April 2024 Commentary

Market Commentary

Following a 5% pullback in the S&P 500 to start the month and quarter, stocks attempted a late-month rally, but still ended the month of April down -4.1%. As we have noted over recent months, the stock and bond markets’ biggest worry were a reacceleration of the inflation rate, quelling prior hopes and expectations of any Fed rate cuts sooner, rather than later. Also, helping to put an end to the 5-month winning streak for the S&P 500 dating back to last October was U.S. economic growth (GDP) coming in weaker than market forecasts for the first quarter. Higher-than-expected inflation along with increased government spending, put upward pressure on longer-term yields, weighing on both stocks and bonds.

Stocks were hit broadly across most capitalizations, styles, and segments with exception of a couple of standout sectors including Utilities, Energy stocks, and Emerging Markets. International and emerging markets stocks performed better than US stocks, with the emerging markets index posting positive results for the month. Within the developed markets, broadly speaking, European economies are seeing inflation decelerate, such that EU central banks are more likely to reduce rates sooner than the Fed in the U.S., which would be positive for those markets.

The bond market took it on the chin with the Bloomberg US Aggregate Bond index down -2.5% for the month. With the resurgence of inflation and onset of reality that the Fed would not be lowering rates anytime soon, interest rates rose during the month across the maturity spectrum. The 2-year Treasury rose from 4.63% to 5.04%, reflecting revised market expectations with respect to the Fed’s actions, while the 10-year Treasury rose from 4.21% to 4.68%, reflecting higher inflation expectations. Rising interest rates have a negative impact on bond prices.

Inflation Reaccelerates and Fed Changes Tune

Inflation continues to be a concern, as illustrated by the latest readings on the Consumer Price Index (CPI), Personal Consumption Expenditures (PCE) Index, and ISM Prices Paid Index, all of which are beating market expectations to the upside and showing a reacceleration of prices. The latest data has dampened the Fed’s confidence that inflation is headed toward its 2% target. The response from central bank officials was clear: rates will stay higher for longer.

As noted, in the recent GDP report on economic growth, the personal consumption expenditures (PCE) price index, a key inflation data point for the Federal Reserve (Fed), rose 3.4% in Q1, its biggest gain in a year. Lastly, the US Inflation Rate (CPI) accelerated for the 2nd straight month to 3.5% in March, the highest rate of change since September, compared to 3.2% in February and market forecasts of 3.4%.

Within that CPI report, Shelter and Energy contributed more than half of the increase. Shelter comprises roughly 1/3 of headline CPI and was up +5.7% year over year and +0.6% M/M. Meanwhile, Energy, reflecting the increase in the price of oil in the first quarter, was up +3.1% month over month.

The Shelter component of CPI will likely continue to increase the odds of higher for longer inflation. On the supply side, U.S. Housing Inventory remains close to a 40-year low. Combined with 30-year mortgage rates remaining elevated near 7.0%, the “all-in” price of homes is historically costly. This tight inventory dynamic should continue to put upward pressure on home prices. Rent is a bit more of a deflationary tailwind than buying a house, but even here the story isn’t great. According to Zillow.com, in March, rents were up +3.6% Y/Y nationwide, tracking in line with inflation.

The inflation data came with markets on edge about when the Fed will start cutting the Fed Funds rate. Investors have had to adjust their view of when the Fed will start easing as inflation has remained elevated. The view as expressed through futures trading is that the Fed may only be able to cut once this year in December.

As reported by Reuters, in a speech that didn’t mention rate cuts, Fed Vice Chair Philip Jefferson said, “it will be appropriate to hold in place the current restrictive stance of policy for longer,” if inflation stays high and sticky. Other Fed heads, John Williams and Raphael Bostic have also suggested that there is no hurry or urgency to cut rates. Finally, Fed Chair Jerome Powell reiterated similar thinking at the same forum, “If higher inflation persists, Fed can maintain the current rate as long as needed.”

