Market Commentary Q1 2024
IS THERE ANYTHING LOWER RATES CAN’T CURE?
The Federal Reserve began raising interest rates two years ago in response to the highest inflation in a generation. While pundits debated how much was transitory (supply chain disruption) or structural (the largest monetary expansion on record), it was clear that easy money was stoking the inflationary fire and substantial intervention was required.
Since then, the Fed Funds effective rate has climbed from near zero to 5.3% and inflation (as measured by the Consumer Price Index) has retreated from 9% to 3%. U.S. economic history is fairly conclusive; most rate hiking cycles end in a recession and soft landings are rare. In fact, 1995 is the only successful soft landing since World War II. Combined with an inverted yield curve (where short rates exceed long ones), there were indications suggesting a recession was more likely than not.
Many suspected a wave of high-profile bank failures last Spring could be the first domino, yet here we are 12 months later, and the economy refuses to shrink. Last year, existing home sales fell to levels not seen since 2010, industrial production contracted, and unemployment rose by almost half a percent. But GDP kept chugging along and no one seemed to tell the stock market.
True, the S&P 500 sold off from August to October of 2023 as interest rates on the 10-year Treasury rose from 4% to almost 5%. But since October 27th, the market has been up 18 out of the past 22 weeks largely on the prospect of lower rates. In February, the S&P 500 crossed 5,000 for the first time ever and has hit 22 all-time highs in 2024 alone. If you’re looking for an explanation, look no further than the Fed’s December Summary of Economic Projections where they suggested three rate cuts were likely in 2024.
Our continued view is that inflation progress is seldom linear (see the January CPI report) and bond investors lean premature when anticipating cuts. But the consensus seems to be that the economy will avoid a recession, Artificial Intelligence is the next Industrial Revolution, and the U.S. has unlimited borrowing capacity (despite the views of Fitch).
We issued a mea culpa last quarter, saying our cautious stance in 2023 was unwarranted and in the past five months or so, the S&P 500 is up almost 30%. We also said that we expected 2024 to be a less exceptional year than 2023. Yet through the first quarter, the S&P has returned 10% year to date, which is roughly what we expected for the year.
There is ample evidence of froth in the equity markets. After rising 240% in 2023, Nvidia is up over 80% in the past three months and is now the third largest company in the world. The VIX (an index that measures the price of hedging equity volatility) is at a post-pandemic low and prices of cryptocurrencies have gone parabolic. Market strategists are being forced to revise their year-end price targets higher just three months after setting them.
To be fair, there is some justification for the market’s optimism. Leading economic indicators recently turned positive for the first time in two years. Fourth quarter earnings were stronger than expected and market breadth seems to be improving.
But when markets throw caution to the wind and appear unanimous in their expectation of strong returns, the phrase ‘goldilocks’ comes to mind. It’s times like these that we like to sharpen our pencils, examine our risk appetite, and ask what might the market be missing?
We don’t have an answer for you today, but we’ll keep you apprised as events warrant.
As always, thank you for your confidence and should you have any questions, don’t hesitate to reach out to your relationship manager.
Sincerely,
Bridges Trust Investment Committee