QUARTERLY LETTER
“People who think they know everything are a great annoyance to those of us who do.” – Isaac Asimov, American Writer
The bull kept running in the first quarter despite any number of reasons to take a rest. It has been a fun ride, as large U.S. company stocks, represented by the S&P 500 Index, posted 10 percent back-to-back quarterly gains for just the eighth time since 1950, and it was the best first quarter for stocks in five years.
Despite these results, much has been written by people very sure in their belief that stocks should go down:
- The economy is doing better than expected, so interest rate cuts by the Fed are unlikely, and stocks will, therefore, fall.
- Stock market valuations are high and should, therefore, decline.
- Commercial real estate is a ticking time-bomb for U.S. banks, and banks provide the ballast to support favorable economic growth.
- The yield curve remains inverted, so a recession is overdue.
- The political situation is at an inflection point, and no option looks favorable.
Of course, the big problem with these arguments is that they have been true for well over a year, and stocks have nonetheless made consistent gains. Leonardo da Vinci wrote, “Simplicity is the ultimate sophistication.” To us, that is what the nay-sayers have overlooked. The simple rationale for the market going up is that innovation and entrepreneurship in this country have surged and are leading the world, most recently reflected in advancements in Artificial Intelligence (AI). It has led to exceptionally low unemployment, dramatic wage gains at all levels, strong corporate earnings, a relatively robust housing market despite higher interest rates, and significant worker productivity gains.
While trees do not grow to the sky, the long-term outlook for stock market investors is still quite favorable. Supporting that view, Chairman Powell of the Federal Reserve says recent data has not materially changed the big economic picture, and we agree. This suggests that the Fed’s base case remains for three interest rate cuts this year, possibly starting in June. If so, that would likely be welcome news for investors, as lower rates imply healthier banks, easier access to credit and potentially higher corporate earnings.
Unfortunately, bond investors did not participate in the first quarter party. Most fixed-income investments were flat overall, and many had slight losses. Interest rates (to the surprise of most) rose marginally in the first quarter after making significant declines in the fourth quarter of 2023. The current consensus seems to be that interest rates will stay “higher for longer”, an opinion with which we agree. The Fed’s goal is to drive inflation to a two percent annual rate, but recent data suggest getting inflation much below three percent may be challenging. Thus, the Fed continues its tightrope walk, trying not to cut interest rates prematurely, which might allow inflation to pick up. On the other hand, the Fed cannot cut rates too late or risk pushing the economy into recession by keeping monetary policy overly restrictive. It is a tricky balancing act.
There were some interesting side stories in the first quarter. For example, one might assume that NVIDIA or another technology stock was the big winner in the first quarter. Not so. According to Dow Jones Market Data, the commodity Cocoa was up over 140 percent, and is up 250 percent over the past year. We assume that is bittersweet news for Nestle! (Sorry for the pun, and we hope it didn’t cause any Snickers.) As noted by J.P. Morgan in one of their reports, the Three Musketeers for the rally have been aging trees, bad weather and crop failures in West Africa, where seventy-five percent of the world’s supply is grown.
On a more serious note, when markets have strong runs it is reasonable to expect some downside in coming quarters, as markets have a way of balancing out. Indeed, stock market valuations are in a position where one can make a good case for either positive or negative results for the rest of 2024. Candidly, we would be pleased with flat markets for a time, allowing corporate earnings the opportunity to grow and bringing the overall market valuation nearer historical norms. Unfortunately, five percent stock market declines tend to occur about three times a year, and ten percent declines occur at least once a year on average. We reluctantly admit that we cannot predict when stocks will correct, but our guess is this year will be the same as others and that a few such dips are on the horizon. Nonetheless, investing in growth assets, i.e. stocks, remains the best long-term investment strategy no matter the short-term headwinds. Of that, we are certain.
MARKET COMMENTARY – APRIL 2024
The first quarter saw stocks reaching new heights, while bonds experienced a mild downturn amid rising interest rates.
- U.S. Large Cap Stocks, as gauged by the S&P 500 Index, climbed 11%, the second consecutive quarter of double-digit growth.
- U.S. Small Cap Stocks rose an additional 5%, following a banner fourth quarter in which Small Cap Stocks jumped 14%.