Given the above, The Fed is expected to make no change in its key rate over the next few meetings, but investors will be looking for direction from Chairman Powell in his press conferences as to how long the current “higher-for-longer” could last and to what the trend data may be needed for the Fed to make its first rate cut.

Economic Growth in Transition

A number of key economic releases showed the demand side of the economy still humming. From wage growth to manufacturing to consumer spending, evidence continues to mount that current restrictive monetary policy is not restraining activity as much as anticipated, placing upward pressure on inflation. While economic growth slowed from the torrid pace of the 4th quarter of 2023, this was expected, however, growth for Q1 did fall short of expectations with Gross domestic product (GDP) increasing at a 1.6% annualized pace in the first quarter. Estimates called for an increase of 2.4% following a 3.4% gain in Q4 and 4.9% in Q3.

Consumer spending increased 2.5% in the 1st quarter (down from a 3.3% gain in Q4), which was supported by an acceleration in retail sales in both February and March from a drop-off in January. U.S. Retail Sales increased 4% year-on-year in March 2024, following an upwardly revised 2.1% gain in February. (source: U.S. Census Bureau).  In other positive economic news, we are also seeing a rebound in Durable Goods orders in March with Global PMI’s, Global trade, and Export Orders growth generally bottoming and flashing an acceleration in activity.

While U.S. economic growth did slow from its 4th quarter pace, growth is being supported by a resurgence in the manufacturing sector where the March data indicated that the U.S. economy is emerging from the manufacturing recession of the last 18 months, which should help propel corporate earnings growth more broadly, across more sectors. On queue, the latest data from Factset Earnings Insight reflects that 77% of S&P 500 companies have reported a positive earnings surprise and 61% of companies have reported a positive revenue surprise. For Q1 2024, the blended (year-over-year) earnings growth rate for the S&P 500 is 5.0%. If 5.0% is the actual growth rate for the quarter, it will mark the highest year-over-year earnings growth rate reported by the index since Q2 2022 (5.8%).

The Bottom Line

As we have discussed in prior monthly comments, the stock market was long overdue for a setback or retrenchment of some sort, given the 28% move off the October 2023 lows, combined with the high level of investor optimism and complacency. So, the April price action should not have come as a surprise. Generally speaking, we believe the following items do provide a constructive backdrop for the market:

• Corporate earnings growth beginning to beat investor expectations and accelerate more broadly
• A resurgence in the manufacturing economy, which should spur economic growth and earnings growth
• Modestly accelerating inflation which is generally good for the economy, corporate profits growth, and the markets

Inflation has remained stubbornly above its 2% target, which has been clearly acknowledged by the Fed.  As such, in just 4 months, we saw the financial markets go from pricing in 7 rate cuts to just a single rate cut. As solid economic data and earnings continue to be reported, the Fed now has the task of threading the needle on the timing of that first rate cut. If it cuts too soon, it could create new inflationary pressures. If inflation remains higher for longer and the Fed cuts too late, then it could have a negative impact on economic growth.

Since the October lows, investors have priced a lot of good news into the stock market, lifting it to new highs, but also to elevated valuations. However, there remain segments of the market that may be more undervalued relative to others that could prompt a rotation of capital to those segments. Investors will continue to monitor Q1 earnings season for confirmation that today’s valuations are supported by solid and/or accelerating earnings growth.

We should not overlook the fact that non-US companies, both developed and emerging markets, outperformed the US market in April with emerging markets stocks outperforming everything else. Given the lower relative valuations of the broader equity market, including “value” stocks, small and mid-sized companies, and non-U.S. companies, we believe that portfolios can benefit from diversification away from these larger companies and into quality companies that demonstrate high levels of profitability, financial strength, and stable and/or growing dividends across the market cap spectrum. Lastly, we continue to construct portfolios with exposure to niche segments of the private lending market that can offer higher income and returns with lower volatility and uncorrelated risks with traditional stocks and bonds.