Atlantic Edge Insights
April 2024
Market Commentary
Market Recap
Stocks
The S&P 500 returned just over 10% in just the first quarter of 2024, which is greater than the average annual S&P 500 return of 9.9% (since S&P inception in 1928). At first glance the stock market seemed to be continuing the strong growth trend that led the S&P 500 to return 26% in 2023. Despite the headlines generated from excessively high returns for firms like Nvidia and Super Micro Computer, the S&P achieved broader market success than in 2023 as over 80% of stocks are currently above their previous 200-day average price (see orange line in graphic above).
In January, when discussing stock market performance in 2023, we noted that the broader stock market was weighed down by concerns that the Federal Reserve would tighten monetary policy sufficiently enough to induce a recession to bring inflation back down to 2%. However, the Federal Reserve’s signal in late 2023 that it expected no further rate increases amid a strong economy and falling inflation removed a roadblock that seemed to be holding back much of the stock market. This shift in policy and continued better than expected corporate profits provided an impetus for broader market participation.
International stocks added 4.4% in the first quarter. While in comparison to US stocks this seems low, however, when measuring stock returns in local currency (which is the same as saying measuring the S&P 500 in US dollar returns), International Developed stocks returned 9.96% for the quarter, in line with S&P 500 returns. Emerging Market stock returns lagged in both US dollar and local currency returns due to being weighed down by weakness in China, which despite massive government intervention, still lost 2.5% during the quarter.
Bonds
The Aggregate bond market fell almost 1% in the first quarter. This drop is primarily due to rising interest rates that caused the value of bonds to decrease. The yield curve inversion remained static, meaning that the interest rates on shorter maturity bonds were higher than interest rates on longer maturity bonds, and yield spreads, or the increase in yields for riskier bonds, remained well below its historical average.
Against this relatively static bond market, rising interest rates finally brought the bond market’s expectation into sync with the Federal Reserve’s own predictions for rate cuts in 2024. Throughout 2022 and 2023, the bond market repeatedly under-estimated the Federal Reserve’s own predictions surrounding the pace and magnitude of rate hikes, despite Chairman Powell’s consistent refrain of “higher for longer.” Consistent with this behavior, the market was pricing in 6 rate cuts for 2024 at the beginning of January, while the Federal Reserve’s own prediction, based on the votes of Fed officials, only predicted three cuts in 2024. At the end of March, the Fed’s prediction remains unchanged, while the market has moved to match the Federal Reserve as the pace of disinflation has slowed considerably.
Strong Economic Fundamentals with Looming Risks
From the lows in late 2022, market returns were driven by strong economic data, rapid disinflation, and technological advancements in artificial intelligence. In December, the Fed signaled that they planned to begin lowering interest rates in 2024, providing a tailwind for stocks, which was bolstered by better-than-expected economic data.
Economists raised their 2024 GDP targets throughout the quarter as economic growth remained healthy. The labor market added more jobs than expected and hourly earnings growth outpaced inflation. The Purchase Managers Index, which surveys purchase managers at large multinational companies on the health of their business, rose during the quarter. Leading Economic Indicators, which had been contracting for 2 years, posted their first gain in February, and corporate earnings remained strong as a majority of companies exceeded their earnings expectations.
Economic growth during the quarter trickled down to stocks. In the first three months of 2024, the stock market achieved 22 all-time highs and by the end of March was 13.8% above its average price over the previous 200 days, a signal of strong market momentum within an uptrend. We view this as an overall positive omen for future stock returns (see graphic above).
Extreme levels of momentum are consistent with overbought levels as shown in the chart above when the stock market has exceeded 20% above its 200-day average, current market levels should benefit from both the trend and momentum of the last three months. Stated differently, the magnitude of the S&P 500’s level over its 200-day moving average is currently ‘just right’.
As the fed aggressively raised rates in 2022 & 2023, money markets yields increased rapidly from 0 to 5%. This fueled banking instability in 2023 as customers moved assets from low yielding bank accounts to high yielding money market funds. Money markets, which consist of ultra short-term investments that provide yields close to the Federal Funds Rate, should begin to decline when the Federal Reserve signals that rate cuts are imminent. As these yields become less attractive, some of the inflows from 2023 may seek investments with a higher expected return, providing more demand for risky assets, potentially benefiting corporate bond and stocks returns.
While the Federal Reserve has signaled that it expects to cut rates in 2024, continued strong employment allows the Fed to keep rates high until it is confident that inflation will fall to target. While inflation declined sharply in 2023, data during the first quarter signaled that the last mile may be the most difficult. The shelter component (which is a measure of what people pay to rent) of CPI, which comprises 40% of Core CPI, has not declined as much as other components. Because of this, bringing inflation back down to 2% will be challenging as home affordability (which is historically low) will keep demand for rental units high.
Energy and other commodities that helped champion the rapid decline in inflation bottomed out late last year and have started to flat line or trickle up. Oil, which was down over 10% last year, rallied 14%, while Cocoa prices have inflated dramatically, more than doubling since the start of 2024. If inflation remains at current levels or begins to reaccelerate, the Fed may delay the expected start or slow the pace of rate cuts in 2024, which we would expect to negatively affect both stock and bond market prices.
Portfolio Positioning
Stocks
Short-term: Investor sentiment has remained optimistic to very optimistic throughout the first quarter. While this can often be a contrarian indicator, markets can provide higher than average returns during times when investors are optimistic, especially when economic data is stronger than expected. We view the broadening of stock market returns as a positive signal for market performance during the next several months. Any pullback in stocks without a meaningful degradation in economic data would present a buying opportunity.
Long-term: While returns in global markets were more balanced, US stocks continued to outperform despite their relative expense compared to Europe or Asia. The US economy has proven incredibly resilient in the face of a restrictive Fed, maintaining strong growth while experiencing a substantial reduction in inflation. Barring worsening economic data, we maintain a modest overweight to US stocks.
Within foreign stocks, we have maintained minimal exposure to Chinese companies. This tilt has protected portfolios from losses as the Chinese stock market lagged the global stock market by over 30% in 2023. This underperformance continued in 2024 despite massive stimulus by the Chinese Communist Party, as the country continues to be weighed down by an unproductive real estate sector that suffers from falling prices and massive debt. While the stimulus will likely limit downside risk, we will continue to limit our exposure to that part of the world.
Bonds
The aggregate bond index did not provide a positive return in the first quarter as interest rates across maturities rose modestly. However, portfolio bond returns faired far better, aided by investments that provide differentiated returns regardless of the direction of interest rates and a continued bias toward shorter maturity bonds. While we maintain a tilt toward shorter maturity bonds, especially as they provide a higher yield than longer term bonds, we increased exposure to intermediate term bonds during the 1st quarter. These bonds should do better if intermediate rates decrease, as has happened historically in the months after the Federal Reserve has begun lowering the Federal Funds Rate.
Economic and company fundamentals continue to support taking some risk, and we hold some exposure to bonds that pay higher interest payments. If economic fundamentals start to turn, we remain ready to reduce lower quality bonds in favor of high quality.
Atlantic Edge Insights
Matthew Cochran, CFA
Robert Filosa, CFA
Ethan Caldarelli, CFA
Opinions expressed in this commentary may change as conditions warrant and are for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources that we believe to be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. No graph, chart, formula or other device can, in and of itself, be used to determine which securities to buy or sell, or when to buy or sell such securities, or can assist persons in making those decisions. Consider seeking advice from a professional before implementing any investing strategy.
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