Market Navigator – May 2024 edition

Market Navigator

May 3, 2024

This monthly publication provides regular and timely economic and investment strategy views.

April showers

After an abnormally smooth period for stocks, which included a five-month winning streak and shallow setbacks, April brought with it showers for the market. The S&P 500 suffered its first 5% pullback, while interest rate sensitive areas, such as real estate and small caps had deeper setbacks before recovering slightly before month end. International markets fared slightly better as they had already been hit earlier in the year.

As for the cause behind the market pullback, hotter-than-consensus inflation reports and a resilient economy resulted in the 10-year U.S. Treasury yield jumping by 50 basis points intra-month and the market pushing out the timing and magnitude of the Federal Reserve’s (Fed) pivot to an easing cycle.

A very normal pullback that never feels normal

Entering April, the weight of the evidence in our work suggested the primary market trend remained positive but was vulnerable to a pullback.

Investors may recall that since 1950 after 10%-plus first quarters, such as what occurred this year, the market showed further gains by the end of the year 10 out of 11 times.

However, it typically wasn’t a smooth ride getting there. Indeed, the shallowest pullback seen at some point of the year was just 4%. Moreover, there has only been three years since 1980 in which the market did not see at least one 5% pullback during the year.

Notably, since March 9, 2009, where stocks bottomed following the Global Financial Crisis, we count 28 previous pullbacks of at least 5% for the S&P 500. Impressively, despite these setbacks, stocks are up 644% on a price basis and 900% including dividends over that entire period.

“In late April, we made several changes to our positioning: Upgraded our view of equities to more attractive to take advantage of the pullback, upgraded duration to more attractive given higher rates, and downgraded cash one notch.”

An improved risk/reward

In our view, what we have seen over the past month has been more of a reset of an extended market as opposed to a fundamental shift. And this pullback led to an improved risk-reward for markets as we discussed late last month.

Indeed, U.S. GDP growth forecasts continue to get revised higher, and S&P 500 forward earnings estimates just made another record high.

Now, some investors may be disappointed that U.S. economic growth in the first quarter clocked in at just 1.6%, alongside higher inflation readings. Hence, we’ve seen a pickup in the word “stagflation” – but, at least, at this point, we don’t see it.

First quarter GDP was dragged down by inventory and trade, which are volatile components, but consumer and business spending remained firm. Moreover, the labor market remains solid along with wage growth, which should continue to buoy consumer spending.

House views shifts

In late April, we made several changes to our positioning:

  • Upgraded equities to more attractive following the pullback
  • Upgraded bond duration to more attractive given higher rates
  • Downgraded cash one notch

Stocks should remain supported by a resilient economy, record forward earnings estimates, and positive technical trends. To be fair, we didn’t get a deeper reset in investor sentiment that often—though not always—occurs near market lows. That said, based on the typical pullbacks since 2009, downside should be somewhat limited relative to the recent lows (there is strong support for the S&P 500 between 4700 to 4850). And on a net basis, we see more upside than downside potential for equities over the next 12 months.

We raised our fixed income duration to more attractive after downgrading it to neutral when the 10-year U.S. Treasury yield was below 4% in December. The move higher in rates has restored value and should provide a cushion should the economy weaken more than our current expectations or geopolitical tensions escalate.

Also, as gold and commodities have given back some of their recent run up, we see a benefit in adding a modest position. Over the past decade, they have underperformed the equity market by a wide margin though we are starting to see tentative signs of stabilization. Moreover, paired together, this should offer portfolio diversification benefits beyond the traditional markets considering elevated geopolitical risks, heightened interest rate and inflation volatility, deteriorating fiscal discipline, and Chinese stimulus.

Taking a step back, we still have a U.S. and large cap bias, waiting for a more sustainable shift in earnings and price trends before changing our position. We are seeing incremental improvement in emerging markets, aided by the discussion of more steps by the Chinese government to aid the economy, though so far, this has not translated into stronger earnings.

As always, we will continue to track the data and keep you informed as our views evolve. 

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