1st Quarter 2024 Market and Economic Commentary

Dear Valued Client:

Before entering 2024, two questions dominated investors’ minds; could the mega-cap technology stocks continue to rise and support the market rally? Will the Federal Reserve (Fed) lower interest rates in March? As we sit at the end of the first quarter of 2024, we have the answers to at least some of those questions. First, the majority of the aforementioned mega-cap tech names have continued to push higher, however, Apple and Tesla are significantly negative for the year, turning the “Magnificent 7” into the “Fabulous 5.” This seems to be the beginning of a welcome sign for a healthier market dynamic as we have seen gains more broadly spread across stock market sectors. Second, the Fed did not cut rates in March but continues to support the case for three rate cuts this year. Unlike most historical episodes, the Fed is not considering cutting rates because the economy is too weak. Instead, it is doing so because inflation is heading in the right direction, and there is no longer a need for such a restrictive policy. If the Fed is right and can engineer a soft landing, (decreasing inflation after increasing interest rates, without causing negative GDP growth or an uptick in unemployment) then 2024 could continue to be a good year for both stock and bond investors alike.

Domestic Equities

The first quarter saw U.S. equities continue to rally. The Dow Jones Industrial Average, NASDAQ Composite, and S&P 500 indices each set all-time highs in March. This marked the first month since November 2021 that the trio of indices closed at an all-time high in tandem. What may be more impressive is that for the first time since 2012, the S&P 500 Index posted two consecutive quarters of returns greater than 9% (Q4 of 2023 and Q1 of 2024). Gains were supported by a strong earnings season which gave market participants confidence in the durability of earnings growth through the rest of the year. Although returns continued to be concentrated within large-cap growth equities, which returned 11.41%, other areas in the market also posted strong returns. This is a positive development given the market concentration we witnessed in 2023. Large-cap value gained 8.99%, mid-cap stocks returned 8.60% and even small-cap stocks were positive, returning 5.18% in the first quarter. Although stocks reached all-time highs during the quarter, the path forward may still be higher. History shows that markets favor election years, with an average return of 12%. Over the past two decades, the only times markets have performed negatively during an election year were due to anomalies such as the dot-com bubble in 2000, and the Global Financial Crisis in 2008. In addition, the Fed’s consideration of lowering rates may offer additional support to the economy and risk assets like stocks.

International Equities

International equities underperformed U.S. equities in the first quarter of 2024, with the S&P 500 returning 10.56% while the MSCI EAFE Index returned 5.78%. While lagging U.S. equities, international domestic stocks were still higher as Japanese stocks (the largest constituent in the MSCI EAFE Index) reached an all-time high in the first quarter. However, market performance is disjointed from the economic picture, as many developed countries outside the U.S. are plagued by slow growth. Japan narrowly avoided a recession after printing a quarter of negative GDP growth, the United Kingdom slipped into a technical recession in the fourth quarter of 2023 by notching the second consecutive quarterly GDP decline, and Germany had GDP growth shrink by -0.3% in the full year of 2023. Couple this with the geopolitical conflicts (i.e., the ongoing war between Russia and Ukraine and the situation in the Middle East) and the risk-reward tradeoff for international stocks looks less than attractive. The MSCI Emerging Markets (EM) Index, which posted a return of 2.37%, lagged both internationally developed and U.S. markets. A sizable portion of this underperformance can be attributed to a strong dollar, which gained 3.12% in the first quarter of 2024. Continued economic struggles out of the largest EM benchmark constituent (China) also hampered index returns, with the MSCI China index down -2.19%. On a brighter note, for many Emerging Market countries, some commodity prices have started to increase, such as oil which is up over 18% for the year. Given that most EM countries are commodity exporters, those countries could see a broad lift if commodity prices rise.

