Global equities continued to roar ahead in Q1-2024 buoyed by the resilient U.S. economy and ongoing investor infatuation with all things AI which powered technology stocks globally. Government bonds generally declined as slowing U.S. disinflation and stronger GDP growth pushed Treasury yields higher and prompted a reappraisal of expectations for the pace and scope of Federal Reserve rate cuts. There was broad strength within commodities, led by oil on geopolitical tension, supply constraints and most importantly, prospects for stronger global demand.
In March, there were definitive early signs of a change in equity market leadership. For example, the S&P Equal Weight Index outperformed the market-cap weighted index which is heavily tilted toward mega cap technology companies. In addition, international equities slightly outperformed U.S. stocks in local currency terms, though returns for U.S. investors were muted by continued U.S. Dollar strength. We will continue to monitor these two key benchmarks closely as a sustained period of outperformance would mark a major change in existing market dynamics.
We note, however, despite the broadening out of equity market performance, U.S. markets remain extremely concentrated. Indeed, the market cap of the top 10 S&P 500 stocks is currently 32.4%, surpassing the previous 2021 peak and almost 25% higher than the peak of the 1997-2000 “dot com” market bubble. This makes the market vulnerable to any stumbles or earnings disappointments from what has now become the “Fabulous Four” stocks: NVIDIA (NVDA), Amazon (AMZN), Microsoft (MSFT) and Meta Platforms (Meta). In Q1-2024 these stocks drove 47% of the S&P 500’s 10.6% gain. Similarly, while much has been made about the rebound in small cap stocks (Russell 2000), more than one-third of the index’s 5.2% first quarter gain was driven by only two companies: MicroStrategy (MSTR) and Super Micro Computing (SMCI). The common theme among all these S&P 500 performance leaders is that they are front runners in various aspects of the AI revolution, from semiconductors and cloud computing to high-capacity servers (SMCI was added to the S&P 500 on March 15th). MSTR’s outsized gain was driven by its large Bitcoin holdings.
U.S. economic data broadly surprised to the upside in the first quarter. The latest revision of Q4-2024 GDP growth, released in late February, was 3.4%, a deceleration from Q3-2024, but still well ahead of expectations. The Federal Reserve’s estimate for Q1-2024 growth, which stood at 2.8% at the end of the first quarter, signals a continued deceleration but is hardly indicative of an economy headed for a recession. Similarly, although the labor market loosened slightly during the quarter, job creation and job openings exceeded forecasts, and real wages are still rising, albeit at a lower rate than during 2023. Accompanying this was a strong rebound in manufacturing to the first expansionary level since October 2022, as measured by the ISM Manufacturing Index.
The flipside of this accelerating growth, however, has been a stalling of the disinflation trend in place for most of the prior six months and rising concern that this trend will reverse over the next several quarters if economic growth strengthens. Higher commodity prices will likely come with higher growth, especially for oil and industrial metals, which would add to inflationary pressures.
These factors have already reduced market expectations for the scope and pace of Federal Reserve rate cuts and though the Fed in March guided to three 25 bp of cuts over the course of the year, investors are now expecting a roughly 60 bp decline in benchmark interest rates, with the first cut perhaps slipping from an expectation of June to July. This is a dramatic shift from the 150 bps of rate reductions expected as recently as December 2023, and the situation will remain fluid based primarily on the strength of the upcoming inflation and labor data prints.
Internationally, Japan raised its interest rates for the first time in 17 years, ending its long experiment with zero interest rates. Although the increase was a paltry 10 bps – raising the target range to 0.00% to 0.10% - it represents a sea change in Japanese monetary policy and a sign of confidence in the growth prospects for that long moribund economy. Eurozone disinflation gathered strength and there are strong indications that the European Central Bank will begin its rate-cutting cycle prior to the Fed. In China, a slew of recent data indicated that it’s economy, though still plagued by a residential real estate hangover and high levels of regional government debt, could grow faster than the official 5.0% growth target. Taken together, we believe we are likely to see a period of synchronized global growth that will be supportive of equity markets. We caution, though, that this may be relatively short-lived and more of a mid-to-late cycle economic recovery than the sharp growth experienced after the 2007-2009 Global Financial Crisis and the post-Covid global reopening trade.
We believe the prospects for fixed income have improved; however, near-term inflation conditions represent a headwind. Starting yields, currently near the highest levels in 15 years, are comparable with improved forward returns, offering attractive income and potential downside support for a variety of market conditions. Our selection emphasis within portfolios is in the middle to front end of the yield curve, as longer duration bonds are susceptible to pressure from rising bond supply needed to finance the U.S. deficits. We remain focused on high-quality bonds which tend to have lower volatility than stocks, providing investors with more stability against a range of economic scenarios. Within the asset class, we are seeking higher quality, more liquid, and resilient investments, and find reasonable value in industrials and financials with strong capital positions. U.S. agency mortgage securities are also attractive at current levels and represent a high-quality compliment to portfolios. Portfolio duration positioning is intended to be neutral to slightly underweight yet will be dictated by client cash flow needs.
Our prediction for muted U.S. equity market performance in 2024 did not pan out in the first quarter, although the start to the second quarter has been underwhelming. We recently have become more constructive on the strength of the economy, and do expect a shift in market leadership to favor more late-cycle beneficiaries while several longstanding portfolio themes remain intact. These include the broader use of and additional indications for GLP-1 anti-obesity drugs, significant industrial capex related to the green energy transition and expansion of domestic semiconductor manufacturing and data center capacity, as well as power generation and transmission systems required to fuel this growth. We remain cautious on consumer related sectors given increased evidence of growing stress from high interest rates, particularly among lower- and middle-income consumers. A recent spate of weak results and poor guidance from numerous staples and discretionary companies reinforces this view.
Our global equity portfolio remains overweight large-cap domestic stocks relative to foreign stocks, but we have continued to raise our exposure to international markets in the relevant portfolios. We continue to favor high-quality style factors, stable growth, and a selective mix of cyclical value.
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Bruce Schoenfeld Principal Investment Analyst First American Trust |
Bruce is the Principal Investment Analyst responsible for investment research coverage of various asset classes and equity industry sectors. Bruce has more than 20 years of experience as an equity analyst and portfolio manager. He joined First American from 3P Associates, LLC, an investment and strategic management consulting firm he founded. He previously served as Director of Research at BlueStar Global Investors and as an analyst and portfolio manager focused on emerging markets for Delaware Investments, Artha Capital and Caisse de depot et placement du Quebec, Canada’s second largest pension fund.
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Jason Nerio SVP, Director of Investment Research & Strategy First American Trust |
Jason Nerio is the Director of Investment Research and Strategy at First American Trust. Mr. Nerio has more than 20 years of investment research experience. He is responsible for formulating investment strategy and serves as a leading member of the investment committee which monitors and manages the firm’s allocation strategies for over $1 billion in client assets.
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Scott Dudgeon, CFA Director, Equity Research First American Trust |
Scott Dudgeon is the Director of Equity Research at First American Trust. Mr. Dudgeon is a Chartered Financial Analyst (CFA) and has more than 25 years of investment research experience. He also serves as a leading member of the investment committee and has a proven track record for outperforming the markets for our clients. He has been with The First American Family of Companies for 16 years.
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