Q2 2024 Market & Economic Outlook

 

Current Economic Views

The strong economic momentum from 2023 carried over into early 2024. Job growth continued. With the unemployment rate at a low 3.8%, the resiliency of the U.S. consumer continued.

 

The U.S. economy (real GDP) grew a solid 2.5% in 2023, and initial estimates for growth this year have increased. Coming into the year, Bloomberg’s consensus estimate was for growth of 1.4%, and due to stronger activity in the first quarter, the estimate was revised upwards to 2.2%. Also, the estimate for a recession in the next year is down to 35%.

 

The Federal Reserve has also boosted their real GDP growth expectations. The Fed increased their figure for 2024 up from 1.4% to 2.1%, followed by 2% in both 2025 and 2026. While the Fed bumped up their growth forecast, they maintained the expectation of three interest rate cuts (0.25% each). The core inflation estimate rose slightly from 2.4% to 2.6% and down to their target of 2% by 2026. Overall, the Fed boosted their growth estimates without changing their estimated number of rate cuts. Market expectations are for the first Fed cut mid-year.

 

Overseas economic growth has been mixed. China’s consumption has slowed, and policymakers have lowered interest rates to boost consumption. In Europe, 2023 growth stagnated near 0%, although early reports in 2024 have pointed to a slight uptick in activity. Some emerging markets have experienced strength related to “re-shoring” or “friend-sharing” as some trade has shifted away from China and towards other parts of the world.

 

Levels of inflation outside the U.S. also continue to move in the right direction. After peaking at 10.6% in 2022, Eurozone inflation came in at 2.4%. China’s inflation rate was reported at 1%.

Looking ahead

We expect the economy to continue to grow, but at a more moderate pace. There are currently more job openings than unemployed people looking for work. There are 1.36 job openings for every job seeker, which points to continued strength in the labor market and should support consumer spending.

 

There are reasons to expect a slower pace of growth compared to the 2.5% witnessed in 2023.

 

Estimates of Covid stimulus-related “excess savings” have been depleted for the most part, and nationwide the savings rate is now below pre-pandemic levels. Student loan deferrals ended in late 2023. Furthermore with overall interest rates higher than several years ago, the cost of financing for borrowers (consumers, businesses, governments, non-profits, etc.) has increased.

 

While other parts of the globe have slowed, the U.S. economy has remained resilient. The U.S. economy is large, dynamic and diverse. While some areas of the economy have slowed (housing and manufacturing), activity levels have not collapsed. Overall, the U.S. has been able to “weather the storm” despite stagnant growth elsewhere.

Current Investment Views: Equities

Equities posted yet another strong quarter, with the S&P 500 achieving a 10.6% total return, which marks the second consecutive quarter of double-digit performance. Momentum was the dominant characteristic, as stocks that experienced the greatest price appreciation in 2023 reasserted market leadership. The S&P 500 has never posted three quarters of double-digit growth in a row.

 

Although there was greater differentiation between them, mega cap growth stocks significantly outperformed broader indices. The S&P 500 Equal Weighted Index returned only 7.9%.

 

Artificial intelligence investment was the dominant theme of the first quarter, with semiconductors in the AI value chain rallying substantially. Nvidia was the biggest outlier, which advanced an astonishing 82.5% given their scale. As the market leader in AI chip design, Nvidia benefitted from cloud service providers announcing large-scale technological infrastructure investments throughout 2024. While Nvidia was the largest beneficiary of AI enthusiasm, companies that manufacture AI chips and those that make semiconductor fabrication equipment also handily surpassed the broader market.

 

Energy returned 13.7% with oil prices reaching highs not seen since October. Ongoing drone attacks on Russian refineries, escalating tensions in the Middle East, and expected production cuts are all spiking oil prices.

 

REITs and utilities were the worst performing sectors, returning -0.6% and 4.6%, respectively. Strong growth and sticky inflation data caused the timing of rate cuts to be delayed. Income-oriented investors often gravitate towards the relative safety and higher yields of U.S. Treasuries in times like these.

Looking ahead

The S&P 500 is expected to deliver 3.3% year-over-year earnings growth in the first quarter, markng the 3rd consecutive quarter of annualized growth. While the bottom-up estimate has slipped slightly since the start of the year, it remains ahead of the historical averages.

 

The resiliency of the first quarter earnings estimates is notable, considering first quarter guidance trends from fourth quarter earnings season skewed more negative than usual. Earnings growth has continually decelerated since the third quarter. However, that trend is expected to reverse throughout the remainder of the year as margin expansion is driven by the lagged impact of prior labor expense reductions, cost optimization efforts, and productivity enhancing investment.

 

Given the recent strength in equity markets, it would not be surprising to see stocks take a breather over the upcoming quarter. Over the last six months, the S&P 500’s forward price-to-earnings ratio has increased from 18x to 21.1x at quarter-end. Earnings will need to continue growing into the multiple. 

 

The S&P 500 is nearing our year-end discounted cash flow targets. We are entering a weak period for seasonality too.  There is also a risk – given stickier than expected inflation data – that price increases do not cool to the central bank’s target as quickly as expected and monetary remains tighter than forecasted.