Fixed Income

Coming into 2024, the 10-year yield had fallen from a peak of over 5% in October 2023, down to 3.88% by year-end. This looked to be the beginning of a downtrend as the Fed hinted that rate cuts were coming soon due to inflation continuing to moderate. Remember, falling yields are positive for your bond holdings as the price of a bond moves higher when yields fall. However, in the first three months of 2024, we have seen a reversal in the 10-year treasury yield. The main factor driving yields back up was hotter-than-expected inflation readings in both January and February. We can measure inflation with the Consumer Price Index (CPI), which is like a lengthy list that shows how prices for things we buy, like groceries and gas, etc. change over time. When the CPI goes up, it means things are getting more expensive, and when it goes down, it means things are getting cheaper. In January, the overall CPI rose 3.1% from a year earlier, which was down from 3.4% in December but more than the 2.9% that investors had forecast. In February, CPI showed prices rose 3.2% from a year earlier, more than what was forecasted and an acceleration from January’s annual gain. Market participants have watched for any signs that inflation has cooled enough to allow the Fed to begin cutting interest rates, and what January and February inflationary readings told us is that some progress had been made on inflation, but more work is required to reach the Fed’s 2% CPI target. This pushed bond yields higher from 3.88% at the start of the year to 4.20% as of the end of March. As mentioned earlier, higher bond yields lead to lower bond prices. As a result, the Bloomberg U.S. Aggregate Bond Index returned -0.78% for the first quarter. The cause and effect of higher bond yields and lower bond returns are two-fold. For one, if investors expect higher inflation in the future, they may demand higher yields to compensate for the loss of purchasing power. This can push the 10- year treasury yield higher. Secondly, expectations for interest rate cuts have now been moved to later in the year, with investors now widely expecting the first rate cut to take place in June rather than the March date that was expected at the start of the year. Although off to a lackluster start, we still expect the Fed’s anticipated three rate cuts to come to fruition this year, which leaves bonds set to deliver potential price appreciation.

Recession calls have faded as the economy gained additional steam with the latest GDP reading showing annualized growth of 3.2%. The strong labor market remains the centerpiece. In February, the economy created 275,000 jobs and the 3-month average for job growth is running at 265,000. For perspective, monthly job growth in 2019 averaged 166,000. This was also the 25th consecutive month with an unemployment rate below 4%, the longest streak since the late 1960s. The U.S. labor force participation rate among 25-54-year-olds (prime working age) moved up to 83.5% in February, tied for the highest level since May 2002. Ultimately, a healthy labor market is keeping wages elevated and supporting consumer spending. Adding fuel to the fire, history is on our side. Since 1950, there have been 28 years during which the S&P 500 had positive returns in January and February (such as we have seen in 2024). In an amazing 27 of those 28 years, the next 10 months were also positive, providing an average return of 12.2%. With Fed rate cuts on the horizon and history on our side in more ways than one, we believe the current market is poised to deliver an optimal environment for a diversified portfolio in 2024.
Since the market decline in 2022, we had been tactically creating cash for portfolios from the fixed income and bond alternative portion of the asset allocations for accounts taking recurring income withdrawals. This portfolio management decision resulted in two things. Creating withdrawal cash from the income and stable side of the allocations allowed time for the equity sleeve to recover value, but in doing so we were slowly but surely tilting the portfolio allocations towards more stock market exposure thus increasing risk while we drifted away from target exposures. In late February we felt enough recovery in overall stock market values had occurred and as a result we executed rebalancing transactions in all of our income portfolios to bring them back to their allocation targets. By now, you would have received trade confirmations on all of the moves, but if you have any questions on the transactions and their impacts on your particular strategy please feel free to call us.

As always, we are available if you have any questions about your portfolio, our current views and plans, or if you’d like to schedule a review, please don’t hesitate to contact our office at (858) 550-3960 or (800) 884-5121.

 

Sincerely yours,

 

J. Graydon Coghlan, CRPC – President/CEO
Registered Representative, Securities America, Inc.
Financial Advisor, Securities America Advisors, Inc.
CA Insurance License #0B31440