After the first quarter of 2024, there is little change since our last writing. Market momentum is still strong and there are even fewer signs of the oft-mentioned looming recession. The S&P is up over 10%, the 11th-best start to a year since 1950*. The market rally continues to broaden as more stocks contribute to returns. The titans in the Magnificent Seven are no longer the only names contributing to performance. In equal-weighted terms, the Financial, Energy, Industrial, and Material sectors all outperformed Tech in Q1. REITs were the only sector to post negative returns for the quarter, falling after a strong 2023 Q4. It appears the bull market remains intact.
In the face of a still inverted yield curve, intermediate and long-term Fixed Income continues to struggle. The Bloomberg US Aggregate Index was down 0.8% in the first quarter, while short-term yields remain over 5% year-over-year, allowing short-term fixed income to continue outperforming the index.
Interest Rates
As we predicted in January, the Federal Reserve has not cut interest rates and continues to call for patience. Market expectations finally aligned with the Fed, and we witnessed a significant change, moving from six cuts in 2024 to only two or three cuts by the end of the year. The market took this news in stride, without the typical volatility expected when rate cuts are delayed. Inflation remains steady, with the U.S. CPI at 3.5% year-over-year in March. Unemployment is still low and consumer spending hasn’t faltered. The Fed is in a difficult position, as markets eagerly await the first rate cut, and politicians and consumers clamor for lower rates, yet the data indicates that holding off until there’s a clear sign that inflation has truly been subdued is prudent. History reminds them inflation can come in waves, and the Fed is cautious. Cutting rates while the economy is still strong will only increase demand and spending, possibly spurring a second wave of inflation and forcing a reversal in policy. It’s ultimately less disruptive to hold rates as they are than to cut prematurely and be forced to backtrack. However, if they hold too long, they risk pushing the economy into the recession they’re trying to avoid. Needless to say, a soft economic landing is not easy to execute.
Housing and Inflation
In our 2023 Q3 Commentary, we highlighted the “rolling recession” scenario, where sectors of the economy experience individual downturns, yet GDP remains positive. We’re seeing this continue to play out as pockets of weakness roll through the U.S. economy, with housing and manufacturing already taking a hit. Housing appears to be attempting a bottom, even as mortgage rates remain high. Manufacturing continues to show signs of a rebound. Small weaknesses may be rotating into the employment sector in the form of fewer job openings and temporary employment trending lower, however, those cracks remain small. The economy added 303,000 jobs in March, nearly 100,000 more than projected. The unemployment rate fell 0.1% points to 3.8% and labor force participation rose to 62.7%.
Inflation continues to trend lower but remains above the Fed’s 2% target. However, if we remove the sticky and lagged shelter component, the number is closer to target and has remained relatively stable since the fall of 2023, providing support for interest rate cuts later in the year. U.S. GDP has remained positive, yielding six quarters of consecutive growth. In Europe, inflation continues to slow, and the European Central Bank is feeling pressure to begin cutting rates as well. Corporate confidence is up, and balance sheets are surprisingly strong. Earnings have come in above consensus as businesses focus on cutting internal costs and reaping the rewards of higher prices and consumer spending.
Weighing Risks
While we remain positive on the current bull market, we always consider potential risks. Consumer sentiment remains a concern as wages still struggle to keep up with inflation over the long term. Consumer spending was solid in February, but a declining saving rate implies a lack of sustainability. Looking back historically, the two biggest drivers of recession have been rapidly rising oil prices and geopolitical shocks. While geopolitical issues are almost impossible to predict, history shows if oil prices rise 80% year-over-year, a recession inevitably follows. Oil prices are only up about 5% year-over-year now, and considering upcoming elections, it’s appropriate to assume the current administration will do everything in its power to keep prices low.
The inverted treasury yield curve is also a concerning indicator, as it has typically been a precursor to recession. However, this time is somewhat different considering the rapid rate increases by the Fed. The curve has been inverted for 18 months—the longest period it has remained inverted without a recession since the 1980s. While in the past this has been an accurate recession indicator, it’s now essentially signaling that the market feels the Fed is keeping interest rates too high. Once they begin lowering rates, the hope is the yield curve will even out without causing a recession. An inverted curve is absolutely a consideration but shouldn’t be the only metric scrutinized.
We’re 48 months into the current U.S. economic expansion. Historically, the average expansion lasts 64 months, but the four most recent expansions have averaged 103 months. At this point, it appears the arguments in support of the bull market outweigh the arguments against it. That doesn’t mean there won’t be short-term market volatility and seasonal slowdowns, but the probability of a recession this year and into early 2025 continues to trend down.
While the numbers may be slightly intimidating, it’s important to discuss valuations in a bit more detail. Comments and questions on an overvalued market are rightly top of mind for a lot of investors. It’s true that historically, valuations of the S&P 500 are high, but let’s look at some of the most recent numbers. The P/E ratio is the price per share divided by earnings per share. A high P/E ratio can signal that a stock’s price is high relative to earnings and possibly overvalued. A low P/E ratio could indicate that the stock’s price is low relative to earnings. These are the historical P/E averages for the S&P 500: 5-year: 19, 10-year: 18, 15-year: 16, 20-year: 16, 25-year: 161. At the end of Q1, the S&P’s P/E was 21. However, when excluding the top ten largest companies, the remaining 490 stocks have an average P/E of 18. This feels a bit more reasonable. It’s also a great argument for diversification within your portfolio. While those larger and more prominent names may drive the news, they shouldn’t be the only thing driving your portfolio.
Within our portfolios, we continue to prefer U.S. Large Cap Value and Core over Large Cap Growth due to L.C. Growth’s extended valuations. We remain underweight in Emerging Markets due to their outsized exposure to China and are neutrally weighted in International Developed. In Fixed Income, we remain underweight in duration compared to the benchmark, as short-term bonds continue to outperform intermediate- and long-term bonds. We intend to hold off on extending duration until the timing of the Fed’s rate cuts becomes clearer. We continue to encourage clients to focus on personalized planning, diversification, and goals-based investing over short-term market timing. Please reach out if SIMA can help you reach your investment goals.
*Individual returns will vary based on percentage allocated to equity, fixed income, and cash
1: S&P 500 Forward P/E Ratio Rises Above 20.0 For First Time in 2 Years (factset.com)
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Heather A. Voight, AIF® | Portfolio Manager
Previous market commentaries
2023 Third Quarter Market Commentary
2023 Second Quarter Market Commentary
2023 First Quarter Market Commentary
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