- International Developed Market and Emerging Market Stocks gained 6% and 2%, respectively, amidst a persistently complex global economic and geopolitical environment.
- Bonds, as measured by the Bloomberg U.S. Aggregate Bond Index, declined by 1%, with interest rates rising and investors debating the longer-term direction of interest rates.
The U.S. economy outperformed most economic projections, with a GDP growth rate of 3.3% (net of inflation) in 2023. Inflation continues to fall, although it is stubbornly clinging around 3%, not the Fed’s target rate of 2%.
The Federal Reserve has maintained short-term interest rates at a range of 5.25% to 5.50%. Fed Chair Jerome Powell indicated that rate reductions are likely later this year, but warns they do not want to cut rates prematurely in their fight against inflation.
A STRONG BULL MARKET
- The strength of the U.S. stock market has produced five consecutive months of positive returns. Surprisingly, such a trend has often been a precursor to more upward momentum, as shown to the right.
- This is only the eighth time since 1950, and the first time in more than 10 years, that the S&P 500 Index has had consecutive quarterly gains of at least 10%. In every other instance, the Index was higher a year later, with an average additional return of more than 10%.
- While the valuation of the U.S. stock market is above-average (as shown in the box below), it is not at unreasonable levels, particularly if earnings remain strong. Since the end of World War II, stock prices have spent 7% of their days at all-time highs, and nearly half the time within 5% of their all-time highs.
IT IS ALL ABOUT THE EARNINGS
- Analysts predict growth in S&P 500 earnings for 2024. As shown at the right, the ‘Magnificent 7’ companies (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, and Tesla) should continue to have outstanding, but declining, earnings growth, while the broader market’s earnings growth rate should increase, a favorable trend for investors.
- Analysts are forecasting that in the fourth quarter the Magnificent 7 will have earnings growth of 15% year-over-year, while the rest of the S&P 500 could produce an even more robust 18% growth. This would confirm a shift towards broader market participation (beyond the Magnificent 7).
- Consumer spending could see a boost if interest rate cuts begin this year, contributing to company profits. In addition, there are signs of ongoing worker productivity gains, something that should also support higher market valuations.
HIGHER FOR LONGER?
- As the Fed aggressively raised interest rates in 2022 and 2023, many forecasted that higher rates would stymie consumer spending and trigger an economic slowdown. That has not happened. The yield curve, as shown at the right, first inverted in 2022. The current consensus seems to be that interest rates are going to stay higher for longer.
- The U.S. economy, as shown below, has taken higher interest rates in stride and continued to grow – even accelerate – after adjusting for inflation.
- The labor market has cooled but remains healthy by nearly all measures. Nonetheless, as shown at the bottom right, the gap between job openings and the unemployment level has been narrowing. A better-balanced labor market should cause wage gains to moderate, helping push inflation lower.
CHECKING ON INFLATION
- Inflation has decelerated to 3.2%, a significant decline from its peak, which underscores the effectiveness of the Fed’s recent monetary policy measures. Yet it remains above the Fed’s 2% target, as shown below. Persistent inflationary pressures in core living expenses, such as shelter and food, continue to challenge the downward trajectory towards the Fed’s goal.
- The Fed’s cautious approach to lowering interest rates reflects the complex economic landscape of the U.S. economy. As one can see at the right, various components react very differently to each other. Interpreting this data is a challenge for the Fed, as they balance inflation risks against the triggering of a recession by keeping interest rates too high.
CONTRIBUTORS
Important Disclosures and Information
© 2024 The Finerty Team
The S&P 500 Index is a free-float capitalization-weighted index of the prices of approximately 500 large-cap common stocks actively traded in the United States. The Bloomberg US Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
Advisory services offered by Moneta Group Investment Advisors, LLC, (“MGIA”) an investment adviser registered with the Securities and Exchange Commission (“SEC”). MGIA is a wholly owned subsidiary of Moneta Group, LLC. Registration as an investment advisor does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified.
Trademarks and copyrights of materials referenced herein are the property of their respective owners. Index returns reflect total return, assuming reinvestment of dividends and interest. The returns do not reflect the effect of taxes and/or fees that an investor would incur. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. An index is an unmanaged portfolio of specified securities and does not reflect any initial or ongoing expenses nor can it be invested in directly. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.
