February 2024 Commentary

Key Observations & Outlook

• Stocks rose steadily in February with mega cap technology stocks continuing to lead the way year-to-date, powered by Nvidia’s 60% year-to-date return.

• Index gains are still being driven by a select few companies with 95% of the Nasdaq 100 market cap gains coming from just 4 companies: Nvidia, Meta, Microsoft, and Amazon.

• While large cap tech is still boosting the S&P 500 returns, chinks within the “magnificent 7” are emerging with Apple and Google posting negative returns for the month.

• We also saw some evidence of the market broadening with Mid-Caps outperforming in February, along with emerging strength in economically sensitive areas, such as consumer discretionary and industrial stocks.

• Bonds continued to slump as the excitement over near-term rate cuts by the Fed has tapered and expectations shift to cuts later than originally anticipated.

• Inflation also came in slightly above expectations. Now, with oil prices starting to turn higher as global growth seems to be bottoming, we will be monitoring the impact on upcoming CPI reports and how that may impact the Fed’s future actions.

Market Commentary

The stock market continued its upward advance that began in late October 2023, as the S&P 500  hit new highs through the month of February, rising 5.3%. Stocks continued to benefit from strong performance from Mega-Cap technology stocks such as Nvidia and Meta, driven by solid earnings growth. Nvidia, the Silicon Valley-based AI chipmaker, remains the talk of equity markets, given its recent strong earnings announcement. Fourth quarter revenues soared above already high expectations to $22 billion (versus consensus estimates of $20 billion) — a 270% increase from the previous year. The subsequent rally for the company’s stock pushed NVDA’s overall market cap to over $2 trillion, joining Microsoft (MFST) and Apple (AAPL) as the only US companies to reach that mark. Nvidia shares have jumped nearly 60% YTD, including a market cap gain of $277 billion on February 22, the largest single-day move for a stock in US equity market history.

The broader market began to show some signs of life toward the end of February, demonstrated by the performance of Mid-Cap, Small-Cap, and Emerging Markets, with Mid-Caps leading the way, up 5.9% during the month.  As discussed previously, the divergence in performance has largely been a function of relative earnings growth. To see continued strong performance from the broader market, it will be necessary to see accelerating earnings growth across these companies to attract capital away from the Big-Tech growth stocks. Given the fact that the manufacturing economy has already experienced a recession, as opposed to the consumer economy, there is a good probability that we see accelerating growth from this segment of the market , as profits begin to recover against easy comparisons. See comments from S&P Global regarding the latest reported US manufacturing data:

The S&P Global US Manufacturing PMI was revised upward to 52.2 in February 2024, surpassing a preliminary estimate of 51.5 and January’s 50.7. This latest reading indicated the swiftest expansion in the country’s manufacturing sector since July 2022, with output rising the most since May 2022 and total new orders growing at the strongest pace in 21 months. Additionally, new export orders expanded for the first time in three months, achieving the fastest rate since May 2022. The pace of job creation accelerated to a five-month high, and input buying saw an increase for the first time since July 2022.

The S&P Global US Manufacturing PMI has been trending below 50 points over the past year or so, which is considered recessionary. Notice how the index is trending higher over the last couple of months.

Magnificent 7: Emerging Chinks in the Armor?

As noted, recent performance of the “Mag 7” Mega-Caps has been boosted by super strong performance out of Nvidia and Meta (up 60% and 37% respectively year-to-date), overshadowing deteriorating performance from three of the “Mag 7” constituents: Apple, Google, and Tesla. These stocks have started off the year on a slower note, demonstrating decelerating earnings growth and fundamental momentum. For example, Apple reported revenue growth of only 2% in the 4th quarter and projected negative earnings and revenue growth for the first quarter of 2024. This performance is significant because it represents early signs of shifting momentum from both a fundamental basis (earnings and revenue growth) and relative price performance versus the S&P 500 itself, as per below.

Bonds, Inflation, and the Fed

Over the last couple of months, we have discussed how the market overshot lofty expectations for Fed rate cuts back in December. Just a few short weeks ago, markets had been pricing in an 80% probability of the first Fed rate cut in March. That timing has been pushed back to June as Fed members have expressed concern about giving up the inflation fight too quickly, while noting that an otherwise stable economy buys them time before having to cut rates.

We believed that the bond market would see some volatility associated with this change in expectations.  As interest rates have moved higher early in the year, the bond market has struggled a bit, as the Aggregate Bond benchmark posted a negative return of -1.70% year-to-date. Shorter-term and high yield bonds are basically flat for the year as credit markets have managed to remain fairly stable.

In February, inflation reports continued to drive the bond market, as the consumer price index (CPI), a broad-based measure of the prices consumers pay for goods and services, increased 3.1% on a 12-month basis. Economists had been looking for an annual increase of just 2.9%. However, housing and shelter prices, which comprise about one-third of the CPI weighting, contributed more than two-thirds of the headline increase. Part of the Fed’s thesis with respect to achieving 2% inflation is founded on a decline in housing costs. This month’s CPI report could be problematic for the Fed and for those anticipating the Fed to cut rates this spring or early summer.

Though financial markets have been looking for aggressive interest rate cuts, policymakers have been more cautious in their public statements, focusing on the need to let the data be their guide rather than market expectations. Even as Treasury yields moved higher on the back of solid economic and market data last month, stock investors have focused on improving earnings rather than the risk of rates staying higher for longer. With oil prices and commodities moving higher this year, unless the economy slows from current rates, the Fed may be forced to hold rates higher for even longer. 

Note how both Oil and the CRB Commodities index have both moved higher this year, increasing by 10.4% and 4.8%, respectively.

The Bottom Line

There is the old saying that the stock market likes to climb a “wall of worry”, which means that the stock market will tend to rise in the face of negative news flow, which one might think would be problematic for the stock market. Currently, however, the stock market’s list of worries seems to be dissipating, as investors do not seem overly concerned about much of anything these days with the S&P 500 up almost 25% since the October lows. Market complacency has taken center stage with investor sentiment remaining in an overly bullish posture. Such bullishness is not itself a catalyst for the market to decline, as it can persist for some time. However, it is more of a conditional factor of a complacent market that could be ripe for a correction or pullback of some sort.

With risk assets such as cryptocurrency experiencing high levels of speculation, the possibility of inflation surging higher with oil and commodity prices up this year, a domestic economy that continues to be propelled by strong government and consumer spending, and global growth reaccelerating, why would the Fed even need to cut rates? Doing so would only propagate a stronger risk that inflation moves higher and that the economy grows faster, which would get us back to the same place we were at in early 2022.

We maintain our posture that economic growth will slow from the rapid 4th quarter pace, and that the odds of settling into a recession continue to fade. As such, the focus for 2024 seems to be on the reacceleration of corporate earnings growth in order to drive equity prices higher. Furthermore, this reacceleration will be necessary to shift the flow of investor capital away from the Mega-Caps into other companies. With three of the “Magnificent 7” companies demonstrating slowing earnings growth, this increases the relative attractiveness of other companies that may be seeing a resurgence of earnings growth. This could serve as a catalyst for stock market performance to broaden to a wider segment of companies, which we are already seeing in the form of new highs in the S&P 500 Equal-Weighted Index and the S&P MidCap Index.

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 attractive income and returns with lower volatility and uncorrelated risks to traditional stocks and bonds.