There’s nothing like spring in Maine. Last week I came into the office with half a foot of fresh snow on the ground. Today, it’s 60 degrees and the snow has melted. For us Mainers, this time of year is always a tug-of-war between winter’s last gasps and the warmer months that lie ahead. Personally, I’m happy that the warm weather team always wins this tug of war.
The economy seems to be engaged in its own game of tug-of-war between inflation and growth. The theme in the market for much of 2023 was “inflation is coming down and that will be good for asset prices.” Thus far, 2024 has seen a bit of a narrative shift. As we’re in the “last mile” of the Federal Reserve getting inflation down to its 2% target, we’ve seen a modest resurgence in inflation, yet the S&P 500 was up more than 10% in the first quarter.[1] What gives?
We came into 2024 with the S&P 500 on a nine-week winning streak and bond yields plummeting. The 10-year US Treasury yield fell from roughly 5% to 3.8% to end 2023, boosting stocks and bonds.[2] Much of the market enthusiasm coming into this year was focused on the “soft landing” scenario where the economy avoids a recession and inflation returns to 2%. With the Consumer Price Index hovering around 3%, the market and the Fed were squarely focused on rate cuts.[3]
The topic of rate cuts is two-fold: 1) when will the Fed initially cut, and 2) how many cuts in 2024. As we wrote in last quarter’s letter, the market was pricing in 6-7 rate cuts in 2024[4], something we didn’t think as realistic, given the strength in the economy. Further, the 6-7 rate cuts being priced by the market differed significantly from the Fed’s own 2024 forecast of 2-4 cuts.[5] As the market has been adjusting closer to the Fed’s forecast this year, we’ve seen the yield on the 10-year US Treasury move higher from 3.88% at the beginning of the year to 4.2% at the end of the first quarter.[6] As we saw in 2022 and much of 2023, rising yields in the treasury market was a bad sign for stocks. In the case of 2024, we’ve seen both yields and stocks rise.
Our explanation is that the rise in Treasury yields reflects the market adjusting to an economy that is stronger than expected and, therefore, inflation that is going to hang around for a bit longer. The tradeoff that stock investors are seeing is that a stronger economy leads to rising earnings for stocks and, right now, investors are putting rising earnings ahead of rising yields (and fewer rate cuts) on the list of what matters. This is why stocks haven’t fallen despite the rise in bond yields. This is not to say that stocks would applaud a continued rise in yields. If yields continued to rise, at some point stock investors would notice and that could bring on a market correction.
What is our view for the rest of the year? Historically, a strong first quarter is bullish for the rest of the year. This is just the tenth time since 1970 the S&P 500 had a 10%+ return in the first quarter of the year. In the previous nine occurrences, the S&P 500 was positive seven times in the second quarter and eight times for the rest of the year.[7] Only 1987 saw negative returns for the rest of the year, and this coincided with “Black Monday” in October 1987.
We also continue to see signs of cash that has been out of the market being put to work. According to Natixis, their data that shows money moving into stock funds has seen one of the strongest stretches of inflows in over two years, with flows having accelerated within the last month.[8] Fear of missing out is certainly a factor in investing and, while earning 5% in a money market seemed like a solid investment to start 2023, seeing stocks rise close to 25% makes one rethink the concept of opportunity cost.[9]
The biggest recession risk continues to be a re-acceleration in inflation which could result in no rate cuts in 2024 or even additional hikes. This is a lower probability event but is our main risk for the markets. Financial shocks and geopolitics (i.e. war in the Middle East) could also create market volatility and increase the risk of recession.
We’re likely to see this economic tug-of-war continue for the foreseeable future. Right now, the market is embracing the world with slightly higher inflation (and yields) with the tradeoff of higher economic and earnings growth. If inflation continues to be stuck in the mud, or even reaccelerate, the market will take notice. Our job is to pay attention to the data but not overreact to each datapoint.
To close, we’re beyond grateful for you, our clients, and your continued trust, partnership and support. As always, we’re here to answer any questions you may have. In the meantime, we wish you and your family a wonderful spring season.
Warmest Regards,
Jack Piper
Founding Partner & Portfolio Manager
[1] Dorsey Wright April 4, 2024
[2] Dynasty Financial Partners February 21, 2024
[3] Dynasty Financial Partners February 21, 2024
[4] Goldman Sachs January 15, 2024
[5] Dynasty Financial Partners, February 21, 2024
[6] Y-Charts March 31, 2024
[7] Morningstar Direct and Dynasty Financial Partners March 31, 2024
[8] Natixis April 9, 2024
[9] Natixis April 9, 2024
Disclosures
Great Diamond Partners, LLC is an investment adviser in Portland, Maine. Great Diamond Partners, LLC is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Great Diamond Partners, LLC only transacts business in states in which it is properly registered or is excluded or exempted from registration. Great Diamond Partners, LLC’s current written disclosure brochure filed with the SEC which discusses among other things, Great Diamond Partners, LLC business practices, services, and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov.
This information should not be considered investment advice. Opinions expressed reflect the judgment of the authors and are current opinions as of the date appearing in this material only. While every effort has been made to verify the information contained herein, we make no representation as to its accuracy and it should be regarded as a complete analysis of the subjects discussed. All investing involves risk, including the loss of some or all of your investment.
Past performance does not predict future results.
Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and do not reflect the impact of advisory fees. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular fund.
Certain information contained herein constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events, results or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Nothing contained herein may be relied upon as a guarantee, promise, assurance or a representation as to the future.