It’s hard to complain about the stock market’s performance in the first half and how it prepares investors for the rest of 2024 – difficult, but not impossible. A 15% year-to-date total return for the S&P 500 is the 21st best result through June since 1900, according to Goldman Sachs. Among years where the index was up at least that much at this point, the rest of the year was up 72% of the time for a median additional gain of almost 9%. The reward reaped by investors in large-cap U.S. stocks per unit of risk has been extraordinary, with the 12-month Sharpe ratio for the S&P 500 (return relative to statistical volatility) being more than three times higher than average long-term. The S&P 500 since the October 2023 correction low is up 33%, for an annualized total return pace of 56%. Not only did the index’s smooth advance allow its holders to sleep well at night, but the extreme calm made it safe to sleep in step with the market during the day. The S&P went eight sessions without moving half a percent. Its worst daily decline in June was a negligible 0.4%. The CBOE Volatility Index is near its multi-year low, around 12, but that looks positively rich compared to the S&P’s realized volatility over the past 30 days: just above 7, in terms of VIX. There’s not much to complain about on the surface here, but that shouldn’t stop us from watching. Market Concerns The most popular objection to this happy story came from here because it was the most obvious: The stellar returns come largely from a relative handful of very large-cap companies, with the typical ticker that lags far behind. True in magnitude: The market-cap-weighted S&P 500 has outperformed its equal-weighted version by more than ten percentage points this year. Without Nvidia’s accumulation of $1.8 trillion in additional stock market value since January 1, we wouldn’t be handing out so many superlatives about the market’s rare, rosy performance in 2024. I’ve long argued that narrower rallies are always legitimate, that money is chasing a rare offering of high-conviction secular growth that lands disproportionately on the fundamentally strongest and most macroeconomically insulated companies. I have also argued that the prevailing tone of frustration and grievance among investors toward this large-cap rally phase has somehow helped to maintain a beneficial wall of worry that would not otherwise exist in a market which reached more than 30 records in six months. Additionally, the equal-weighted S&P is posting a 9% annual return run rate this year – not exceptional, but not downright low either. It would be more worrying if traditionally defensive sectors start to outperform to send a sobering economic signal. Credit conditions have become a little less robust in recent weeks, although they started from extremely high levels. Jeff deGraaf, founder of Renaissance Macro, argued that the powerful “magnitude surge” of the fourth-quarter rally had positive implications for three-, six- and 12-month gains. The three- and six-month projections have been made, which gives him hope for a continuation of the increase – with hiccups along the way – in the fourth quarter of this year. All of this remains the case, perhaps the most credible base case in fact – and yet the perverse internal dynamics of this market could create more dangerous extremes that could make the chart more fragile in a crisis. Not only have the up days not been broadly inclusive, but the direction of the S&P 500 has been inversely proportional to daily magnitude over the past month. Of course, this is partly a quirk of the index concentration we’ve already noted (three stocks worth 20% of the S&P), but it still shows some underlying dissonance. French The extreme tendency of individual stocks to go their own way, often independently of the S&P, is illustrated here by the CBOE Implied Correlation Index. It measures the market-based expected volatility of the index’s major members relative to that of the S&P 500 itself. This is both an observed pattern and an active tactical strategy. So-called dispersion trading – selling short the volatility of the index while holding the volatility of an individual stock usually via options – has become popular. It stands to reason that a market-wide burst of stress would reverse these trades, with unknown cascading effects. Momentum Stumbles A separate but related piece of weather has been the recent sprint-and-stumble performance of high-momentum stocks, which peaked more than a week ago when Nvidia reached a buying crescendo. This break in stride of the “momentum factor” resembles, in some ways, what happened in early March with a very similar reversal at Nvidia. This month, the market held near its highs for a while thanks to a healthy rotation between the Magnificent Seven and the rest of the market. Until the end of March (the very end of the previous quarter), when broadband peaked and the S&P 500 fell 5% – the only notable decline in eight months – ensued. This setback in an overbought market at the end of the quarter coincided, of course, with some macroeconomic fear. Treasury yields broke out of a range, with the 10-year heading toward 4.5%, as high inflation figures forced a rethink of the Federal Reserve’s rate cut trajectory and obvious questions about capacity of the economy to withstand “higher for longer” rates. Last Friday, as the quarter ended with a new intraday high, the index weakened throughout the day despite a favorable PCE inflation report, while Treasury yields moved back above 4 .3%. Whether election-hungry traders are once again paying attention to the fiscal setup in the event of an extension of the Trump tax cuts or otherwise, the interaction is worth watching. More generally, macroeconomic data was weaker but generally benign, consistent with a deceleration of the economy towards a sort of soft landing, with oil prices under control, earnings forecasts reaching new highs and inflation low enough to give some flexibility to a data-dependent Fed. Investors still cannot know whether the Fed’s patience in keeping rates at cyclical highs since last July will outlast the market’s ability to wait for “insurance” rather than “emergency” easing. Other nagging points to ponder: Wall Street strategists rushed to raise their year-end S&P targets (although they generally remain moderate), depleting the reservoir of skepticism that fueled this bull market. The extremely hostile reactions to large-cap earnings disappointments point to pockets of unreasonable expectations (Micron) and reflexive selling among fallen barometers (Walgreens, Nike). Consensus estimates for the second quarter were not revised downward to lower the bar during the quarter, as is typically the case. An inordinate but justified focus on mechanical and structural machinations hints at a market that is, in a sense, beyond its shell. We’ve spent weeks engaging in intense analysis and heated discussions about the massive influences of options expiration due to the abundance of retail call option buying in the technology sector. How widespread is trade dispersion? The long-short momentum “factor” caused the tape to run on its own some days. Not to mention the huge index rebalances and distorting effects of diversification rules, which required a big change in Apple’s weightings relative to Nvidia in the tech SPDR. In 2018, Standard & Poor’s felt compelled to reorganize the communications services industry to accommodate some of the big names that are clogging up the tech sector (Meta, Alphabet, Netflix). Technology was reduced from 26% to 20% of the index; today, it is at 32.5%. None of this can predict the direction of stocks, and we should never make “machines” or “quants” the scapegoats of what is ultimately an asset market that values economic reality. Yet it’s easy to see increasing friction between the underlying market and the vehicles used to drive it.