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Market Update Spring 2024

Market Update Spring 2024

Market Update

The S&P 500 Index reached an all-time high last quarter. Strong stock market returns usually follow Bear markets, which we experienced in the last two years. US Large-cap Growth stocks are outperforming foreign stocks and US Small-cap stocks. Artificial intelligence-related stocks have dramatically outperformed all other areas of the equity market. The US stock market is in a Bull market that could last much longer and go a lot higher given the Fed’s next move is easing and not a hike. This Bull market (S&P 500 Index) gains are not even half of the average bull-market gain according to Bespoke research note.

Recent inflation measures have been hotter than expected. The Fed wants to see more progress in inflation before easing and has backed off talking about cuts. In response, Bond yields have risen to their highs for the year, which is not entirely a terrible thing as long as the US economy keeps growing at its current pace and inflation isn’t reaccelerating but just temporarily stalled. Core PCE, the Fed’s preferred measure of inflation has declined from 4.8% in March 2023, to 2.8% - that is progress. Core-inflation must cool down from its current pace to ease the burden of compounding effect of inflation on the current cost of living. The last mile in reducing it towards the 2.00% Fed goal is here and gains on the inflation will come slower and smaller.

And so the Federal Reserve is in no hurry to cut its key interest rate as inflation is stubborn and economic growth is healthy. Even so the US economy is in expansion and a slower easing cycle is better than a fast-easing cycle when the economy is expanding. A Fast-easing cycle signals the economy is in trouble whereas slow cycle implies economy does not need monetary stimulus to avoid a recession. Economic growth is more important than faster rate cuts for markets. Earnings are driven by economic growth and stock prices follow earnings.

Interest rates have just normalized from a zero-interest rate policy (ZIRP). ZIRP is not only inflationary but not normal, and only warranted in an extreme economic crisis. Today’s yield curve is trying to normalize incrementally away from a recession warning inverted yield curve as evidenced by narrowing yields spreads between two year and ten-year Treasuries from peak spreads. A normal positive sloping yield curve is healthier for economic growth. Corporate earnings growth is associated with a positive yield curve with a growing economy.

The US economy could be less sensitive to higher rates as in past tightening cycles because services are seventy percent of the US economy. Manufacturing industries are impacted by higher rates more than Service industries. The Manufacturing PMI sector posted an expansion reading, it has been 15 months since the last positive reading! In the past, the economy has endured and grown for much longer periods of a sustained Real Fed Funds rate greater than 2.0% without a recession according to Fidelity. The higher probability of a soft-landing is very bullish for risk assets such as equities. History shows that when Central Banks cuts come without a recession, the economy typically skips into a stronger expansion as restrictive monetary policy headwind ends.

My view is that the economy does not need more than 1-3 cuts to adjust the Federal Funds rate to a neutral level closer to its long run average. Financial conditions are not historically restrictive based on current rates and inflation levels. Although consumer rates and mortgage rates are higher than ZIRP levels, interest rates are not historically high nor excessively restrictive on a relative basis. Today’s rates have drained out a substantial amount of excess money supply from the system – the “free money highly inflationary” paradigm is no more. The Fed must be careful not to remove too much liquidity otherwise it could trigger another event like the regional banking crisis last Spring. The Chicago Fed National Financial Conditions Index shows an easing in financial conditions in the last twelve months. The lag effects of the tightening cycle should be a drag on growth by now, however, not too restrictive monetary policy, government deficit spending, consumer spending and savings, backed by very heathy labor market is generating enough economic activity to reach escape velocity from a recession. Credit spreads are tight suggesting recession risks have receded.

For 2024, analysts are projecting earnings growth of 11.0% and revenue growth of 5.0% according to FactSet. Earnings growth estimates are above the long-term average of 7%, which would be consistent with a single to double digit return for the S&P 500 Index this year. Both the ISM Services Index and the Manufacturing Index were in expansion readings in March, which bodes well for earnings estimates to be met. Historically, a bottom in ISM indexes is positive for earnings growth in cyclical sectors. What is more is The FRED Personal consumption expenditures (Household consumption expenditures) continues to rise as it has over the last 12 months. Earnings, revenues, and profit margin are forecasted to be higher in 2024 based on FactSet. Historically, Stock prices lead earnings growth.

The forward 12-month P/E ratio for the S&P 500 is 20.5 above the 10-year average (17.7) according to Factset. This suggests that the S&P 500 Index is trading at above fair value – it is not cheap implying lower forward returns. It also implies that the S&P 500 Index must achieve its projected earnings estimates for the stock market to advance higher by year-end. Likewise, the US economy must continue to expand for that to work out, and more progress on reducing inflation must be made.

The S&P 500 Index has not had a correction since last October. Most Sentiment indicators, such as the NDR Crowd Sentiment Poll, are at extreme bullish levels. Correspondingly, leading areas of the equity market are in overbought levels as determined by Full Stochastic technical indicator and are vulnerable to a pullback on any unwelcome news such as hotter inflation reports. The first quarter earnings season will be the arbiter of whether the market corrects or consolidates in a trading range into the election. Current FactSet bottom-up earnings projection is forecasting the S&P 500 Index could rise 9.5% from the April 12th close. Expect revisions along the way to this forecast as data changes. There are no promises or guarantees that the forecast would come to fruition, however, if the economy does expand and earnings grow then it is reasonable to assume the S&P 500 Index could be higher by year-end holding all else equal.
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