Happy Spring!
As we welcome the longer days and warmer temperatures, the adage “April showers bring May flowers” got a jumpstart in March this year. Notably, Boston had its fifth snowless March in a row yet recorded nine inches of precipitation in the month, well above the average monthly rainfall of between three and four inches for all regions of the state. Still, the soggy weather did not dampen investors’ enthusiasm, with both the S&P 500 and the Dow Jones Industrial Average finishing the quarter at new record highs. The S&P 500 hit 22 new highs in the first three months of 2024, while the Dow ended the quarter just points away from reaching the 40,000 threshold for the first time. The economy continues to defy expectations as recession worries have moderated.
We started the year optimistic that inflation was contained and the U.S. Federal Reserve (Fed) could reverse course and begin to reduce interest rates. After the December Fed meeting, the majority of Fed officials expected 75 basis points (bps) worth of rate cuts in 2024 and 100bps worth of additional cuts in 2025. But when? The Fed’s monetary tightening campaign culminated in a final 25bps increase in July 2023, bringing its benchmark interest rate to a range of 5.25% to 5.50%. Since then, inflation has tapered back yet the benchmark rate has plateaued, with the Fed leaving rates unchanged at both the January and March meetings.
Consumer spending remains robust, up 0.8% in February from 0.2% in January. Following favorable inflation readings in the second half of 2023, the personal-consumption expenditures (PCE) price index, which reflects changes in the prices of goods and services purchased by consumers in the U.S. and is the Fed’s preferred indicator of inflation, ticked back up to start the year. The overall PCE price index rose 0.3% in February, down from 0.4% in January, but up from 0.1% in December. The annual rate crept up to 2.5% in February from 2.4% in January. Excluding food and energy, the core PCE price index rose 0.3% in February, down from 0.5% in January, but up from 0.2% in December. The annual core PCE price index dipped to 2.8% in February from 2.9% in January. Notably, the Fed did not react to cooler-than-anticipated monthly inflation readings at the end of last year, or to firmer-than-expected readings at the beginning of this year. The Fed still expects three rate cuts this year but will continue to exercise discipline: cutting too soon runs the risk of inflation popping back up, while waiting too long may cause unnecessary harm to the economy.
After rebounding a bit in December, consumer confidence declined in the first quarter and remains below historical averages. Despite a backdrop of easing inflation, energetic growth and impending cuts to interest rates, many Americans remain frustrated with higher prices, particularly for food and housing. Shoppers are also put off by paying the same or higher prices for smaller amounts, also known as “shrinkflation.” Basically, prices remain markedly higher than they were before the pandemic began, and Americans’ expectations for how much goods and services should cost have not caught up. Add to that, rising prices at the pump which weigh on consumers, especially headed into spring when travel tends to pick up. According to AAA, the national average price for regular gas climbed to $3.53 a gallon at the end of March, up 43 cents since mid-January.
Meanwhile, the labor market remains strong. Employers added 303,000 in March, above the average monthly gain of 230,000 over the prior 12 months. This marks 39 consecutive months of job growth through March. Unemployment came in at 3.8% in March, below 4% for the 26th straight month, the longest stretch in more than 50 years.
| Asset Class | Benchmark | Q1 | YTD |
|---|---|---|---|
| US Stocks | S&P 500 | 10.6 | 10.6 |
| US Gov't Bonds | Bloomberg US Govt Intermediate | (-0.3) | (-0.3) |
| Cash | Bloomberg US Treasury Bill 1-3 Mon | 1.3 | 1.3 |
The stock market continued its rally in the first quarter, powered by the likelihood that the economy has escaped a deep recession and that the Federal Reserve is on track to begin cutting interest rates, even if not as soon as some investors had previously hoped. The S&P 500 climbed 10.6% in the first quarter, its best start to a year since 2019, whereas the tech-heavy NASDAQ composite was up an impressive 9.3%.
Resilient corporate profits and artificial intelligence (AI) developments helped drive the market boom. In 2023, seven companies fueled most of the S&P 500's gains, propelled by enthusiasm surrounding AI: Apple, Alphabet, Meta Platforms, Microsoft, NVIDIA, Amazon and Tesla. Often referred to as the Magnificent Seven, the group’s sheer size is highly influential on the direction and sentiment of the overall market. The seven companies accounted for 28% of the market cap-weighted S&P 500 as of year-end, according to S&P Dow Jones Indices.
We saw a divergence in the Magnificent Seven in the first quarter, with Apple and Tesla declining 11% and almost 30%, respectively. Alphabet was lackluster for most of the quarter before rallying in March to finish up 8%. Meanwhile, Meta Platforms, Microsoft, NVIDIA, and Amazon continued their impressive run and outpaced the broader market. Now dubbed the Fab Four, these four stocks are responsible for nearly half of the S&P 500’s first quarter advance. Considering the market is still rallying despite Apple and Tesla’s declines means that other groups are taking part. More than half of the stocks in the S&P 500 have notched new 52-week highs.
