2024 started with concern over stock prices, focused on the widening gulf between the price moves of the “Magnificent Seven” tech stocks and the rest of the market. Expectations for this gulf to close were rooted in the Fed’s actions – when they would begin cutting interest rates and how many cuts would occur in 2024.
At the end of 2023, the bond market had priced in nearly a 100% chance that rate cuts would begin in March.
Our expectation has been that cuts were not likely to begin until this summer. Given the most recent inflation data, and conceivably similar readings to come, it would now not be surprising to see no cuts until even deeper into the year, if at all.
The 1st quarter saw the S&P 500 rally 10% while almost totally discounting Fed rate cuts this year. This could be the market seeing lower rates and slowing inflation ahead, however, inflation is proving to be more difficult to tame towards the Fed’s 2% target. Sticky inflation may prove to be the Achilles heel of the current advance.
We also wrote in our Q4 2023 commentary that the focus of the market would soon turn from interest rates to the market fundamentals of earnings and valuation. This has started coming to fruition, but complicating this calculus is the momentum of any company involved with artificial intelligence, and market expectations for revenues and earnings of all companies due to AI’s influence. While in early days, “AI” has overtaken the narrative of the Fed needing to lower interest rates, and the speculative nature of investors has re-emerged. Today we are in a momentum-led rally with the market assuming rate cuts later this year and a renaissance of capital spending on AI over the next many years.
While the advance has its roots firmly embedded in the AI excitement, other green shoots are becoming visible as well.
Valuations are very attractive in small caps and international stocks, and mutual fund flows are reflecting an increased appetite for value vs. momentum. These are signs of a healthy market – ones that should be embraced, although they will likely be tested.
While not our base case, there is a chance that with financial conditions having eased so much already, a renewed upswing in inflationary forces are taking root. Should the economy remain strong, coupled with government stimulus funds (JOBS Act, Infrastructure, Inflation Reduction Act, etc.) flowing into the economy and consumers continuing to spend, inflation may not recede to the Fed’s 2% goal. Perhaps worse, the Fed may start easing only to have to pivot and raise rates again. These are risks we are mindful of and recognize that regardless of how rosy a set of projections may look now, there are several catalysts that could change investor sentiment in a meaningful way.
We continue monitoring all these factors, watching developments, and adjusting our strategies and client portfolios as necessary. Where there is disruption and change, there is often opportunity.
Learn more about Integras Partners’ investment strategies.
