As we head into Q2 2024, many investors continue to set their sights on whether the Fed will finally begin to reduce interest rates to more consumer-friendly levels. While the Fed’s action does play an important role in the direction of the economy (though financial pundits love to debate that statement ad nauseum), there are other factors that impact the direction of the market—sometimes despite any actions taken by the Fed. Here are the drivers we believe are likely to propel the markets in the months ahead.
Economics & Interest Rates
At the start of the year, the futures markets pointed to as many as six 25-basis-point rate cuts by the Fed in 2024. As of April 1, some higher-than-expected inflation numbers in the first quarter have whittled those expectations down to just three expected rate cuts for this year. And yet, the economy has powered on, the market has remained resilient, and the numbers we are seeing today are surprisingly positive.
The recent US economic data (released for March 2024) presented encouraging signals, especially around the state of US labor. Non-farm payrolls delivered an upside surprise in March, adding more than 303,000 jobs compared to last month, as well as some small upward revisions to prior months’ data. At the same time, overall unemployment fell -0.1% to 3.8%—a level that tends to point to a strong economy as most people who are actively seeking employment have been able to find jobs. It’s also impressive that unemployment hasn’t risen materially given that there are now more workers contributing to the economy, indicated by the labor force participation rate rising to 62.7%, almost fully recovering to pre-pandemic levels. The labor market remains strong with hourly earnings up +0.3% over last month and +4.1% year over year. While helpful for GDP and the bottom-line for consumers, this income growth boosts demand for goods and services across the board—an inflationary force that may increase the difficulty of the Fed’s job in tackling inflation.
Recent economic data supports that positive perspective, illustrating that the US economy is not moving quickly toward recession. In fact, it seems we could be moving further away from recession than what was forecast as recently as the end of last year. The Atlanta Fed’s GDPNow estimate, a model that uses incoming economic data and past historical relationships to estimate real GDP growth, came in at +2.5% for Q1 2024 (as of April 4, 2024). And while strong economic data in March led to a spike in US Treasury yields, it is very possible that yields and inflation have already peaked for this cycle.
Still, we are also closely watching the retail price of gasoline and future releases of the Consumer Price Index (CPI) for indicators of which direction inflation will take. We are also monitoring the mood of voters in this all-important election year when surprises of any kind have the potential to increase market volatility.
Equity Markets
With the economy and interest rates as the backdrop, the equity markets share an equally optimistic outlook. The equally weighted S&P Index closed out Q1 up ~+7.9%. Contrasted with a +10.6% gain in the more commonly referenced market cap weighted index, we see some hopeful signs that, unlike last year, the market is broadening out beyond the all-powerful Magnificent Seven stocks. And while earnings for the S&P 500 were up only ~1% in 2023 year-over-year, earnings in Q4 showed some welcome upward momentum, closing up +7.5% compared to 2022. At the moment, we aren’t seeing any glaring indications that the current bull market has reached a pinnacle. It’s hard to foresee a significant downturn at a time when the labor market remains strong, credit spreads are holding tight, and earnings continue to beat consensus forecasts.
Looking beyond our borders, there is no doubt that geopolitical risks are very real. So far, however, this has not dampened the US markets, which are at or near all-time highs. This is also true for European equities and Japan’s Nikkei, which recently surpassed its all-time high. Gold and Bitcoin also reached record highs, and commodity prices have rebounded sharply, indicating that inflation may persist above the Fed’s preferred target for longer than market expectations.
So… Bull or Bear?
Even with a plethora of data and analysis at our fingertips, the future remains unknowable. The complexity and volatility of the markets are influenced by everything discussed above and more. In addition to all the ‘rational’ factors, we must also consider the potential for unexpected events, as well as the irrational behavior of investors which, ultimately, result in actions that drive the market up or down. In the short term, nothing is predictable. But there are certainly arguments for both sides: the Bulls and the Bears.
On the side of the Bulls, inflation has likely peaked and consumer balance sheets remain strong. On the corporate side, companies are still carrying high levels of cash on their balance sheets, job openings have come down but are still plentiful, credit spreads remain tight, and AI and other forms of automation innovation are driving up productivity. Plus, the election year is likely to prompt additional fiscal stimulus by the Administration which would further buoy the market.
The Bears also have a case to argue. Inflation is still sitting above the Fed’s target of 2%, potentially delaying interest-rate cuts. Forward corporate valuations remain elevated, which could mean that investors are pricing in too-high expectations for future growth and profitability. The US Treasury yield curve for 2-year Treasury bonds and 10-year Treasury bonds remains inverted, and Treasury supply is likely to surge as funding costs reset to adjust to higher interest rates. And, of course, both regulatory and global risks remain present and volatile.
Though the short term is nearly always uncertain, the good news is that the long term is quite predictable. Historically, no event—economic, political, or geographical—has managed to thwart the rising value of market investments over time. To help tilt that reality in your favor, our investment strategy is based on deep research, intelligent analysis, and decades of experience. One of our primary goals is to help grow and protect your assets in any market environment. No matter what the economy and the market deliver in Q2 and throughout the year, know that we are here to make the most of every opportunity that comes our way.
