A solid start to 2024
After ending with a bang in 2023 and a nine-week winning streak, the market is holding up relatively well so far early into 2024. After a healthy digestion phase in the first two weeks of the year, the S&P 500 broke to an all-time high.
Making a record high after a prolonged period tends to be a positive sign.
- Following past instances, the S&P 500 was up 12 months later in 13 out of 14 occurrences, or 93% of the time, with an average gain of 14%.
- The one negative outlier was the May 2007 signal, as a recession unfolded in 2008.
This reiterates the importance of the Federal Reserve’s (Fed) ability to engineer a soft economic landing, which the market appears to be pricing in. We view this as a positive signal, though like all historical studies, it should not be used in a vacuum.
The U.S. economy remains resilient, with fourth quarter GDP clocking in above 3%, a blowout January jobs report that came in at 350k, almost double the consensus, while consumer spending remains supported by solid wage growth. Consequently, our head of U.S. economics is bumping up our 2024 GDP forecast to 1.4% GDP from 1.2%.
Further, there may be upside to this estimate, given that fiscal spending increases in 2024 from existing legislation and new proposals combined could be as large as 1.5% of GDP.
Some offsets remain, however, such as the negative impact from the cumulative increase in rates on segments of the consumer. Moreover, the recent revival of concerns in the commercial real estate market is a reminder that higher rates are biting in some areas of the economy.
While the strength in the economy is a positive, it also complicates the Fed’s job. The scar tissue of higher inflation over the past year suggests the Fed wants to have greater conviction that inflation is truly in the rear-view mirror and avoid the stop-and-go policy of the 1970s. That’s part of the reason Fed Chair Powell pushed back against a March rate cut, a view we share.
From our perch, for the equity market, we would trade a more resilient economy with less rate cuts to a weaker economy with more aggressive rate cuts. This is also the lesson from market history – in 2001 and 2008, aggressive rate cuts did not help the stock market or help us avoid a recession.
What’s notable so far this year, is how the dominant themes of 2023 have reasserted themselves. That is, while tech leadership took a temporary breather in the final two months of last year, the sector has come out of the gate in front early into the new year; we remain overweight the sector.
Valuations remain rich, but earnings momentum tends to be a bigger driver of near-term performance for tech. Here again, we are seeing the strongest upside in earnings revisions in the tech and growth-related sectors. The risk, of course, is the concentration of the top 10 holdings, driven by tech names, in the S&P 500 is the highest in 40 years.
From a global asset allocation perspective, U.S. dominance in tech, which is by far the largest sector in the S&P 500, is one reason we are maintaining our long-standing domestic overweight, though balancing that with a mix between growth and value from a domestic style bias.
The stronger economic growth, in theory, should be helpful for some of the areas outside of tech, such as small caps and financials. We upgraded financials late in January in part due to this.
While we maintain a preference for the traditional S&P 500, we have advocated having some exposure to the S&P 500 Equal Weight Index, where each stock has approximately the same weighting. We currently view this as one way to diversify the large cap space; however, if relative prices show another step down, we may reassess our view.
Turning to the fixed income markets, intermediate and long U.S. yields have fallen sharply since October but remain elevated in comparison to the past 20 years, and we still see value.
U.S. yields are beginning to converge with their more typical path following the end of a rate hike cycle. But it won’t be a straight line as federal deficits and robust government debt issuance may fuel periodic disruptions to the broader trend, as could the potential for more fiscal stimulus mentioned earlier.
For T-bill investors, we recommend proactive deployment of cash balances. T-bill yields are likely to trend consistently lower over the next 12-24 months.
To summarize, the weight of evidence suggests the primary stock market trend remains positive. We are sticking with our U.S. and large cap bias, though also diversifying some of the concentration risk through other asset classes.
The tension between a stronger economy and inflation and Fed policy is set to continue and add to market volatility, both in equities and fixed income. A solid economy should continue to support earnings growth, but higher rates will likely also serve to cap valuation expansion. We continue to expect tactical opportunities to emerge as the year progresses
We would trade a more resilient economy with less rate cuts to a weaker economy with more aggressive rate cuts
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