Investment Overview: 1st Quarter 2024

The economy

The U.S. economy continued to prove resilient by posting better-than-expected growth. U.S. GDP advanced by 3.4% in the fourth quarter and advanced 2.5% for 2023, far better than the slowing growth and recessionary expectations projected at this point last year. Stock markets hit record highs during the first quarter of 2024, with the Dow Jones Industrial Average and S&P 500 closing at fresh all-time highs. The wealth effect from high stock prices may contribute to the positive trends of GDP growth, although the consensus among economists is that growth will slow from current levels into 2024 as the lagged effects of higher interest rates begin to take hold.

At this time, the inflation outlook is seemingly as important to the overall economic picture as GDP growth. The United States has continued to see a degree of cooling on the inflation front from the multi-decade highs seen two years ago. The core PCE Index (the Fed’s preferred inflation measure) rose 0.3% in February, which was in-line with estimates. This figure puts inflation at 2.8% higher than a year ago, which is much improved from the recent elevated levels, but still above the Fed’s stated 2% target. Nevertheless, the significant progress made on inflation likely means that Fed can begin cutting interest rates in the second half of year.

The U.S. labor market remains strong and has led to a very healthy consumer backdrop. Weekly jobless claims remain below average, and while the unemployment rate modestly ticked up to 3.9% in February, new jobs created remain robust. Importantly, wage growth remains above 4%, which has helped consumers keep up with elevated prices for many goods and services. In fact, consumer spending rose 0.8% in February, its largest increase in over a year. While personal income has risen to fund the higher level of spending, the personal savings rate has declined and may be an area of concern should the labor market weaken.

With a stronger-than-expected economy and inflation still above targeted levels, longer-term interest rates trended higher during the quarter. The bond market is now more closely aligned with the Federal Reserve’s projections that future rate cuts may not come as quickly or aggressively as previously expected by the market. Higher interest rates benefit savers but are often a headwind to economic growth, especially among capital-intensive industries. Interestingly, despite much higher mortgage rates, the housing market is in decent shape, with building permits and housing starts rising. House prices have continued to increase above levels of inflation, which indicates a strong market but may present affordability issues at some point.

In contrast to the robust state of the consumer, the manufacturing side of the economy had been in contraction for over a year. However, March’s ISM report hit 50.3, the first time its reading indicated expansion since September 2022. New orders and production were both stronger than previous readings, helped by improved demand and some improvements in the supply chain. However, manufacturing employment declined and many industries continue to grapple with high raw materials prices.

In conclusion, the U.S. economy remains resilient, but risks remain both domestically and abroad. A resurgence of inflation cannot yet be ruled out, and any weakening of the jobs market could push the economy into recession. Geopolitically, armed conflicts remain in place and have the potential to upset supply chains and access to key commodities. Moreover, China remains closely watched due to issues in their property and credit markets. Of course, the 2024 election cycle will soon be in full swing and carry the potential to increase volatility as well.

Fixed income

For the quarter, interest rates pushed higher on stronger-than-expected economic growth resulting in modest losses in most bond portfolios. Corporate bonds and particularly high-yield issues were among the best performers as the market continued to dismiss the likelihood that increasing interest rates will cause impending economic stress for borrowers. 

Coming into the year, prognosticators expected the Fed to cut its benchmark short-term rate six times throughout 2024 as higher interest rates slowed the economy. However, economic activity continues to surprise to the upside giving the Fed reason to hold rates steady as they contend with inflationary pressures. The most recent comments from Fed officials suggest three rate cuts this year, while they also express optimism that a “soft landing” will be achieved.

As such, short-term Treasuries experienced little variation during the quarter as the Fed left its target rate unchanged at the current range of 5.25% to 5.50% at its March 20 meeting. The Fed has not changed its interest rate target since July 2023, keeping rates at 22-year highs in its ongoing effort to combat inflation. In their associated statement, Fed officials commented that “the committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.” 

Despite stable short-term rates, longer-term rates moved significantly higher. The 2-year Treasury bond increased almost 40 basis points during the quarter to 4.62%, while the 10-year Treasury climbed to 4.20% as early calls for rate cuts never materialized. The 2- to 10-year Treasury curve has now been inverted since July 2022, surpassing the previous record of 624 days set in 1978. An inverted yield curve is often an indicator or a pending recessionary period.  