Current Investment Views: Fixed Income

The first quarter’s fixed income environment was characterized by a pullback in rate cut expectations but a continuation of risk-on sentiment. The U.S. 10-Year Treasury Yield rose three basis points in January before climbing 34 basis points in February, peaking at 4.35% on February 21. March reversed some of the previous months’ losses as the U.S. 10-Year Treasury fell five basis points. All in all, the benchmark U.S. 10-Year Treasury Yield rose 32 basis points, settling at 4.2% at the end of March. Reasons for the increase in yields include:

 

• Strong economic data continued into 2024 as the fourth quarter 2023 real GDP growth was measured at 3.4% and the first quarter 2024 real GDP growth is an estimated 2.3%.
• Higher-than-expected inflation prints for January through March continued to show that the road to 2% inflation is bumpy.
• Multiple Federal Reserve members reiterated their hesitancy to cut rates before ensuring that inflation will sustainably settle at 2%.

 

The paring back of rate cut expectations, however, did not deter investors from moving to riskier fixed income asset classes. Credit spreads (the excess yield investors demand for holding a corporate bond instead of a similar treasury) continued to tighten throughout the quarter. The average U.S. Investment Grade spread finished the quarter down 11 basis points to 93 basis points. The average U.S. High Yield spread told a similar story, tightening 27 basis points to 312 basis points. Spreads are nearing post-Great Financial Crisis lows seen briefly in 2018 and throughout 2021.

 

Even with the shift in expectations to fewer and slower rate cuts, markets still believe the odds of a recession this year are very low.

Looking ahead

In the Fed’s latest economic projections, the median unemployment projection was lowered to 4% from 4.1%. The Fed, like the market, sees an economic slowdown in the near future as unlikely. However, the Fed’s median core PCE inflation projection for the end of the year was pushed higher from 2.4% to 2.6% following the previously mentioned inflation data. Despite this, the median projection for three rate cuts in 2024 was unchanged. However, fewer cuts were projected for 2025 and beyond as the Fed seemingly expects the economy to remain strong.

 

As seen by January through March data, risks still exist that inflation could remain elevated. Supply chain healing has largely run its course. Housing/rent prices continue to rise at fast rates, although these are expected to slow. The labor market remains tight despite moving into better balance. Household balance sheets generally remain solid, bolstering resilient consumer spending. Despite the economy’s continued strength, the Fed firmly believes monetary policy is restrictive.

 

Although the odds are low, an economic slowdown is still possible. The lagged effects of the Fed’s tightening cycle may still be making their way through the economy, and signs of a downturn in the labor market can appear quickly.

 

The growing national debt, international conflicts, and the political uncertainty of a presidential election year also create more unknowns.

Asset Spotlight: Alternatives

In the investment universe, companies that issue public equity and debt represent only the tip of the iceberg. Many investable businesses are private companies. Investments made in those private companies – along with anything that falls outside the realm of publicly traded stocks and bonds – are “alternative investments.”

 

Alternatives offer investors the potential for greater diversification and enhanced returns. As a result, portfolios including alternatives often outperform traditional asset classes on a risk-adjusted basis.

 

There are four broad categories of alternative investments:

• Private Equity (includes Venture Capital)
• Real Assets (includes Real Estate)
• Private Credit
• Absolute Return Strategies

 

We selected Proteus as our partner in providing alternative investment capabilities to our clients. Proteus offers an impressive combination of due diligence excellence, cost transparency, and robust reporting, all within a streamlined investor experience. The individual asset managers available to 1834 clients through this platform go through a vetting process. Proteus conducts this vetting in collaboration with Callan, a research firm specializing in due diligence for alternative investments. Within the platform, 1834 directs asset allocation decisions on behalf of our clients, which means setting target weights to asset classes such as private equity, real estate, private credit, and others.

 

The 1834 approach emphasizes prudence and the importance of robust due diligence for selecting individual asset managers across the full spectrum of alternative investments. Meeting our high standards for stewarding client assets requires both a high level of subject matter expertise and an operational framework that combines sophisticated technology with extensive investment, legal, and tax knowledge.

Looking ahead

The investment rationale for alternative investments is compelling, but there are nuances that prospective investors need to be aware of.

 

Due to their illiquid nature, alternatives should be approached with a long-term mindset. Not only are the underlying assets themselves illiquid (meaning there is no exchange on which to trade them). Also, the partnerships’ structures which pool investor capital to be deployed into alternative strategies typically require investors to agree to long periods (often more than 10 years). During that time capital cannot be drawn back out from the investment strategy.

 

Having a long-term view from the outset therefore leads potential investors toward the best possible outcomes. In addition to illiquidity, investors must understand and anticipate other important aspects that are unique to alternative investments, including:

 

• Infrequent reporting from asset managers.
• Higher fees to the general partner(s) who manage private capital and hedge fund assets.

 

While our partnership with Proteus mitigates some of these challenges, most are unavoidable, and the long-term nature of private capital means that these new considerations will become a part of the investor’s financial life over the long haul – something investors need to know with absolute clarity before proceeding.

 

As always, please reach out if you have questions on this subject.