Market Navigator – April 2024 edition

A good start

After a robust 2023, equity markets’ upward trajectory continued in the first three months of 2024 as the U.S. economy remained fiercely resilient, translating into record highs for the S&P 500 and earnings estimates.

This backdrop helped to offset a significant market repricing for the number of Federal Reserve (Fed) cuts from more than six expected late last year to closer to three today. Our motto for several months now—and the lesson from market history—is a stronger economy with fewer rate cuts is preferable to a weakening economy in need of significant rate cuts.

The first quarter market results were impressive, not only for the overall gain but for the shallowness of the pullbacks. Indeed, the S&P 500’s total return of 10.6% was the best since 2019, and the market has now risen five-straight months. Moreover, the deepest setback was less than 2%.

Importantly, market participation broadened significantly – nine of the 11 S&P 500 sectors rose more than 5%, and five sectors rose more than 10% in the first quarter, with economically-sensitive sectors, such as industrials and financials, making all-time highs alongside mid caps and the S&P 500 Equal Weight Index. Moreover, it’s been a global affair, with multi-year highs recorded in markets such as Germany, France, and Japan, though the broader international developed markets as a whole and the emerging markets still trailed the U.S.

“Similar periods of {market} strength have tended to be a positive when looking out 12 months. Yet, it’s crucial to recognize that the additional gains did not come without hiccups along the way.”

Where do we go next

Strong momentum tends to be a characteristic of bull markets, something we have highlighted with various studies over recent months. While markets are stretched to the upside in the short term, and due for a breather, similar periods of strength have tended to be a positive when looking out 12 months.

• In the 11 previous instances since 1950 where the S&P 500 rose at least 10% in the first quarter, stocks were higher by year end 10 out of 11 times.
• Likewise, after previous five-month winning streaks that witnessed cumulative gains of at least 20%, as has been the case recently, stocks were up a year later in each case.
• Yet, it’s crucial to recognize that the additional gains did not come without hiccups along the way.
• The average maximum pullback for the S&P 500 over the rest of the year following strong first quarters averaged 11% (7% median).

Moreover, since 1980, there have been only three years – 1993, 1995, and 2017 – that did not see at least one 5% intra-year pullback. Indeed, periodic pullbacks are the admission price to the market.

As we think about the rest of the year, the biggest known market risks appear to stem around the potential of sticky inflation, a higher and more volatile interest rate environment that could pressure stocks, and a bar for positive surprises that has risen.

Market valuations, even outside of the tech heavy weights, have also expanded alongside the rally this year, and concentration risks in tech remain a concern. As we move deeper into the year, the election will come closer into view, likely injecting periodic bouts of volatility. And, of course, there will be unexpected events.

Still, until the weight of the evidence shifts, our view is bull market rules apply. That is, investors should stick with the primary market uptrend, and look to pullbacks as opportunities.

Positioning

From a global equity perspective, we have been team U.S.A. for several years and maintain that bias today. As mentioned, we are seeing international markets participate in the rally, and valuations on a relative basis remain attractive. However, valuations are a condition not a catalyst.

We await a shift in relative earnings and price momentum to upgrade our international exposure, and typically international markets do best in periods of U.S. dollar weakness. We expect the choppy U.S. dollar environment to persist, but the downside to be limited by a U.S. economy that remains a global leader and a Fed that is likely to be slower to cut rates than some of its central bank counterparts, such as in Europe. 

Within the U.S., we keep our large cap preference, where earnings trends remain stronger relative to mid and small caps. The latter of which are much cheaper and would likely do better if we see more relief in interest rates, as the companies tend to be more exposed to floating-rate debt.

We still have a focus on high quality in the bond market, where yields remain high relative to the past two decades. Our fixed income team sees intermediate yields trading near fair value, as the current market outlook is aligning with our long-held assumption that the Fed will resist easing policy too early or too swiftly. However, we still anticipate two to three rate cuts later this year.

We continue to expect tactical opportunities to emerge and look forward to keeping you informed as the year progresses.