stock market financial market update

Stocks Keep Rolling

For stocks, the first two months of 2024 look similar to the last two months of 2023.  The market, led by the technology sector, is continuing to rise from its recent low in October and is notching new records.  The emergence of artificial intelligence as an investment theme has captivated investors, and any companies even remotely tied to this transformational technology are getting lots of attention.

Sources of Strength

Two factors, in our view, are driving this rally.  First, investors seem convinced that the Fed is finished raising interest rates and will soon begin to cut them.  Swiss Bank UBS released its 2024 edition of its Global Investment Returns Yearbook this week, and one of its many findings was that both equity and fixed income investors capture the best returns during periods when central banks are either lowering interest rates or keeping them low after having lowered them.  While we are not yet technically into a rate-cutting cycle, investors seem to want to front-run this trend in 2024 by bidding stocks up well before the Fed actually begins to cut rates.

Second, the economy is continuing to perform well, despite the pressures of higher short-term rates.  Growth expectations have climbed, and financial conditions have eased since the Fed’s soft pivot to easier monetary policy in December, giving the economy a tailwind, and, paradoxically, probably making it more difficult for the Fed to achieve its 2% inflation target.  Better conditions in the economy and capital markets will support strong consumer spending and higher corporate capital expenditures, making it tougher for the Fed to keep pushing inflation lower.  And that means higher rates for longer.

Stocks Unphased by Higher Rates

Normally higher interest rates beget lower stock valuations, but that has not been the case for the last year and a half.  Recent research by Bank of America suggests that stocks are more expensive today relative to their earnings than they have been for 95% of their history.  Elevated valuations do not necessarily mean that stocks are primed for a retreat, but they do reflect the current high level of investor enthusiasm.  Since the beginning of 2023, stocks have seemed impervious to both awful geopolitical events as well as a dogged, determined Fed looking to lasso runaway inflation.  Stocks have largely shrugged off the Fed’s interest rate hiking cycle and seem more focused not on the fact that rates are now considerably higher than they were eighteen months ago, but rather on the notion that the hiking cycle has come to an end and the next move the Fed will make will be to cut rates.  For several months now, Wall Street analysts have been forced to push back their projections for when the Fed will begin to cut. 

Wall Street may be eager for lower rates, but there seems to be no urgency on the part of the Fed.  With inflation slowly settling down below 3% and the economy still in very good shape, there are no obvious reasons for the Fed to do anything other than wait.  Yesterday morning, the core Personal Consumption Expenditures Index (PCE), which disregards the price changes of food and energy, came in at 2.8%, its slowest annual increase in nearly two years.  Core PCE is one of the Fed’s preferred gauges of inflation, so investors cheered this number and sent stocks higher.

Higher for Longer

Our view is that the market’s expectations for Fed interest rates cuts is a bit too optimistic, and we expect to see the Fed hold its current stance for longer than is currently forecast.  (Many economists expect rate cuts to begin in June.)  We think investors, in the coming months, will have to come to grips with the fact that the Fed is still facing sticky inflation and has not yet finished its job.  In the 1970s, the Fed made the mistake of lowering rates too early, before inflation was really quashed, and it subsequently had to ratchet them back up.  This Fed does not want to make that mistake.

As always, we welcome your comments and feedback.  Please contact us if there is anything you would like to discuss about your investments or the markets.

 

 

*Photo credit: GoodLifeStudio from Getty Images Signature

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Picture of Peter Thoms, CFA, MBA

Peter Thoms, CFA, MBA

Peter Thoms, CFA, founded Orion Capital Management LLC in April 2002. Peter has extensive experience managing investment portfolios for clients pursuing a wide range of financial goals.

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