Mana’s Economic and Market Update Q1 2024
Asset Class Performance
Stocks started the year strong, with US Large Cap stocks leading the pack at +10.3% in Q1 of 2024. Ten of the eleven S&P Sectors posted positive total returns. The Energy sector led the way with a 13.5% total return, followed by Communication Services (12.7%), Financial (12.4%) and Industrial (10.8%). Commodities rebounded +10.4%, with large gains in gold and copper. Both fixed income and real estate suffered losses in Q1.
Investment Commentary + Outlook
Year to date performance and Fed on watch
The first quarter of 2024 brought exciting opportunities for investors across global financial markets. While stock markets experienced some volatility, major indexes like the S&P 500 and Nasdaq ultimately ended the quarter with solid gains. In the bond market, rising interest rates as central banks addressed inflation opened the door for attractive yields on newly issued fixed-income securities. Notably, Q1 2024 marked just the 11th time since 1926 that stocks delivered positive returns while bonds experienced a temporary decline over the first three months of the year – a relatively rare occurrence highlighting the resilience of diversified portfolios. Overall, the quarter reinforced the importance of staying invested and maintaining a well-balanced portfolio strategy for long-term success.
As we moved into April, the tone shifted as the Federal Reserve reiterated their commitment to lower inflation ahead of making any changes to the target Federal Funds Rate. The S&P 500 index and the Nasdaq Composite Index lost 4.2% and 4.4% respectively, in April, ending five straight monthly gains. The market is expecting three rate cuts in 2024, and that we have reached peak interest rates in this cycle.
Stock Market
Following an impressive performance in 2023, US equities have sustained their upward trajectory into the early months of 2024. Robust corporate earnings and optimism regarding potential policy adjustments have led to numerous record highs in the market this year. Nevertheless, market activity remains concentrated, with the largest stocks in the index maintaining their dominance. Despite appearing overvalued, there are still abundant appealing investment prospects beyond the realm of these Mega Cap stocks.
The recent rally's narrow focus has rendered the top 10 stocks considerably pricier than the broader index, whereas the remaining stocks appear comparatively inexpensive and are trading closer to their historical averages.
Although index concentration is not a novel occurrence, as the weight of the top 10 stocks in the S&P 500 has been steadily increasing since 2016, their earnings contribution hasn't kept pace over the long term. Despite now representing a third of the index's weight, the top 10 stocks contribute only a quarter of the earnings, making a compelling argument for diversifying investments across the broader index. Positively, we have started to see this breadth expand during the first four months of 2024, where energy stocks and financial stocks are leading YTD performance.
Valuations are attractive for small-caps after a long period of underperformance, both in the US and Eurozone. UBS advises that since nearly half of the debt held by Russell 2000 companies is floating-rate, versus around a tenth for large-cap companies, Fed rate cuts can quickly start to reduce interest expenses for small-cap companies. Our expectations are that the ECB will cut rates in 2024, and since Eurozone business and individual debt is primarily floating rate, this will also push for positive momentum of international stocks.
Global stock market valuations are attractive, particularly in emerging markets where earnings growth is expected to outpace the US by over 7%. Their main headwind is the strength of the US dollar. Below we show a chart from Russell Investments on price ratios of emerging markets, Japan, and Europe compared to the US.
Bond Market
As we entered 2024, the market expectation was that the Federal Reserve would begin cutting interest rates. The Federal Reserve is remaining vigilant on monitoring market conditions, and specifically their inflation target of 2%. Powell has stated that he believes we have reached peak interest rates in this cycle, and the market generally expects that the Fed will cut rates three times during 2024. Current yields appear attractive, and higher yields provide a “yield cushion”. Taking the US Aggregate as an example; if yields were to fall by 1%, an investor could expect a return upwards of 11%. However, if rates were to rise by 1%, the coupons from the bonds would help offset some of the price depreciation, and that same investor could expect a loss of only 1.5%.
Although rising interest rates led to negative bond returns in 2022, today's higher rates offer investors the prospect of positive real income and the portfolio protection typically associated with bonds rallying when stocks falter amid economic weakness.
Despite the recent bond market rally, current yields are still at some of their highest levels in the US in the past decade, illustrating that the fixed income market offers meaningful income, yield protection and relatively attractive valuations.
Dollar Dominance
This year we’ve witnessed a strengthening US dollar against most foreign currencies. Notably, the Japanese yen hit 34 year lows compared to the US dollar. The Euro is down -3% year to date. The strength of the US dollar can have far-reaching effects on other countries, influencing trade balances, financial markets, and economic policies worldwide. The strength of the dollar is attributed to factors such as robust economic growth in the United States and higher interest rates compared to other countries.
A stronger US dollar could help the Fed in lowering interest rates this year. A strong dollar tends to slow US growth - export prices are higher to foreign countries, resulting in decreased exports, and price drops (read: lower inflation).
However, a strong US dollar can come with challenges, particularly for emerging markets and countries with significant dollar-denominated debt. A strong dollar can lead to currency depreciation in other countries, making their exports more expensive and increasing their debt burdens. This, in turn, can lead to economic slowdowns and financial instability in affected countries.
Is now the time to invest?
Consumer confidence continues to retreat as they become less positive on the job market and have concerns around their financial wellbeing due to experiencing higher prices on food and gas, as well as elevated interest rates. If inflation stays stable, the Fed would likely maintain interest rates at these higher levels for longer, which could trigger declines in the stock market. However, as we look at the economic data, we continue to see strong job numbers (wage growth, low unemployment), strong consumer spending, and household wealth. We are continuing to watch employment data; Ed Yardeni, President of Yardeni research describes on Schwab’s Market Update how there has never been a recession during a time where employment or construction employment continues going to record high territory.
Investors often think that investing at all-time highs is a mistake, and a reason to stay in cash. However, historical data suggests that investing at these peaks isn't necessarily unwise. In fact, all-time highs tend to cluster together, indicating a pattern where strong performance leads to further gains.
Consider the S&P 500 price index: each all-time high serves as a "market floor," representing a point from which the market has seldom dropped more than 5%. Since 1950, there would have been many instances in which an investor sitting on the sidelines with markets near all-time highs would have never seen a better entry point.
JP Morgan shows that returns from investing on any given day versus an all-time high are comparable, and in some cases, better when investing at market highs.
We know that volatility is the price you pay to invest in the stock market, and intra-year since 1980, the average drawdown in the S&P 500 intra-year was 14% according to JP Morgan. We’ve already seen volatility pick up in the month of April, and our expectations are that the market will continue to react to the language used and actions taken by the Federal Reserve. However even as we think on a shorter term basis, history shows a similar message on investing, and staying the course. Following a strong Q1, where returns of the S&P 500 Index have exceeded 10%, 9 out of 10 times since 1970 the S&P 500 was higher by the end of the year.
Follow our Instagram for personal finance tips and inspiration.
Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.