Market Review – 2024 Q1

After ending 2023 on a high note, the market continued its advance in the first quarter against the backdrop of strong economic data and corporate earnings that surpassed expectations. The S&P 500 had its best first quarter since 2019, rising 10.6% on a total return basis. Large-cap stocks outperformed mid- and small-caps, with mega-cap technology stocks continuing to drive market performance. However, there were some divergences within the group as only four companies of the “Magnificent Seven” outperformed the index. In a sign that the equity rally is broadening out, cyclical areas of the market, notably Financials, Energy, and Industrials, were among the top performing sectors of the S&P 500. Broader participation is a sign that recent market gains are on a stronger footing and shows that investors have grown increasingly confident that the U.S. may be able to avoid a recession after a historically fast pace of interest rate hikes by the Federal Reserve.

While the equity market rally was impressive coming off a strong 2023, the fixed income market gave back some of its gains from the fourth quarter. The Bloomberg U.S. Aggregate Bond Index had a total return of ‑0.8% as bond yields crept higher. The U.S. 10-year Treasury yield rose to 4.2% by the end of March, from 3.9% at the end of last year, and continued to rise to over 4.5% through the first two weeks of April. A strong labor market and higher inflation readings drove down expectations for interest rate cuts and pushed yields higher across the treasury curve.

We began the year with the Fed having pivoted its stance on monetary policy and projecting three interest rate cuts for 2024. The market was pricing in expectations for six cuts. With inflation trending down throughout last year, and signs of slowing jobs growth on the horizon, expectations for a slowdown in the economy and an end to restrictive monetary policy became a consensus view. The first quarter’s strong economic data has been changing this narrative. For the first three months of the year, jobs growth averaged an impressive 276k per month, well above the pre-pandemic average. The downward trend in inflation has stalled, with monthly data indicating a potential reversal. In response, market pricing for rate cuts in 2024 has fallen to less than three, with expectations for the first cut pushed to the back half of the year. A resilient economy coupled with inflation remaining well above the Fed’s 2% target makes it difficult for the Fed to gain the confidence it needs to begin lowering interest rates. It certainly complicates the task of navigating the economy toward a soft landing, and makes the second quarter’s inflation data all the more important in determining what the timetable may look like for rate cuts this year, if there are any at all.

Aside from macroeconomic data, corporate earnings will also be under a microscope given the rise in valuations in the face of higher-for-longer interest rates. With the limited breadth of the market’s gains, driven mainly by technology stocks with exposure to artificial intelligence, earnings will need to continue to validate higher valuations. Company guidance will play an important role in this regard, as the first quarter showed that meeting or even surpassing earnings estimates might not be sufficient for investors if it’s paired with guidance that doesn’t meet already lofty expectations.

Quickly shifting market narratives have been all too common ever since the Fed began its rate-hiking campaign, and the first quarter was no exception. We’ll be closely monitoring how expectations evolve over the coming months, and the impact it could have on markets for the remainder of the year.