February 2024 Market Commentary

February 16, 2024

• S&P sets new all-time record high.
• 4Q23 GDP data stronger than expected, suggesting economy entered 2024 with good momentum.
• Federal Reserve holds rates steady. Chair Powell indicates satisfaction with economic strength and downward trend in inflation but indicates Fed unlikely to cut rates at March meeting.
• Returns: S&P 500 1.6%. Bloomberg US Aggregate Bond index 0.1%.

Keep on Keeping On. It’s a simple exhortation, typically offered when one is faced with a challenge. Yet it’s also an apt theme for the economy in 2023. Despite predictions at the outset of the year that the economy would experience a recession, economic data, particularly related to the consumer and labor markets, consistently surprised to upside, helping the economy defy expectations. Economic data released in January further corroborated that theme. Having avoided a recession in 2023, the economy enters 2024 on solid footing leading to questions about what’s next. While new themes are likely to arise in 2024, it remains clear that inflation and monetary policy will remain at the forefront of investors’ minds for the time being.

Continuing the economy’s 2023 theme of Keep on Keeping On, preliminary GDP data released in January showed economic activity expanded at a 3.3% annualized rate in 4Q23. That was above the expected rate of 2.0% and the second fastest pace since 2021, trailing only 3Q23. Growth was broad based as all four major components- consumer spending, business spending, government spending, and trade- made positive contributions. Despite growing concerns about the various pressures facing consumers, including modest real wage growth, declining savings, increasing credit card debt, and overall tighter financial conditions, consumer spending in the fourth quarter grew by a respectable 2.8%. Separate from the GDP data, December retail sales grew 5.6%, the strongest pace since January 2023, helping assuage concerns about the consumer’s willingness and/or ability to spend during the all-important holiday shopping season.

As expected, the Federal Reserve left rates unchanged at its January meeting. Given that assumption, markets were more focused on Fed Chair Jay Powell’s press conference following the meeting and whether he might provide any indication as to when the first rate cut will occur. Powell’s comments left investors disappointed as he indicated a rate cut was unlikely to occur at the Fed’s March meeting, as investors hoped. With respect to timing, Powell noted the past six months of inflation data had been “very good,” but that he would like to see more good data to be confident inflation is moving sustainably down to the Fed’s 2% target. As a result, Powell didn’t think the FOMC Committee would “reach that level of confidence” by the March meeting. On the heels of that comment, market expectations for the first rate cut shifted to May. The total number of expected rate cuts remained unchanged at six. As the fed does not meet monthly, and assuming the first rate cut occurred at the May meeting, current market expectations imply the Fed will cut by 0.25% at each meeting for the remainder of the year.

One notable aspect of Powell’s press conference was his positive tone; he mentioned on several different occasions that he is pleased with how economic data is progressing. He noted that 2023 marked the second year in a row in which unemployment was under 4%, something that hasn’t happened in 50 years, leading him to say, “it’s a good labor market.” Overall, Powell described the combination of slowing inflation, coupled with still strong labor markets and overall economic activity as “a good picture.” Powell also noted that should economic activity in 2024 progress as expected, it would “likely” be appropriate to begin cutting rates “at some point this year.” Powell’s upbeat description of the economy and the fact that he still expects rate cuts to occur in 2024, was comforting to the markets. At various times in 2023, better-than-expected economic data elicited a “good news is bad” reaction from the markets. Now, markets seem more inclined to embrace “good news as good,” especially after Powell’s comments in which he effectively said that as long as inflation continues to recede there is no reason why strong economic growth and rate cuts can’t occur simultaneously.

For the month, equity returns were mixed. Large caps gained 1.6%, pushing the S&P 500 to a new all-time record high, aided in part by continued strong mega-cap tech stock performance, similar to 2023. Small caps (Russell 2000) fell 3.9%, hurt by stronger-than- expected economic data which pushed out timing expectations for the Fed’s first rate cut. International returns were also mixed with developed markets (MSCI EAFE) up slightly, 0.2%, while emerging markets shed 1.0%, weighed down by a 7.5% decline in China’s stock market as the country’s ongoing real estate slowdown continues to weigh on investor and consumer confidence.

