“I skate to where the puck is going to be, not where it has been.”
-Wayne Gretzky aka “the Great One”
Nine-time winner of the Hart Trophy (NHL Most Valuable Player)
INVESTMENT UPDATE
This year’s market advance (saying nothing of the advance since the end of October 2023) has been breathtaking to say the least. While 2023 was dominated by the Magnificent Seven (Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla) so far in 2024 the market has broadened out to include many other stocks and sectors. In fact, the two leading sectors so far in 2024 are Energy and Communication Services.
For the 1st quarter of 2024 the S&P 500 was up 10%, which would be annualized out to almost 50% if the market continues at this pace. Although S&P 500 earnings are expected to grow by approximately 10% in 2024 there have not been any significant upward revisions to these estimates since the end of the 3rd quarter of 2023 along with the fact that the 10-year Treasury Note yield has increased from 3.90% at the end of 2023 to 4.20% currently. The significance of these points is that almost the entire move in the equity market can be explained by the multiple expansion of the Price to Earnings ratio.
Said a different way, investors are paying more today for a $1 worth of future earnings than they were 5 months ago.
So, what are investors to do? While the easy approach would be to continue to invest in the “hot” sectors of the market, we at Cypress Capital Group subscribe to a more rigid investment process than just chasing the most recent fad. Like how Wayne Gretzky approached hockey, we believe in using our quantitative investment approach where we can identify tomorrow’s opportunities today. In this way, we strive to minimize the risk of getting caught up in the emotional throes of the market and make sound investment choices for our clients’ portfolios. Admittedly, this approach requires a certain degree of patience, which is often said to be the rarest commodity on Wall Street, but our experience has taught us that in order to responsibly manage and grow wealth an investor needs to be patient.
THE MARKET UPDATE
Equities
The equity markets started off at a positive pace to begin the year. The S&P 500 ended the quarter at an all-time high along with posting the best first quarter in some 5 years. The S&P 500 was up just over 10% for the quarter, while the Dow Jones Industrial Average and Nasdaq also participated, up 5.6% and 9.1%, respectively. Much like 2023 ended, the market’s gains were pushed by the excitement around artificial intelligence (“AI”) and the demand for stocks that had exposure to that industry. While those stocks associated with AI led the markets early on, there was some broadening out towards the end of the quarter. The Invesco S&P 500 Equal Weighted index participated also, outpacing the major indices for the month and up greater than 7% in the quarter.
As for earnings, the S&P 500 delivered 10.1% growth in 4Q23. This was driven by double digit growth by Communication Services, Consumer Discretionary, Utilities, and Technology. These growth numbers were dragged down by Health Care, Materials, and Energy. There was a significant spread between the top and bottom section of some 74%. Each reported negative earnings for the quarter. Revenues by comparison were up 3.7% for the most recent quarter. These numbers did not have the variance that
earnings had. There was only an 18% variance. Of the 11 major sectors, only 3 had negative results: Materials, Utilities, and Energy. The remaining sectors are reported at between 2.9% (Consumer Staples) and 7.9% (Technology). Source: LSEG S&P 500 Earnings Scorecard as of 3/28/24
Where do we go from here… The markets have all been positive not only since the beginning of the year, but also looking back to the lows posted in October. Prices have moved higher and while some stocks have gotten cheaper on a valuation basis, the major indices have not. Going forward, what are investors going to do? Will they continue to stay invested in those names that have outperformed, and do they continue to deliver based on expectations? Or is there broadening of the market participation that is sustainable? For either decision, what are investors willing to pay based upon interest rates and their direction? These seem like the same questions we have been asking for the last year plus. Will we get any answers or continue to climb those walls of worry?
Fixed Income
The fixed income markets continue to be volatile, but at the intermediate to long end of the curve. While the Fed has hinted at lowering rates, the evidence of when and how much continues to be the major discussion. Late in 2023 the Fed issued their “dot plots” (the expected path for rates) and targeted some 3 cuts in 2024. There was a major disagreement as the market had forecasted 6 – 7 cuts. Three months into 2024, both seem to have been way off. The Fed has an expectation of 0-2 cuts now, while the markets are betting on 1-3 cuts. This uncertainty has added to confusion and volatility in all markets. Numbers across the economy have been mixed while inflation remains sticky around the 3% level and job growth remains persistent (unemployment rate remains below 4%). The short end of the curve will not begin to move until the Fed starts to cut but the benchmark 10-year US Treasury continues to move based on those expectations for future cuts and more importantly the reasons for the cuts or the impact on the economy. The 10-year US Treasury closed the quarter with a 4.26% yield. In the last couple of days, it has even pushed slightly higher, putting it at levels we have not seen since late 2023. Where we go from here will be based on both the Federal Reserve and the economy, and their impact on each other.
OUTLOOK
If the year ended now most investors would be happy with a double-digit return, and to get that in only 3 months is even more impressive. That is on top of the gains investors got in 2023. But most investors, while concerned with the short run, own equities for longer-term appreciation. That is what has investors on uneasy ground. The yield curve has given investors an alternative to stocks with Treasuries maturing within the next 12 months still yielding over 5% with much less inherent risk. Going forward, we all ask the same question – is the risk worth the reward? This is also a question the Federal Reserve seems to be asking. Not what is the Fed’s next move in interest rates, but when will their first cut take place? One of the questions we continue to ask is – what will be the Fed’s rationale for the looming rate cut? With a stronger than expected economy and an inflation rate that appears to be sticky around the 3% level, currently we are having a tough time producing a reason for the first and subsequent rate cuts. Earnings and expectations around those reports will help drive investor sentiment going forward.
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