped to 2.2% year over year in August, making the second cut less technical than the first.
The first cut in June was set up with President Lagarde all but boxing the ECB into a move in the summer; the next move will have less of that pressure.
As with all meetings, investors will look for any hints at the future path of cuts.

Fed Watch

The Consumer Price Index (CPI) report will provide the central bank with the freshest inflation numbers to digest before its rate decision.

CPI is expected to have risen 2.6% year over year in August, easing from 2.9% in the previous report.
The Jobs report on Friday failed to clear up the 25 or 50 debate, leaving the world anxiously watching the inflation figures for a scale-tipping surprise.
CPI is not the preferred inflation gauge of the Federal Reserve but is still a major inflation indicator.
The Producer Price Index and the Consumer Sentiment Index are the other significant economic releases next week.

Distractions that Matter

Besides the start of the football Season, we have a Presidential Debate on Tuesday, and Apple has a highly anticipated event on Monday.

Apple’s “Glowtime,” unlike the June worldwide developers conference, which focused on the iOS operating system, is expected to be all about the iPhone and Apple Watch.
The event where the new iPhone 16 lineup is unveiled is also expected to reveal and showcase all the latest Artificial Intelligence integration that will entice users to upgrade their devices.

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