First Quarter Market Update: Markets Rise and Await the Fed’s First Rate Cut

FIRST QUARTER EQUITY MARKETS

U.S. Markets

Markets continued to rise for the second quarter in a row and the S&P 500 stayed on a stable upward path over the last five months. For the quarter the S&P total return rose an impressive 10.6% which we attribute to good economic data on inflation and the economy, better than expected corporate earnings growth, and a positive sentiment on the Fed’s eventual interest rate cuts.

From a sector perspective, we are seeing much broader stock participation in the S&P 500 today than in 2023 which was the dubbed “the magnificent seven.” During the first three months of the year we saw double-digit gains in energy, financials and industrials (along with tech and communication services). Additionally, from an investment style perspective, the market was not led by just growth stocks, creating a more balanced market return in the first quarter f 2024. This broadening of price leadership outside of a handful of stocks is likely due to profit growth returning to a number of economic sectors after a difficult 2023. According to J.P. Morgan, analysts expect earnings of the S&P 500 companies to grow 11% in 2024.

International Equities

Returns outside of the U.S. were more tempered relative to the U.S., but still solid, with a 5.8% return for developed country equities and 2.4% for emerging market equities. Germany and the United Kingdom have slipped into a shallow recession at this point and the expectations of growth among non-U.S. corporate earnings is lower when compared to the U.S. as demonstrated by the chart below.

Our underweight to international equities been a relative benefit to client portfolios over the past few years. We have been below our baseline historical weight since 2020. Our international equity exposure is also below that of the all country world index (ACWI).

FIRST QUARTER BOND MARKETS

Yields rose through the quarter sending prices of bonds down slightly. The benchmark Barclays Aggregate Index was down a modest -0.8% for the quarter. Yields moved mostly in reaction to reduced Fed rate cut expectations. This came on the heels of slightly higher than expected inflation data (CPI and PCE) and stronger manufacturing data from the ISM report. For the quarter, the 10-year treasury yield rose 32 basis points (0.32%).

We still have inversion where short-term rates are higher than longer-term rates. The 2-year to 10-year yield curve inversion stood at negative 42 basis points at quarter end. This inversion has been present for nearly two years (21 months) and is largely being dismissed as a recession indicator in this economic cycle. We are still in the camp that a soft landing can be achieved given the strength of U.S. employment and corporate earnings.

The graph below shows two yield curves at different times. The green line is year end, the red line is from March 31, 2024. Yields have shifted slightly higher across the entire curve.

Municipal Bond Market

Municipal bonds saw modest negative returns for the quarter. Demand continued to remain high, especially in the primary market, while supply was seasonally weak to begin the year. In March, bond issuance picked up and demand still outstripped supply. To put demand into perspective, a NYC municipal bond initially brought to market at $879 million was upsized twice by another $485 million and fully bought, according to GW&K Investment Management.

Intermediate term bond yields are down from last year and the only significant pick-up in yield is seen in longer duration bonds (10+ years) or lower quality (junk or high yield).

We continue to expect a much better year for fixed income where investors are finally earning income from coupon rates that are nearly 3x what they were during the near-zero rate environment of the pandemic. We are in a more normal environment where bonds are providing steady income.

Until the Fed cuts rates, the shorter end of the curve is still attractive and cash is still paying a 5.0% yield!

FIRST QUARTER ECONOMIC PULSE

In March, the Fed left rates unchanged, and signaled that three rates cuts of 0.25% each is the goal for 2024. The Fed also raised its full year outlook for GDP to 2.1%, up from 1.4% previously.

JOB GROWTH

Job growth is on a stronger than expected uptrend in 2024. The lastest report for March showed 303,000 new jobs created, 100,000 more than economists predicted. The good news was that the big boost in job growth did not seem to be very inflationary. More people are entering the workforce with participation at 62.7% and immigration has helped fill the job openings as well. Still, the average hourly earnings rose 0.35% from February and is up 4.2% year-over-year, which is not a big move and a relief to equity markets. Real wage growth (wage growth minus inflation) was again positive, marking the 10th straight month after two years of earnings not keeping pace with inflation.

One strategist from AXIOS noted of the March jobs report “.. if you went into a lab and tried to design the perfect jobs report, you'd have a hard time coming up with something better than the one the Labor Department issued yesterday.”

INFLATION

We still see the central banks on a path of cutting rates in 2024 after taming inflation.

