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The Brave Report: Market Commentary for Q1 2024

Click here for .pdf version or this report: The Brave Report-2024Q1

I guess markets only go up….  The markets have continued to surge to start the year, adding to the gains we saw to close out 2024.  Equity valuations seem a bit stretched but economic data has also surprised to the upside creating an environment where the Fed is comfortable keeping rates higher for longer.  This higher rate environment would normally be a negative for stocks, but investors continue to focus on the resilience of the economy rather than the elevated rates.

We are probably due for a pause or consolidation period for stocks but it seems that any dips, even small ones, are quickly bought up as investors look to put excess cash to work and chase returns they may have missed out on over the past twelve months.  Without a major change in the economic outlook or some more certainty from the Fed, I do think the upside in the markets could be a bit muted from current levels but if we do see a pullback of any kind a lot of cash will come off the sidelines.

Market Overview

The markets continued their rally to start the new year, maintaining the momentum we saw to close out 2023.  The S&P 500 finished the first quarter right around all-time highs, gaining 10.1% since the start of the year.  The NASDAQ was not far behind, increasing by 8.5% and the DOW industrials added a respectable 5.6%.  After bottoming in late October, markets have been on a straight line up.  This has seen the S&P 500 add 28% over that brief timeframe. While many of the gains can be attributed to a handful of high-flying tech stocks, the rally has been sustained by other participants joining the fun.

On the fixed income side, we saw rates steadily climb throughout the quarter.  The yield on the 10-year treasury rose from 3.86% at the end of 2023, to close the first quarter right around 4.25%. While a sharp drop in rates to close out the year helped to add fuel to the equity markets, during the first quarter, markets were able to shrug off the steady climb in rates.  We have continued to receive clues from the Fed that rate cut expectations were a bit overzealous and this has driven the recent rise in rates.

As has been the case for the past few years, speculation around the Fed’s next steps has been the driving factor around short-term moves in the stock market. However, what we have seen in recent weeks is that as expectations about the number of rate cuts this year have dropped, the resilience and strength of the overall economy has increased.  A year ago, fears of a recession were percolating through the markets, but that fear has dissipated. It seems the economy has handled the higher rate environment much better than many had feared.  I am not saying that we are completely out of the woods yet, but the strength of the economy has given the Fed much more flexibility.

On the economic front, we have seen inflation drop. Albeit it is still above long-term targets, and the speed of the drop has slowed if not stalled.  Jobs numbers continue to impress and have shown little impact from the elevated rate environment.  While this is very positive for the economy, it has reduced the need to cut rates more quickly.  This data point will continue to be important to watch because we don’t want the Fed to wait until it is too late to start cutting rates back to more traditional levels. We have also seen manufacturing data improve, which shows a deeper strength in the economy and that economic growth has some support in a broader range of sectors.

While economic data has been mostly positive, I do not think we are in an environment to go all in on equities.  First and foremost, the market has already run higher rapidly.  We have hardly seen any pause in the upward momentum and there are definitely some areas of the market that seem overbought.  Valuations across many sectors are becoming very stretched and unless we see some blowout earnings over the next few quarters, I think the market upside will be capped into year-end.  I am not saying the market won’t go up anymore, but the pace of the rise will need to slow or the entire market will be highly overvalued.  For the longer-term health of the bull market, some consolidation or even a small pullback would be very healthy as investors let data and risks catch up with current valuations.

Outside of stretched valuations, there are also a number of risks that could weigh on markets moving forward.  We have already discussed the ongoing uncertainty around the path of the Fed.  This will continue to weigh on markets until we have a firmer pathway.

Geopolitical risk has also increased over the past few months.  Wars in Ukraine and the Middle East must be factored in, especially when investing abroad.  So far, the economic impacts of these conflicts have remained pretty isolated, but the escalation of these conflicts could have larger implications in the markets and must be monitored.

Lastly, it cannot be ignored that we are in an election year and domestic issues are moving to the forefront.  Debates over taxes, immigration and government spending will be ever-present.  As we get closer to November and the potential outcomes of the election become clearer, we will need to factor in the economic impacts of the various scenarios.  This is not just limited to the presidential election but also those in Congress.

Strategy Commentary

With these variables all factored in I am very comfortable being patient with any new money.  I am not in a rush to put much new cash to work right now. In the same vein, I am also not reducing any equity exposure either. I think we will see some consolidation or a pullback sometime in the next quarter. At that point I will look to round out any allocations with new cash. However, until that point, I am comfortable earning 5% on my cash using short-term treasuries or money market funds.

On the domestic side, I continue to maintain my overweight to technology and communication services.  However, if both sectors continue to run, I may take the opportunity to trim some of the exposure.  Both sectors are up over 40% in the last 12 months so some profit-taking may be warranted.  Other sectors, such as industrials and materials have begun to catch up a bit over the last three months and will warrant keeping an eye on, especially if we continue to see strong economic data.  Small caps continue to be intriguing as well.  Their valuations are quite low when compared to the large-cap names that have run so much in the past year.  At some point they will have to play some catch up so I will look to add more domestic small caps if the opportunity presents itself.

I am still quite cautious on the international side.  Geopolitical risks still remain, and any escalation of conflicts could ripple through these markets.  Japan has been one bright spot internationally over the past year but like domestic markets, has run quickly to all-time highs so we are not at a great entry point.  Economic growth numbers have also lagged in international markets, so I don’t see much opportunity in the short term.

With rates climbing back up a bit in the past few months, I continue to favor locking in 5+% in short-term treasuries until we see some more confirmation from the Fed that they will cut rates.  With the run equities have been on, I am also comfortable sitting in short-term treasuries with new money while we wait for a better entry point into equity markets.

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