First Quarter Review
Equity markets had a strong first quarter in 2024. After the pivot by the Federal Reserve on interest rates in December of 2023 US equity markets continued to rally off the October 2023 lows, and that rally carried into the first quarter of 2024.
There has been a great deal of prognostication through this interest rate hiking cycle (and its purported conclusion in December of 2023) on the direction of rates and the effect that direction will have on asset prices globally. The Federal Reserve is often described as the central banker to the world, and this cycle has not been an exception.
The year began with an expectation that rates would start coming down in March and continue on a lower glide path for the balance of the year. The economic data, however, has changed that path in quite significant ways. Stronger economic data on the employment and growth front led to a gradual drawdown in expectations for interest rate cuts. Inflation data in January and February (since confirmed in March) has also been stronger than anticipated. So financial markets that were building in several rate cuts for 2024 have had to adjust and the “several” has now been cut to 2 or 3 as strategists start to discuss the possibility of no rate cuts at all for 2024. The questions last year were not only about the path of rates but also the “reason” for that path. A perception of strength in the economy and growth ahead is leading to the idea that the Fed does not need to cut rates even if it appears the bias is towards cutting at this stage. Fear that the Fed would be forced to cut due to economic weakness has not materialized thus far as the longest anticipated slowdown/recession in history still seems ephemeral.
As the number of interest rate cuts has come down, as evidenced by the forward interest rate curve, short term interest rates have risen. Even longer dated treasuries like the 10 year and the 30 year have seen prices come down as yields have gone up. While no longer being quoted daily, the United States still has an inverted yield curve, with higher rates on the short end (lower duration) of the curve. With the “Waiting for Godot” recession still yet to arrive, we just want to point out that the inverted yield curve has yet to be resolved and has almost unfailingly been a harbinger of recessions.
Outlook and Investment Strategy
There are several important data sets to consider in 2024. Economic data, including inflation readings as well as growth and employment data will be very important to the Federal Reserve as they calibrate the path of interest rates in 2024. Any deterioration in good data or a continued lift in inflation statistics will likely be negative for equities. Additionally, as the number of rate cuts expected for 2024 have dwindled and moved out later into this year and possibly into next, we could see a correction and continued volatility in equities.
From the consumers standpoint, even if we get a more helpful drop in inflation numbers that the Fed and economists continue to hope for, the issue will remain the level of prices. A “lower” inflation rate, while helpful as a measure of where things are headed now and positive in the economic sense is not the same as lower price levels, nor does it imply that prices are coming down. This is critical to both consumer confidence, which drives spending, and consumer expectations, which can drive behavior.
The University of Michigan survey that looks at consumer confidence and forward expectations has shown a recent uptick in inflation expectations, which until now had been relatively benign from the Federal Reserve’s standpoint. If this continues it could be worrisome as an “un-anchoring” of inflation expectations which is what the Federal Reserve is trying to forestall (along with inflation itself) by hiking rates. If consumers start to build in higher inflation expectations, that could lead to demanding higher wages, creating the “wage price” spiral of the 1970’s that no one wants to revisit.
The positive story of AI, what looks to be a hopeful earnings season in Q1 as well as the balance of 2024 with expected growth in earnings throughout the year for the S&P 500 has driven equity prices higher in the first quarter of 2024. Coupled with some reasonably good economic data in Q1 this has led to high investor expectations for 2024. Downside risks include the worsening geopolitical situation as well as elevated readings on inflation which have cast a pall over the start of the second quarter. The upcoming presidential election may also add uncertainty, which as a rule financial markets do not like.
Corporate earnings will be paramount, as will forward-looking commentary. If growth is elusive or companies start to temper expectations, the equity story could have trouble staying as positive as it was in the first quarter. Data will also be key, because the current narrative is that we are leaning into strength with mostly positive inflation data (even with some recent less favorable readings) and therefore the economy can withstand higher rates. A flip of the direction of economic data accompanied with higher inflation numbers would be a clear negative for equities given the current valuation levels.
We do see value in certain sectors of the economy and see some opportunity in areas that have been either overlooked (such as energy) or have underperformed (such as healthcare in 2023) and we remain convinced that strong balance sheets and good management can thrive in the current environment.
The views expressed are those of the Alpine Saxon Woods, LLC management team as of the date indicated, and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Performance data quoted represents past performance and does not guarantee future results. All data referenced are from sources deemed to be reliable but cannot be guaranteed. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.
