2024 Q1 Thoughts

Market Recap

In the first three months of 2024, the U.S. economy remained resilient despite short-term rates sitting near 20-year highs. Noteworthy in the quarter was the continuing robustness in the labor market, stronger-than-anticipated corporate earnings, and a convergence of market participants’ aggressive forecast of rate cuts with the Fed’s own projections. Retail sales pulled back, but the trend remains positive.

These factors contributed to optimism around a soft-landing scenario and boosted stocks to new highs, with the S&P 500 Index gaining 10.6% in the quarter. Large-cap stocks (S&P 500 Index) outperformed small-cap stocks (Russell 2000 Index), and growth stocks (Russell 1000 Growth) again beat value stocks (Russell 1000 Value).

Developed International and emerging-market stocks also posted gains but did not keep pace with the U.S. market. Developed International stocks (MSCI EAFE) gained 5.8%, while emerging-market stocks (MSCI EM Index) posted a 2.4% return.

Bond returns were mixed as the benchmark 10-year Treasury yield rose from 3.88% to 4.20%, with market expectations for rate cuts tempered in terms of timing and magnitude. In this rising-yield environment, the more interest-rate sensitive Bloomberg U.S. Aggregate Bond Index declined 0.8%. Credit performed relatively well in the quarter, as high-yield bonds (ICE BofA High Yield Index) were up nearly 1.5% in the quarter.

Investment Outlook and Portfolio Positioning

The U.S. economy has continued to prove resilient despite the Fed maintaining a higher level of interest rates for longer than most expected. A main driver of this better-than-expected economic growth has been the continued strength of the U.S. consumer. The combination of robust job gains and steady real income growth has allowed consumers to continue spending despite higher rates.

Inflation (CPI) has declined meaningfully over the past year, falling from 6% to just over 3%, though still above the Fed’s long-term target of 2%. Our expectation is that inflation will continue to trend lower over time, due in large part to shelter costs, which we expect to moderate.

The combination of steady economic growth and falling inflation makes it difficult to imagine the aggressive rate cuts that many were predicting at the beginning of the year. Indeed, market expectations for the number or rate cuts in 2024 have declined from expectations of six to seven rate cuts at the beginning of the year, to around three as of March 31st. We are currently in line with consensus expectations that the Fed will cut by 25bps in June, with two more cuts later in the year. With inflation still running slightly hot the Fed has to balance cutting too early and potentially causing a second wave of inflation, versus waiting too long and putting pressure on the consumer and the economy. What the Fed ultimately decides will depend on the economic data that unfolds.

For now, U.S. economic data seems supportive of growth, not contraction. If the Fed is able to engineer a ‘soft landing’ of the U.S. economy with inflation converging to 2% and growth continuing, they can incrementally lower rates and ensure that policy does not become too restrictive. If a recession does occur later this year, the Fed will have the ability to swiftly and meaningfully cut rates given current levels.

In terms of The Gardner Group’s portfolio positioning, we made changes this quarter to reduce exposure to emerging-market stocks, reallocating the exposure to a mix of mostly U.S. stocks, with a small amount going into developed international. As a result of these changes, our global equity allocation will be neutral to their long-term strategic targets, and our U.S. equity allocation will be better balanced from a growth/value/blend perspective.

The rationale for a return to a neutral weighting for emerging-markets stocks centers on China, which comprises roughly a quarter of the MSCI emerging-markets Equity Index. Given the level of cyclical and structural headwinds China’s economy faces, we lack the level of conviction we required for an overweight allocation. Meanwhile, outside of China, the broader emerging-market equity index has performed well (India, Taiwan, Brazil, etc.). At just shy of 16x trailing earnings, emerging-market stocks appear fairly valued relative to their 30-year average. Ultimately, the combination of uncertainty around China, combined with valuations that were no longer cheap, led us to unwind the allocation.

Our fixed-income positioning has not changed much since last quarter. The Gardner Group believes that inflation is under control for now, and that short-term interest rates have peaked and will likely decline slightly over the course of the year. For corporate bonds, we do not foresee a near-term risk of a spike in default rates given the still-attractive corporate fundamentals. In this environment we continue to take advantage of the inverted yield curve, emphasizing shorter-term higher-yielding securities with yields in the 6.5% to 7% range, while also maintaining some exposure to longer-term bonds with yields in the 4.5% to 5%, which can also provide protection in the event of a stock-market downturn. And if long-term rates climb, we’ll look at adding exposure to capture these yields while adding defensive ballast to portfolios.

Closing Thoughts

The U.S. economy currently appears to be in in decent shape. The stock market continues to hit new highs as economic growth continues. There continues to be a high level of concentration in the “Magnificent Seven” stocks, which comprise about a quarter of the value of the S&P 500. In our view this creates relative opportunity in the remaining 493 stocks in the S&P 500, which have not seen valuations so stretched. The possibility of a recession isn’t off the table by any means, but if it does happen the timing is likely pushed back until late this year or 2025.

As we look ahead, we anticipate there will be pockets of choppiness given headline risks related to Fed policy, geopolitical events such as the ongoing wars in Europe and the Middle East, and the upcoming U.S. presidential election (election years have historically been more volatile for the equity markets). In anticipation, we are prepared to be opportunistic and take advantage of any attractive risk/reward opportunities that arise.

The Gardner Group thanks you for your continued confidence and trust. As always, please call our schedule time with us if you have any concerns.