Ten of the 11 GICS sectors posted positive returns in the quarter. Communications (+15.8%) was the standout sector, followed by Energy (+13.7%), Technology (+12.7%) and Financials (+12.5%). Real Estate (-0.6%) was the sole negative sector, as high interest rates and ongoing concerns around Commercial Real Estate (particularly office space) continue to weigh on the sector.
If history is any indicator, stocks are well-positioned for 2024. When the S&P 500 adds 8% or more in the first quarter, it finishes the rest of the year higher 94% of the time, according to a Dow Jones Market Data analysis of index performance since 1950. Similarly, since 1950, the S&P 500 has risen in a presidential election year 83% of the time, according to Dow Jones Market Data. However, past performance is no guarantee of future results.
Yields across the curve rose quietly throughout the first quarter under the backdrop of widely expected interest rate cuts in 2024 by the Federal Reserve. Driving the rate increases have been mixed signals from economic data releases including a strong U.S. Jobs report and stubborn inflation numbers resulting in investors dialing back their rate-cut bets.
Lingering inflation and economic resiliency pose a challenge for the Fed in determining when to start cutting rates. By cutting too early or too late the Fed could threaten their ultimate goal of achieving an economic soft landing; an economy that is at a neutral interest rate not restricting or pushing excessive growth, full employment and steady 2% inflation. As doubt was being cast on the initially projected 2024 rate cuts, the U.S. 10-year Treasury increased 32bps or 0.32% from 3.88% to 4.20% by the end of the quarter.
Ultimately, the Fed met in both January and March holding rates steady at 5.25-5.50% which remains a 23-year high. Despite the vote to hold rates stable in March, the Fed Chairman stated it would still likely be appropriate to cut rates this year. Any interest rate cuts would be welcomed news to consumers facing mortgage rates at 20-year highs and corporations facing higher borrowing costs. The Swiss National Bank (SNB) recently became the first central bank to cut key rates in this cycle, by 25bps. The European Central Bank (ECB) is expected to follow suit this summer.
With interest rates rising and credit spreads (the premium paid for corporate bonds over U.S. Treasuries) at tight levels, we saw performance mixed across the bond market. Investors looked to lock in attractive higher yields creating strong demand for credit. This led the corporate high-yield market to be the strongest performing sector this quarter - returning a positive 1.47%. Government securities returned slightly negative (-0.35%) with prices moving inversely to bond yields.
We believe the prevailing interest rate environment will be beneficial for fixed income investors moving forward. Moreover, we structure our portfolios to safeguard against interest rate risk: current rates allow for enhanced compounding if interest rates remain steady, the principal of bonds held to maturity is protected should rates rise any further, and a decline in rates from present levels results in stronger fixed income returns.
| Asset Class | Benchmark | Q1 | YTD |
|---|---|---|---|
| US Mid Cap Stocks | Russell Mid Cap | 8.60 | 8.60 |
| Foreign Stocks | MSCI EAFE NR | 5.78 | 5.78 |
| Emerging Markets Stocks | MSCI Emerging Markets NR | 2.37 | 2.37 |
| Managed Futures | Credit Suisse Mgd Futures Liquid | 0.89 | 0.89 |
| Global REITs | FTSE EPRA Nareit Developed NR | (-1.30) | (-1.30) |
| Global Infrastructures | S&P Global Infrastructure | 1.34 | 1.34 |
| Gold | S&P GSCI Precious Metal | 7.05 | 7.05 |
| MLPs | Alerian MLP | 13.89 | 13.89 |
| Emerging Markets Bonds | Bloomberg EM USD Sovereign | 1.28 | 1.28 |
| US High Yield Bonds | Bloomberg US Corporate High Yield | 1.47 | 1.47 |
| Floating Rate Loans | Credit Suisse Leveraged Loan | 2.52 | 2.52 |
| Long Bonds | Bloomberg US Long Corporate | (-1.69) | (-1.69) |
Aside from Global REITs (down 1.3%), all diversifying equity asset classes posted positive returns in the first quarter. However, MLPs (up 13.89%) was the only asset class to outperform the S&P 500.
Among diversifying fixed income asset classes, Emerging Markets, Floating Rate, and High Yield bonds added significant value in the first quarter, whereas Long bonds underperformed on a relative basis.
The Federal Reserve still has work to do to for a “soft landing”, i.e., taming inflation without triggering a recession. Sticky inflation and uncertainty around the timing of interest rate cuts may continue to cause volatility in the markets. Ongoing geopolitical concerns may add to the uncertainty. We are encouraged that market gains have begun to expand beyond the seven mega cap companies that drove the bulk of gains in 2023. We plan to help you meet your long-term financial goals in all environments and encourage you to stay the course.
Sincerely,
David B. Smith, CFA
Managing Director and Chief Investment Officer
