The Quarter In Review | 1Q 2024
Global stocks had an impressive start to the year, returning 8% in the first quarter. The prospect of an AI-driven productivity boom drove stocks higher, especially in the U.S., outweighing areas of uncertainty such as higher-for-longer interest rates and upcoming U.S. elections. Japan made headlines as the Nikkei reached new record highs for the first time since 1989. And major U.S. indices, including the Russell 3000 and S&P 500 Index, ended the quarter at all-time highs.
IT and Communication Services stocks led stock market gains, but it wasn’t concentrated in the “Magnificent 7” names that led the U.S. market last year. While Nvidia, Microsoft, Meta and Amazon all contributed to market returns, both Apple and Tesla detracted. REITs were the only sector to post negative returns for the quarter, falling after a strong fourth quarter last year.
Globally, small caps trailed large caps. However, value and profitability offered a ballast against the negative size premium, as value stocks and stocks with higher profitability generally outperformed their counterparts.
FIXED INCOME
In the bond market, U.S. Treasury yields recovered some of their decline from the end of 2023 but remained off their highs. After rapidly raising rates more than 5 percentage points over the last two years, the Federal Reserve is pausing on further rate increases and has communicated an intention to implement rate cuts at some point this year. Currently well into May, it is unclear when any rate cuts may happen.
The 10-year yield continues to be lower than that of three-month bills, keeping the yield curve inverted. This is the longest extended period of an inverted yield curve, which normally signals a recession, in more than 40 years.
In terms of total returns, the U.S. Aggregate Bond index declined -0.78% for the quarter ending the past 12 months up a mere 1.7%.
ALTERNATIVES
The Bloomberg Commodity Total Return Index returned +2.19% for the first quarter of 2024. Turmoil in the Middle East and Eastern Europe, along with expanded OPEC oil produced cuts, buoyed energy prices as supply concerns offset record oil production in the U.S. Gold hit record highs and copper broke out of a multi-month slump.
Unleaded Gas and Low Sulfur Gas Oil were the best performers, returning +17.18% and +16.62% during the quarter, respectively. Natural Gas and Wheat were the worst performers, returning -29.65% and -11.24% during the quarter, respectively.
After surging to positive returns in the fourth quarter last year, U.S. Real Estate Investment Trusts (REITs) eased them, down -0.39% for the first quarter and +10.45% over the last 12 months.
ECONOMY
First quarter GDP showed that the U.S. economy’s growth slowed, coming in at a 1.6% annualized pace, which is a decline from 4.3% and 3.4% in last year’s third and fourth quarters respectively.
The manufacturing sector (which makes up less than 10% of the U.S. economy) has contracted for the 16th consecutive month, while the services sector (constituting about 80% of GDP) continues to expand. Headline inflation has continued to trend lower, the year-over-year change in the consumer price index (CPI) peaked at 9.1% in June 2022. As of April 2024, the year-over-year change was 3.4%, a marked slowdown in the rate prices is increasing even with increased upward pressure on wages, skyrocketing home and auto insurance rates, and surging home prices. The volume of home sales remains sluggish due to tight inventory, although prices have continued their upward trend.
NATIONAL DEBT
One area that continues to drive concern is our growing national debt. The Congressional Budget Office (CBO) forecasts a deficit of more than $1.7 trillion for this fiscal year. The annual deficit is the difference between what the government collects in taxes/revenue and outlays/spending. Taxes – Outlays = Net Deficit. Last year, the U.S. federal government took in taxes/revenue of almost $4.5 trillion. To put this in perspective, $4.5 trillion is more than the GDP (total economic output) of every country in the world except China and the U.S.
In contrast to what most would think, Europe has been more responsible in dealing with its government’s finances than the U.S. While the U.S. continues to run increasing deficits relative to our country’s Gross Domestic Product (GDP), the European Union collectively runs budget deficits that continue to decline relative to its combined GDP. To quote JPMorgan Economist David Kelly, “The biggest risk associated with federal debt is not excessive spending growth, insufficient tax revenues, or even rising interest costs. It is the political system and parties who are completely incapable of addressing the issue in a mature way.”
LOOKING FORWARD
Since the second half of 2023 and into 2024, financial conditions have eased considerably. Unemployment remains below 4%; the DOW and S&P500 recently both reached all-time highs; IPO as well as Merger & Acquisition activity have been picking up.
Similar to the varied economy we are experiencing (manufacturing declining vs services expanding) we have seen similar divergence between the performance of the Magnificent 7 of stocks (Apple, Google, Tesla, Amazon, Nvidia, Microsoft, Meta) and the rest of the market. This has resulted in a wide dispersion in valuations. Fortunately, the rest of the market has valuations that are much closer to their historical averages.
For example, Vanguard's S&P 500 Index (VOO) has a trailing 12-month price-to-earnings (P/E) ratio of 26.7 (higher than its average over the last 40 years). Excluding the Magnificent 7 would lower that figure significantly down to a P/E of 17.3. In contrast, Vanguard's Total International ETF (VXUS) had a P/E of 13.5. Similarly, its Emerging Markets Stock Index ETF (VWO) had a P/E of just 11.4.
Value stocks are trading as if we are already in a serious recession. For example, the Dimensional Fund Large Cap Value ETF (DFLV) portfolio of holdings is trading at a price-earnings ratio of 13.3. In contrast, the Vanguard Growth ETF (VUG) portfolio of holdings is trading at a price-earnings ratio of 42.6.
Recency bias can keep one from investing in asset classes that have “recently” performed relatively poorly, such as international stocks (relative to U.S. stocks) and U.S. small and value stocks (relative to U.S. large and growth stocks). Their valuations are now trading at historically large discounts, increasing the odds that they will outperform going forward.
We have attached two articles which we believe you will find of interest. The first talks about common investing mistakes, further outlining some of the points made above. The second article “The Next Blackberry” provides historical context that the future of any company is never guaranteed.
SUMMARY
Remember, we’re here to help. This also is where the time invested upfront with each of you shows its value. Formulating a solid and adaptable financial plan together and discussing liquidity, cash flows, and reserves provides the solid footing needed for times like these with many changing facets.
We appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.
As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we would be happy to discuss with you.
Please follow this link to read the complete Quarterly Market Review (QMR) - 1Q 2024.