Quarterly Market Letter- Q1 2024

By Bruce Thompson on April 11, 2024

Market Review – Keeping Our Heads in a Rising Market

The fundamental investment backdrop hasn’t changed appreciably since our January letter, but there are a few insights to share.

In that letter, our proxy Bill Belichick mentioned that getting across the goal line to the Fed’s inflation target of 2% was likely to be more of a challenge, primarily because of sticky rental costs. Last year’s sharp downward march in inflation has flattened, coming in at an annual rate of 3.2% for the last 3 months.

Indeed, rental costs appear to be the sticking point, and that’s related to a shortage of real estate on the market, an unintended effect of higher rates as home building has trailed off and people are reluctant to move and trade out of low rate mortgages.

Economic growth and employment have remained strong. Putting these factors together, the Fed has pushed out its telegraphed interest rate cuts to later this year. Keep in mind that the Fed can change its mind as evidence presents. And, even as most economists predict rates will cycle back down, they have a checkered forecasting record!

The Fed’s comments had an impact on the bond market index, which pulled back .8% in Q1. Meanwhile, short term bonds eked out a small return, and the Bloomberg High Yield Index returned 1.47%, reflecting confidence in economic fundamentals.

The stock market, though, was unphased as last year’s rally continued. Representative of diversified portfolios, the comprehensive MSCI All Cap All World (ACWI) Index jumped 8.2%. In the US, the large cap S&P 500 Index rose 10.6%., while small and mid-cap stocks returned 7.5%.

International stocks as reflected by the MSCI All-World Ex-US Index rose 4.7%, but returns have been affected by something other than the performance of stocks in those markets – currency exchange rates. For example, in Q1 the benchmark MS EAFE [Developed Country] Index returned 10% in local currency, in line with US equities. Due to strength in the dollar, however, the return for US investors was 6%.

Similarly, in the last 3 years, the EAFE Index returned 8.9% in local currency but 4.7% for US investors after currency exchange. That’s primarily due to the fact that interest rates rose more sharply in the US, which attracted more money to and boosted returns of US dollar assets. It’s important to keep in mind that currency effect hurts international returns over some periods but helps over others, as illustrated in this chart. For example, a potential scenario in which US interest rates decline more sharply could lead to a reversal.

We are gratified to see that last year’s market rally, which was focused narrowly on tech-heavy growth stocks, shows signs of broadening out. Much of the quarter’s advance in value, small and mid-cap stocks happened in March. Investors seem to be rotating into them from large cap growth stocks, which we regard as a healthy sign.

Stocks have come a long way since bottoming out in Q4 2022, making up for lost time and returns during the bear market. Along with the rally, investor confidence has risen to a high level. For example, the current Bull/Bear Survey shows that there are more than 4 bulls for every bear, quite a reversal from Q3 2022, when the reading showed less than 1 bull for every bear.

This isn’t offered as a dependable market timing tool since, as you can see from the chart, confidence can stay elevated for long periods. But just as we counsel you to remain patient when stocks are correcting, we encourage you to remain level headed when they are rising sharply. As always, we believe it is important to maintain diversification, especially among asset classes that have lagged, which may offer higher relative returns going forward. It is also critical to continue to systematically rebalance portfolios. There are no “free lunches” in investing, but diversification and rebalancing come close.

As always, if you have any questions, please reach out to your advisor.

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