April Investment Comments
Expectations for rate cuts in 2024 have moderated since the beginning of the year. Based on the CME FedWatch Tool, the current expectation is for three 0.25% rate cuts in 2024 with the first cut occurring in June. This is down from expectations at the start of the year for six rate cuts with the first reduction occurring in March. One might expect the revisions since the start of the year would spell trouble for equities, but stronger than expected economic data has helped propel the market while calming fears regarding an imminent recession.
Real GDP increased 2.5% in 2023 and economists tracked by Bloomberg now expect real GDP to grow more than 2% in 2024, reflecting the view that the risks of a near term recession are remote. Regardless, the Fed appears ready to step in upon signs of a meaningful downturn in the economy while fiscal policy also remains stimulative, helping support risk appetite.
Through early March, the S&P 500 is up approximately 8% this year. The narrative remains largely the same as a year ago with large cap technology stocks driving the gains, helping the relative performance of the market cap weighted S&P 500. A look at the equal-weighted S&P 500 index paints a less cheery picture, as it trails the cap-weighted index by about 3%. However, it is worth noting that this difference is less pronounced than in 2023.
Interestingly, we have also seen some divergence in performance amongst the “Magnificent Seven” this year, with Meta up more than 40% and Nvidia up nearly 80%, while Tesla is down about 30% and Apple has declined approximately 10%. In a sign of broadening equity market participation, every sector of the S&P 500 has posted gains over the past month.
Since the start of the year rates have risen modestly but have backed off from the highs, with the 10-year Treasury entering the year below 4%, peaking above 4.3%, and since moderating to around 4.2%. This remains elevated relative to recent history but is hard to call “high” when taking a longer historical view. Regardless, borrowers continue to adjust to higher rates. A 30-year fixed rate mortgage currently runs approximately 7%, down from greater than 8% earlier this year but significantly higher than the sub-3% rates consumers enjoyed for a large portion of 2020-2021. Higher rates continue to suppress activity in the housing market as well as in other consumer markets reliant on financing. Higher rates have also weighed on businesses’ willingness to invest.
The February jobs report helped increase conviction that the Federal Reserve will cut rates by midyear, indicating the job market is cooling despite its continued resilience. The headline number of 275,000 jobs added in February was ahead of expectations of closer to 200,000 and outpaced the roughly 100,000 jobs needed per month to keep up with growth in the working age population. However, the robust job additions in February were more than offset by substantial downward revisions to December and January that totaled 167,000. Those looking for rate cuts later this year can also point to a modest uptick in the unemployment rate to 3.9%, the highest level since early 2022 after remaining at 3.7% over the prior three months. Average hourly earnings in February were up less than expected, resulting in a 4.3% increase versus the prior year, down from a 4.4% increase in January. This remains too high relative to a 2% inflation target but continues to trend in the right direction.
The Federal Reserve can point to inflation that has eased substantially without a significant increase in unemployment, as it chases the historically elusive soft landing. In January, the Fed’s preferred measure of inflation, the personal consumption expenditures index (PCE), rose 2.4% over the prior year. The core PCE index, which excludes volatile food and energy prices, increased 2.8% versus the prior year. That is above the Fed’s 2% target but indicative of a trend of moderating inflation when compared to a 4.9% increase during the prior 12-month period. The February CPI data was a little hotter than expected with headline inflation ticking up slightly from January to 3.2% versus the prior year, while the core CPI figure declined from 3.9% in January to 3.8%. Inflation is trending lower and market participants believe the Fed will achieve its goal of 2% inflation with both the 5-year and 10-year implied inflation rate at 2.3% based on Treasury Inflation-Protected Securities.
Between March 2022 and July 2023, the Federal Reserve raised interest rates by 525 basis points to the current 5.25%-5.50% range to combat 40-year high inflation. In his recent testimony before Congress, Chair Jerome Powell indicated that the Fed Funds rate is likely at its peak for this tightening cycle, consistent with consensus expectations. He also noted that it would likely be appropriate to start cutting rates at some point this year, though it will require greater confidence inflation is moving sustainably to its 2% target. Importantly, he also noted the committee is not far from acquiring the confidence required to start cutting interest rates. However, Powell cautioned that these are only likelihoods. Any changes would be driven by inflation that remains stubbornly high or reaccelerates.
There also remains a risk that the Fed keeps rates too high for too long, unnecessarily pressuring the economy and causing damage to the employment market that could have been avoided. The Fed has noted that the risks of doing too much and doing too little have become more balanced in recent months, a further indication it has inched closer towards easing policy. While the Fed is broadly expected to stand pat at its March 19-20 meeting, Chair Powell will likely further clarify the forward outlook at his press conference following the meeting. Also of importance will be the new economic projections from members of the committee, where investors will be looking to see if there is any update to the committee’s prior expectations for three rate cuts this year.
Markets continue to reflect a “risk-on” mentality. In addition to the well-known run Nvidia has been on, Super Micro Computer, another AI beneficiary with a market capitalization of more than $50 billion, is up more than 300% since the start of the year. Bitcoin is up more than 60% year to date, breaking the $70,000 barrier, helped in part by the launch of exchange traded funds that hold the cryptocurrency. Reflecting the bullish sentiment, multiples remain elevated relative to history. The forward P/E multiple is currently 21x versus the 10-year average of just under 18x. Earnings for the S&P 500 are expected to grow 11% in 2024 following just 2% growth in 2023. Early expectations for 2025 reflect robust 13% earnings growth, helping to support the elevated current multiple. Given the recent market strength It is easy for investors to get concerned about the possibility of a near-term pullback. However, history would suggest things work out well over the longer term for patient investors that focus on and stay invested in growing companies with reasonable valuations.
James Skubik, CFA