Steady as She Goes

During the first quarter of this year, equity markets built on last year’s fourth quarter gains and continued their climb. Continued economic strength and lower inflation gave investors reasons to be optimistic that the economy can continue to grow while avoiding a recession. The bond market rally of last year paused, as this same economic strength caused bond investors to rethink their optimism that the Fed will be cutting interest rates multiple times this year.

The current bull market in stocks has been impressive. Stocks have rallied with the “better than almost everybody thought it would be” U.S. economy. As inflation has dropped, recession fears have faded, and equity markets are at all-time highs. The S&P 500 Index set 17 all-time closing highs in the first 50 trading days of this year, the most since 1998. Because the S&P 500 Index is a market weighted index, as opposed to the Dow Jones Industrial Average, which is an equal weighted index, the largest companies have an outsized impact on the index. In fact, the seven largest tech stocks (Apple, Microsoft, Google, Amazon, Nvidia, Meta, Tesla) account for 30% off the S&P’s value, an all time high. Last year, these seven stocks gained an average of 71%, while the other 493 stocks in the index averaged a 6% gain. Looking at a static return number definitely does not tell the whole story of the strength of the stock market.

The bond market has not moved much this year as segments of the economy continue to expand faster than the Fed wants them to. While inflation has dropped dramatically from its high in 2022, it remains above the Fed’s target, and as long as that is the case, interest rates are likely to remain elevated, especially on the short end of the yield curve. The Fed has reiterated that they plan to cut rates at least three times this year, but we will need to see some of these inflationary pressures ease before this happens. Until then, the yield curve remains inverted, and the risk remains elevated that the Fed will not reduce rates in time to prevent a recession.

GDP growth for last year came in at 2.5%, which is quite remarkable given the forecasts of most analysts at the beginning of the year. It looks like GDP growth in the first quarter of 2024 will also come in around 2.5%. Most forecasts we are seeing show our economy growing this year about the same as it did last year. We don’t see anything that would make us forecast growth differently than this consensus. We think inflation will continue to drop to closer to the Fed’s target of 2% later in the year.

Our forecast for the markets has not changed since the end of last year. Stocks will be helped by dropping inflation rates and by lower interest rates, but with sky high valuations, there are elevated risks if there are unforeseen events. Bonds will also benefit from lower interest rates but will tread water if inflation and interest rates stay higher than normal. Much depends on the Fed.

Wabash Capital