Inflation data was a bit firmer in the first quarter than hoped, but the longer-term trajectory was still intact. The February personal consumption expenditure (PCE) report showed 2.5% growth, but core PCE (excluding food/energy) came in higher at 2.8% and is still above the Fed’s 2.0% target. The February Consumer Price Index (CPI) was up 3.2% year-over year and core CPI (ex food/energy) came in at 3.8%. As a reminder, the high water mark on inflation was June 2022 at 9.1%. Graphically, you can see the steady decline in the CPI reading since 2022, with the last few readings hovering above the 2.5% mark.

Other important economic data points during the quarter are highlighted below:

PPI – February producer prices rose 0.6%. Goods rose 1.2% and services rose 0.3%.
ISM – the manufacturing index had an expansive reading of 50.3, well above expectations of 48.3 (contraction).
Retail Sales – rose 0.6% in February from previous month after falling -1.1% in January.
Consumer Confidence – rose to 104.7 in March unchanged from February’s reading.
U.S. Leading Economic Indicators – the Conference Board LEI rose by 0.1% in February, better than the -0.3% expectations.
PMI Manufacturing – registered 51.9 in March, up from 50.1 in February. The latest index reading was the highest for almost a year, and signalled a solid expansion in private sector activity.
Housing Starts – rose 5.9% in February seasonally adjusted versus a year ago to an annual rate of 1.52M homes.
GDP – the final revision to 4Q 2024 GDP was posted at 3.4% growth

As you can see from the data points above, most of the news is good, which is likely why the GDP estimate for the first quarter keeps moving higher.

FEDERAL RESERVE SIGNALS THREE RATE CUTS IN 2024

At the March FOMC meetings, the Fed announced its intent to lower rates three times, but gave no indication of when that might start (data dependent). The markets were finally aligned with the Fed’s vision of rate cuts versus the previous expectations of 4-6 cuts forecasted by the market. Never to be at ease, prognosticators in recent weeks, we have raised doubts of any Fed cuts this year sighting the strength of the economy and the stubbornness of inflation. We’re more inclined to take a step back and look at the broader picture. Inflation hit a high of 9.1% and is now a mere half percent away from target level. The full repercussions of 5.0% short term rates are still working through the economy. We believe the Fed will start the rate easing process in 2024 and are less concerned with the exact month this will occur.

In the March meeting last year, the Fed Chairman said the process of getting inflation back to 2.0% will be a long road and will likely be bumpy. We believe we are still seeing some of bumps, but will ultimately get to target.

SANDY COVE ADVISOR ASSET ALLOCATION SHIFTS

During the first quarter, Sandy Cove Advisors made no asset allocation shifts, but we did make one change in our large cap equity exposure. One of our active managers announced the retirement of their lead portfolio manager who has captained the fund for over 20 years. As is our practice, when a key manager leaves a fund without a performance-proven succession plan, oo remove the strategy from portfolios where it is tax-prudent. Proceeds were added to the Berkshire Hathaway position in large cap.

ON TO SECOND QUARTER

We are a few days away from the kick-off of corporate earnings season where we will get lots of information on where CEOs think the economy and consumer are headed. That is sure to educate markets and potentially test the new markets highs we’ve witnessed of late.

We have an April break with no Fed meeting. Focus turns to the June 12th Fed meeting where markets are anticipating the first rate cut in years. Given the strong economic data we’ve described above, there is certainly a possibility that the Fed holds the course for a few more months. The Fed has been keenly focused on “following the data” and so must everyone else if they’re going to try to determine that exact date.

We recognize that inflation has come down nicely, the economy continues to grow, and the Fed has signaled it is done hiking and will eventually cut rates. However, economic data will continue to come out monthly and the markets are likely to hang onto each data point as the one that might change the Fed Chairman’s mind. This is why we expect a bit more volatility in the coming months in equities. We have reached new highs despite geopolitical disruption, high short-term rates, and a presidential election year. It’s worth reminding ourselves that since 1928, the S&P averages 29 days of declines of 1.0% or more. We have only seen four of these days so far in 2024, so we could see more volatility, which is perfectly normal. To quote Franklin D. Roosevelt, “a smooth sea never made a skilled sailor.” Investors who want and expect growth, have to navigate market volatility.

Overall, we are off to a great start to 2024. If you would like to have further discussions with our team, one-on-one, please do not hesitate to contact us.