Commentary – 2024 2nd Quarter

4/11/2024

The following are our current views on the markets and economy. We encourage all clients to attend our live webinar, Quarterly Conversations, on Thursday, April 18^th at 4:00 PM, where we will discuss these topics in greater detail.

Thank you for your continued confidence in us and we hope to see you soon!

The Stock Market

Year-to-date, the S&P 500 has set 20 new all-time highs, which is the sixth greatest first quarter count since WWII. In addition, the market is up 9.9% on the year, which will at least be the 11th best Q1 showing since 1945. The S&P 500 is not alone in its surge through uncharted territory. Also setting multiple new highs this year have been the Nasdaq-100 (15 new highs) and the Dow Jones (16 new highs), which is now less than 220 points away from the 40,000 threshold. This continues the theme from our last quarterly commentary of “strength begets strength.”

While the headlines may look similar, a look beneath the surface reveals a different picture taking shape. The so-called “MAG 7” stocks and those associated with artificial intelligence were the major gainers throughout most of the five-month run. March, however, saw the equal-weight S&P 500, which de-emphasizes the mega cap companies, outperform the cap-weighted index. At the same time, small cap stocks, based on the Russell 2000, outperformed the “MAG 7.” This apparent broadening of the bull market is a healthy development and could lengthen the uptrend.

The broadening gains in the stock market give us more confidence that the run can continue. Pullbacks are always possible, but with the Federal Reserve not meeting in April and Congress finally passing a budget, conditions remain favorable.

Even though investors are reminded that the trend is your friend, stocks are becoming increasingly vulnerable to a setback due to ever-climbing valuations and extreme movements above 200-day moving averages. Yet, history reminds us that of the 15 years since WWII with the highest Q1 gains, all but one posted full-year double-digit increases after enduring intra-year setbacks averaging 11%.

We believe that there are some signs of stress which are worth watching and which could cause some volatility in the market in the months to come. Earnings releases in April will shed some light on if those stresses are showing up in corporate balance sheets, but with the US economy continuing to grow and the Federal Reserve indicating rate hikes are complete, the bull market looks set to continue. However, unforeseen circumstances can derail a bull market at any time and diversification remains key for long-term success. As always, we will continue to monitor these developments.

The Economy

There’s an old adage about Federal Reserve rate cycles: the Fed takes the escalator up and the elevator down. Because of the destructive impact higher rates have on the economy, the Fed is usually more methodical when hiking rates. On the other hand, the Fed has historically been more aggressive when cutting rates, especially when combatting recessions. This time is different.

Given the pandemic-related surge in inflation, the Fed embarked on the most aggressive tightening cycle in more than 40 years—moving the benchmark interest rate off 0% in March 2022 to 5.5% in July 2023. The Fed clearly “took the elevator” up. With interest rate movements now at a pause, attention has turned to the coming rate cut cycle, but standing in the way is a lack of cooperation by inflation data.

The February consumer price index (CPI), released in mid-March, showed a slight tick down from 3.9% to 3.8%. It was, however, the second consecutive 0.4% month-over-month increase. Another crucial development released in conjunction with inflation data was the revision for gross domestic product (GDP) growth in the fourth quarter of 2023. In quarter-over-quarter annualized terms, real GDP growth was 3.4%, most of which was driven by an upward revision in personal spending.

The strength of personal spending combined with stubborn inflation suggests that the Fed does not yet have a green light to start cutting interest rates. This sentiment was corroborated at the March Federal Reserve meeting, during which Jerome Powell said the Fed needed “greater confidence” before beginning the easing part of the cycle.

Surprisingly, the market is absorbing this news without flinching. At the start of this year, interest rate futures suggested a March start and six-to-seven cuts this year. That has now shifted to a June or July start, with only two-to-three cuts. We believe this will continue to be a moving target as relevant data (both inflation and labor) is released. Particularly if the economy remains resilient, the Fed is eyeing the escalator, not the elevator.

Some exhaustive signs are starting to appear. While personal spending is driving economic growth, the consumer is becoming stretched as pandemic-fueled savings have been largely spent, according to the Federal Reserve. And while still strong, the labor market has begun to soften with unemployment and wage growth retreating from their respective cycle lows and highs.

This combination means less scope for consumption to drive economic growth throughout the year. Spending has been outpacing disposable personal income growth for most of the past year, and a notable February decline in income growth relative to spending means consumers are dipping further into their (already dwindling) savings to fuel their purchases.

It is therefore no surprise that delinquency rates are rising.

Similarly, there is growing discomfort among some major financial figures, including outspoken JP Morgan CEO Jamie Dimon, with the growing levels of government debt. The debt is expected to grow by $1 trillion every 100 days according to the CBO. Government debt isn’t a problem until it’s a problem, and it’s difficult to know when that will be. The cost to insure US Government debt, known as a credit default swap, has risen, indicating increasing concern among investors.

While Fed actions still matter, of course, investors are rightfully becoming more focused on the strength of the economy.

The Bond Market

By most measures, the Fed’s policy interest rate is high enough to keep inflation in check. The real federal funds rate (benchmark interest rate minus the inflation rate) is the highest it has been since 2007. While the economy has managed to do well despite rate hikes, the sudden shifts in market expectations about the direction of interest rates can be unsettling.

However, through the volatility, potential opportunities have emerged in bonds. High quality, intermediate-term bonds offer attractive yields relative to the risk. Investors with a long-term time horizon should consider allocating to core bonds (Treasuries, government-backed bonds, and investment-grade corporate bonds) at current yields of approximately 4.5% to 5.5%. The Fed may be hesitating to cut rates, but there is ample room for yields to fall.

A quick look at short-term total returns supports the case for investing in longer-term bonds once the federal funds rate hits its peak. Over the last four rate hike cycles, intermediate-term bonds outperformed short-term bonds in the 12 months following the last Fed hike of each cycle.

While these total returns might not matter for investors who are holding bonds to maturity (i.e., a 1-year CD), adding some duration can provide a boost to a long-term portfolio.

While the 10-year Treasury yield is off its recent peak of 5% from last October, it is unlikely that this will return if inflation continues to trend lower. Keep in mind that a yield of over 4% on the 10-year hasn’t been seen in over 15 years, prior to the Great Recession.

Sincerely,

The Planning Capital Team

Daniel B. Brady, MBA, CFP® │ Partner

Richard W. Bell, Jr., CKA® │ Partner

David A. Emery, MBA, CDFA®, CFP® │ Senior Financial Planner

Jay D. Ahlbeck, CLU®, ChFC® │ Senior Financial Planner

Paul C. McClatchy, MBA, CFP® │ Senior Financial Planner

Quinn S. Michel │ Paraplanner Associate

Jill M. Hofknecht │ Client Service Associate