Market Commentary - April 2024

Monthly Update

After a strong start to the year, stocks took a needed breather in April. I say ‘needed’ because the annualized return of Q1 was an unsustainable pace and like a runner doing a sprint, it’s always good to take a rest to recharge the energy batteries. Now whether this is a consolidation before another leg higher or the peak for now remains to be seen but something we’re always watching out for. The reason for the stock pullback again ties into the direction of interest rates and inflation. Inflation has been sort of stuck around the 3% level give or take and the market has further pushed out expectations on when the Federal Reserve will cut interest rates.

The S&P 500 retreat in April of 4.2% coincided with a 42-basis point jump in the 2 yr. yield back to around 5% and the 48-basis point increase in the 10 yr. yield to 4.68%[1]. Since the month's end, there was a Federal Reserve meeting and some dovish remarks from Jay Powell during his press conference. This was followed by a slightly softer than expected April payroll report which resulted in a pullback in yields to 4.81% and 4.50% for the 2 yr. and 10 yr. yields respectively as of this early May writing[2].

With respect to inflation, we saw the March Consumer Price Index print in early April and it saw a 3.5% headline y/o/y increase and 3.8% ex food and energy[3]. This compares with a 3.2% and 3.8% y/o/y gains in the month before[4]. While these are the smallest rate of price rises since early 2021, it still is taking longer than the Fed hoped to get it to the 2% trend sustainably that they so covet. Therefore, the mantra of ‘higher for longer’ interest rates is real. That said, a very interesting tidbit from the Jay Powell press conference on May 1^st revealed a committee that after battling inflation over the past few years, is now also focusing on the unemployment rate side when viewing monetary policy the rest of the year, along with inflation.

Regarding the US jobs market, there are many mixed signals, but the predominant theme is a slowing pace of hiring, evident in various economic data points, both hard data and anecdotal metrics. Despite this, there is still limited firing, as indicated by the historically low levels of initial jobless claims and filings for unemployment benefits. This of course is also something very important to watch for the rest of the year as the US consumer is also managing the almost 20% cumulative increase in their cost of living as measured by CPI. This has resulted in a very mixed picture too with consumer spending. As heard from a variety of retailers, restaurants, and consumer product companies, the lower to middle income consumer is much more careful with their spending habits while higher income consumers are not as much. Also, consumers have been prioritizing their spending more so on needs and less on wants and more so on experiences like travel and leisure and less so on stuff.

Being a central banker is a really tough job generally, as trying to pick the right interest rate, rather than relying on the market to set it, is not easy. That job seems even more difficult now because of the inflation run we’ve had. Fortunately, inflation has receded notably from its 2022 highs but the last thing we want to see after this moderation is a reacceleration. As of this writing, the fed funds futures market is pricing in a 100% chance of one 25 basis point rate cut this year and a 70% chance of an additional one by year end. With respect to other central banks, the European Central Bank seems set on cutting interest rates in June as they deal with a slower economy than its peers. On the other hand, the Bank of Japan is leaning towards more rate hikes as it deals with both higher inflation above their sustainable target of 2% and a very weak yen.

That weak yen brought its level down 4% in April to the lowest level vs the US dollar in 34 years[5]. This is a big deal for both Japan and the US Treasury market. For Japan, a weaker currency on top of already inflation rising faster than wages are major cost of living pressure points on the Japanese citizenry. It matters too for the US Treasury market because the Japanese are the largest foreign holder of US Treasuries and the direction of the yen could influence the size of those holdings, just as the ever-widening US debts and deficits needs all the help it could get in being financed. The Japanese, while not outwardly admitting it, did intervene twice finally in the foreign exchange market to stem the yen weakness and for now it has worked. Longer term though, FX intervention rarely works unless the root cause of the currency move is not addressed. In this case, the very wide interest differential between the BoJ and the Fed is that root cause and yen strength sustainably needs more BoJ rate hikes and/or some Fed rate cuts.

I mentioned earlier the mixed picture with the US consumer, and I can argue that there is broad unevenness to US growth and that for the globe too, generally. With the housing market, the pace of existing home sales is near a 30 yr. low, but the rate of new builds is doing better where more housing supply is needed. The manufacturing sector remains in contraction but is showing signs of bottoming out. Export trade is muted but US government spending remains robust and infrastructure and manufacturing facility construction to build EV batteries and semiconductors are a major driver of economic activity. Globally, we have robust growth in India and parts of Southeast Asia, but China’s growth rate continues to slow. In Europe, no growth is being seen in German, slight growth in France and better activity in Spain and Italy helped by their tourism industry.

April also saw many Q1 corporate earnings releases and as is usually the case, 77% of companies reporting exceeded earnings expectations according to FactSet, around the long time average of about 75%. For the top line, 61% beat consensus revenue forecasts and that is below the 5 yr. average of 69% and the 10 yr. average of 64%[6]. For the quarter overall, earnings are expected to be up 5% y/o/y, which is fine but with a P/E ratio for the S&P 500 at 20-21 times 2024 estimates, we can argue that valuations are pretty full for this index and based on that growth rate[7].

Conclusion

Over time, the direction of earnings and the pace of gains drives stock prices, but the multiple investors are willing to put on that stream of earnings many times is determined by interest rates. So, with the very volatile interest rate picture, along with the economic trends and how the Fed reconciles this all with regards to how they set monetary policy, it creates a lot of cross currents with the earnings trends. The result is the S&P 500 that is up about 7.5%, not including dividends, in total over the past 2 ½ years, a more muted pace than we’ve been used to[8]. After an amazing 15 year run in equity returns, the ‘higher for longer’ interest rate environment means we must be more realistic about possible US returns. We still believe healthy equity returns can be had, but in broader parts of the market outside of the previous leaders, including internationally.

The benefit of ‘higher for longer’ comes to the lenders, via owning fixed income, shorter duration the better we still believe. For borrowers though, particularly in commercial real estate that is highly interest rate sensitive, they will have a few difficult years for those who have loans coming due this year and next and/or need fresh borrowing. After a lengthy period of about 15 years of extraordinarily low and artificially suppressed interest rates, the new higher rate backdrop continues to evolve, and the transition is certainly bumpy and still could be for a period of time. It is not that interest rates are high in absolute terms, it is that they are high relative to the previous 15 years of very low interest rates.

We acknowledge that we live in a different macro world than enjoyed in the 15 years pre-Covid and need to have eyes wide open on how things play out from here. Whatever comes our way though in this very tricky investing landscape, it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from the ups and downs of the markets. Time horizon is always crucial and is always the best friend of any investor. We are not just in the asset management business but also in the risk management business and always believe that by watching our back and focusing on the risks, the upside should take care of itself.

Disclaimer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The market and economic data is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information in this report has been prepared from data believed to be reliable, but no representation is being made as to its accuracy and completeness.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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The Hang Seng Index is a freefloat-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong. These 82 constituent companies represent about 58% of the capitalization of the Hong Kong Stock Exchange.

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[1] Bloomberg

[2] Bloomberg

[3] Bloomberg

[4] Bloomberg

[5] Bloomberg

[6] FactSet

[7] Bloomberg

[8] Bloomberg