Although still stubbornly high, inflation appears to be on a downward trend. The most recent GDP report suggested that inflation pressures abated with the Fed’s favored measure of prices (the Personal Consumption Expenditures Price Index, or PCE) rising at a 1.8% annual rate in the fourth quarter, down from a third quarter PCE of 2.6%. For the last 12 months, PCE grew at 2.8%. 

The Federal Reserve’s Open Market Committee will meet next on May 1, with markets anticipating a small chance of an interest rate cut.

Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).

Total return numbers for various fixed income indices over the past quarter and 12 months are below (data from Bloomberg).

Equities

Stocks prices continued their torrid pace upward in the first quarter. The S&P 500 hit 21 record highs and is up over 10%, its best start to the year since 2019. First quarter market strength followed an impressive fourth quarter that witnessed the S&P 500 ending the year with nine straight weeks of gains, its longest winning streak in nearly 20 years. 

Notably, first quarter returns reflected broad market participation, in contrast to most of 2023, where investors benefited from the huge gains of a small cohort of big technology stocks known as the “Magnificent Seven.” While investors continue to be enthusiastic around artificial-intelligence developments, more than half of the stocks in the S&P 500 have notched 52-week highs. Market breadth was also apparent as all major indices posted positive returns, with small cap and international stocks also participating in a strong first quarter. 

Equity markets were no doubt buoyed by a stronger-than-expected economic environment. Corporate profits are proving resilient, lessening worries of a recession. Employers continue to hire and unemployment remains below 4%, helping consumers to spend at a still-brisk pace. Consumer confidence rose to its highest level in almost three years, according to a University of Michigan survey.

Internationally, developed-market equities generally lagged their domestic counterparts, but still posted strong gains for the quarter. Japanese stocks were the exception. The benchmark Nikkei Stock Average last month climbed above 40,000 for the first time ever. With a 21% gain in the first quarter, the index was the best-performing major market globally. 

Emerging market equities also rose during the quarter but remained plagued by weaknesses in Chinese property and credit markets. Positively, recent data indicated China’s official factory purchasing managers index in March moved back above the 50-point level separating expansion from contraction for the first time since September. 

Overall, U.S. large-cap stocks carry above average multiples heading into the second quarter of 2024. Companies in the S&P 500 are trading around 21 times their projected earnings over the next 12 months, above the five-year average of 19, according to FactSet. Potential pitfalls exist within most areas of the stock market. Nevertheless, we are finding compelling value in select domestic equities and smaller capitalization stocks and continue to trim outsized “growth” exposure where appropriate.

Below is a table displaying various equity index returns for the past quarter (data from Bloomberg).

Sector returns

Impressive first-quarter performance was broadly distributed amongst most sectors of the economy. In fact, all sectors but Real Estate rose during the first quarter, with five sectors posting double-digit gains. Importantly, the more cyclical sectors (Energy, Industrials, and Financials) were among those that jumped, fueling bets that the broader market might have more room to run.

The Energy sector, last quarter’s sole negative performer, was the second-best performing sector this quarter on rising oil prices. Crude oil futures recently settled at five-month highs as geopolitical tensions and concerns about tight supplies persist.

The Communication Services and Information Technology sectors, up 15% and 12% respectively, added to robust 2023 gains. Both sectors were up over 50% in 2023, fueled by impressive growth profiles and positive investor sentiment toward artificial-intelligence applications.

The Consumer Discretionary sector, a market darling of 2023, was up just 5% in the first quarter, no doubt hurt by a 30% fall in the price of Tesla, the sector’s second largest holding.

As we move into the second quarter of 2024, sector performance is likely to be heavily influenced by Fed interest rate policy in the months ahead. Sector rotation away from large-cap technology firms may be in the cards as such names were largely unscathed by the Fed’s aggressive hiking campaign and similarly may not get as much of a boost from a rate-cutting cycle.

The following table details S&P 500 sector total returns for the quarter (data from Bloomberg).