With the S&P 500 at a new-all time high, questions abound as to how much higher it can go. In the short term, markets are often driven by sentiment. In the longer term, they tend to be driven by fundamentals. Currently, the S&P 500’s price-to-earnings (P/E) ratio, perhaps the most well-known valuation metric, sits nearly 25% above its longer-term (20- year) average. From such levels, for the stock market (S&P 500) to move sustainably higher, earnings growth will likely need to improve. Current estimates show earnings growth improving over the course of the year, particularly in the fourth quarter. However, future earnings estimates tend to be susceptible to revisions, both up and down. Should economic growth slow more than expected in 2024, earnings estimates would likely see downward revisions, placing downward pressure on equity market performance.

Geopolitical tensions in the Middle East intensified in January. Following Houthi attacks on commercial and US military vessels in the Red Sea, the US and its allies conducted military strikes against targets in Yemen. In addition, Iran-backed militants continued their attacks on US facilities across the Middle East, with one attack in Jordan killing three US soldiers and wounding many others. In response, the US carried out numerous attacks on Iran-backed militants in Syria and Iraq. Thus far, markets have largely ignored the spread of fighting, despite its potential to disrupt global energy supplies.

US fixed income markets, as measured by the Bloomberg US Agg Bond index, the broadest measure of the US bond market, were largely unchanged in January, rising 0.1%. However, the relatively small gain belied meaningful moves during the month. Following the strong rally in November and December, which saw yields fall precipitously, January began with a reversal. Yields moved higher at the start of the month following comments from multiple Fed members pushing back on the market’s aggressive rate cut expectations for 2024. Continued strong economic data also reduced the urgency for the Fed to cut rates.

Momentum shifted near the end of the month, causing bonds to rally (and yields to fall) following dovish comments from the European Central Bank (ECB), which seems likely to begin cutting rates towards the middle of the year to support stagnating economic growth. US rates rallied in sympathy, before receiving an additional boost from the US Treasury announcing that it was reducing its estimate for federal borrowing during the current quarter. In recent years, increased US borrowing has led to concerns about an oversupply of bonds. Thus, the announcement that the government would not need to borrow as much during the quarter led to buyer enthusiasm. Yields moved lower still at the very end of the month, following the Fed’s decision to leave the Fed Funds rate unchanged and indicated that a March rate cut was unlikely. The markets had anticipated a March rate cut earlier in the month and had largely taken those expectations off the table by the time of the Fed announcement. Surprisingly, the Fed’s hawkish announcement led to the largest bond rally of the month on the final day. This was perhaps due to concerns that delaying rate cuts could lead to tighter economic conditions than necessary, damaging what has continued to be a surprisingly strong economic run. With the month-end rally, Treasury bonds ended up with minor movement overall on the month, despite the swings seen intramonth.

Municipal bonds saw a more exaggerated sell-off, but also rallied a bit to end the month. Municipal bonds had outperformed Treasury bonds to end 2023, and the rally was likely overextended, making municipal bonds unattractive on a relative basis to begin the month. As a result, the sell-off in munis was a bit more extreme to begin January, and the correction rally to end the month a little less forceful. That resulted in a month of municipal underperformance after the strong close to 2023.

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Information and research contained herein do not represent a recommendation of investment advice to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment, and it does not constitute an offer or solicitation to buy or sell any securities. It is not possible to invest directly in an index. There is no assurance that investment products based on the index will accurately track index performance or provide positive investment returns. Past performance is not a guarantee of future results. These materials have been prepared solely for informational purposes based upon information generally available to the public from sources believed to be reliable. The views and opinions expressed in this publication are subject to change, at any time, without advance notice or warning.