March 4th, 2024
The market’s narrative has fallen into a pattern, of which, the tension oscillates between central bank policy, and corporate earnings. Each, taking its turn driving the market’s conversation these last several quarters. I feel this pattern will likely continue throughout 2024.
While rate cut expectations were the driving narrative at the end of ’23, and the early weeks of ‘24, the conversation faded as the Fed pushed off expectations into the latter half of the year. Thankfully, 2023’s year-end rally has persisted due to ‘23 Q4 earnings season having arrived just in time to grab the spotlight. Driven by big tech, as usual, the market has been able to shrug off the rate cut disappointment and surge higher due to corporate growth. Now, with earnings news drying up, investor’s attention will soon shift back to the Fed, so we should consider the possible market reactions to incoming inflation data and Fed policy meetings.
The possible scenarios…
First, the bullish case; with investors pricing in a less than 25% chance of a rate cut in the first half of ‘24, any positive surprise from inflation data would potentially be an upside catalyst as the euphoria over big tech’s blowout earnings season fades. The March Fed meeting will also bring the next iteration of the Fed’s “Dot Plot” summary – which projects interest rates – another possible trigger for renewed investor enthusiasm if there is any indication of a dovish shift among FOMC members. January Consumer and Producer Price Index data was disappointing (too high), but the Fed has indicated this was to be expected, cautioning that inflation data would likely be “choppy” rather than persistently downward trending. Having said that, last week the Fed’s preferred inflation metric, PCE, came in 0.1% lower putting the annual PCE inflation rate at 2.4% – closer and closer to the Fed’s ideal 2%.
The downside risk, of course, is that the Fed sees something in the economic data that causes it to further delay monetary easing (rate cuts). There has been some speculation that perhaps the Fed would try to push rate cuts back until November, after the Presidential Election. While I consider this to be unlikely, and still anticipate rate cuts before then, this would result in the Fed falling short of their originally projected three cuts in 2024.
The most likely scenario is that the Fed remains unchanged in its messaging for the next several months, content to let the strength of the economy buy it additional time to sit back and observe inflation and jobs data. In the absence of any further clarity on rate cuts, investor attention should shift back to corporate profitability and the 2024 outlook. The good news is that 2024 earnings-per-share growth for the S&P 500 is projected at 14% according to Standard and Poor’s. Healthcare is likely to lead the way with a projected 34%, earnings-per-share (EPS), growth rate. Followed by Tech which is projected to grow EPS by 27%. Excitement over artificial intelligence (AI) has the potential to expand beyond tech, as more industries integrate AI into their business models.
As I’ve mentioned in previous newsletters, the best chance for the market to maintain its present momentum relies on the broadening out of the rally beyond large caps and into smaller market capitalization companies. Holding small and mid-cap positions in 2024 will likely be the biggest beneficiaries of the eventual rate cuts as price-to-earnings valuations are still well below historical norms.
And now, your Monthly Market & Economic Update by the numbers.
Warmly,
Mark S Sauer
Market Update
Global Equities: Major earnings reports are mostly finished, but domestic indices were able to grind higher thanks to inflation data that was in line with expectations. The S&P 500 closed out the last week of the month with a gain of 1.0%, and a gain for the month of 4.7%. The Nasdaq was up 4.75%, and the Dow Jones Industrial Average advanced 2.15% for the month of February. Small Cap stocks took the lead with 4.85% return on the month, an encouraging sign as investors look for indications that the rally is broadening out beyond the “Magnificent Seven” mega-cap stocks. Developed International stocks gained 2.4% while Emerging Markets returned 3.12%.
Economic Update
Earnings Season: Earnings are mostly wrapped up with 97% of the S&P 500 earnings on the books. 73% of companies reported positive EPS surprises according to FactSet data. Investors have been nervously awaiting Nvidia (NVDA) Q4 results since the start of earnings season, and the chipmaker delivered blowout results once again. Revenue more than tripled from a year earlier, and profit increased nine-fold. Incredibly, this was accomplished with a reduction in Chinese revenue from 20% to “mid-single digits” due to US restrictions. The euphoria of NVDA’s blowout earnings spilled over to the broader market as investors betting on the Artificial Intelligence revolution were, yet again, vindicated.
Charts of the Month
Small Caps Vs. Large Caps
Our first chart shows the 2024 performance of the iShares Russell 2000 ETF (Ticker: IWM – Blue line), representing Small Cap stocks, vs the SPDR S&P 500 Large Cap ETF (Ticker: SPY – Orange line). Small Caps outperformed coming off the November 2023 market bottom, but that rally faded to start 2024 and Large Caps resumed leadership. The most recent month, however, shows renewed hopes for Small Caps. With a handful of Large Cap stocks driving nearly all of 2023 gains, the market desperately needs a change in leadership to keep the rally going.
Semiconductors Vs. Nasdaq Vs. S&P 500
Our next chart is the VanEck Semiconductor ETF (Ticker: SMH – Blue Line) Vs. Nasdaq ETF by Invesco (Ticker: QQQ – Teal Line) Vs. SPDR S&P 500 Large Cap ETF (Ticker: SPY – Orange Line). Following the passing of the Chips Act in August of 2022 we heavily transitioned portfolios to orient toward semiconductors (SMH) and the Nasdaq (QQQ). The Artificial Intelligence craze added fuel to the fire, and looking back the place to have been since the beginning of 2023 was clearing in these two ETF’s and their underlying holdings.
March Rate Cut Potential
Our final chart shows the year-to-date change in probability of a March interest rate cut. After a string of good inflation and economic data, rate hike expectations jumped to nearly 40% for March. However, following hotter than expected Consumer and Producer Price Index reports and hawkish rhetoric from the Fed, the timeline has been pushed back to the second half of 2024. Markets are taking the delayed rate cuts in stride, however, as corporate earnings and positive outlooks have propelled the market to new highs.
