May 2024 Market Perspective
For the first time in more than a year, talk of the Federal Reserve actually raising interest rates to curb growing inflation was heard on the financial news channels. As Treasury yields began edging up in April, all three major U.S. stock indices tumbled. The S&P 500 and the Dow Jones Industrial Average lost 4.08% and 4.92%, respectively, while the NASDAQ dropped 4.38%. The sell-off, which was the first monthly decline this year after a strong first quarter for stocks.
Results were mixed for international stocks. The MSCI EAFE Index lost 2.56% in April. The Emerging Markets Index, on the other hand, edged up 0.47%. Technical factors were supportive for international stocks, primarily based on relative valuation – seen as being “cheaper” than U.S. stocks.
The U.S. bond market continued its year long struggle with interest rates with the Bloomberg Aggregate Bond Index dropping 2.53% in April and remains negative for 2024. The 10-year Treasury yield rose from 4.2% at the end of March to 4.69% at the end of April. A combination of economic growth and higher-than-expected inflation caused the rise in interest rates, putting pressure on bond prices.
Economic data released in April showed continued strong levels of economic growth. The March employment report, which showed an impressive 303,000 jobs were added during the month, marked the largest monthly increase in 10 months and highlighted the continued strength of the labor market. April saw continued growth in consumer and business spending. Retail spending increased more than expected, signaling impressively resilient consumer spending. This is a good sign for overall economic growth given the importance of consumer spending for the economy.
Although these impressive results were a welcome sign of healthy economic growth, the bad news is they contributed to continued stubbornly high levels of inflation. On a year-over-year basis, both headline and core (which excludes volatile food and energy prices) producer prices rose in April. Headline PPI rose 0.5% in April and was up 2.2% on a 12-month basis, the biggest gain in a year. Core PPI also rose 0.5% compared with the 0.2% estimated by Dow Jones.
April consumer price index (CPI), however, came with a sigh of relief. With month-over-month headline CPI rising from 0.1% last October to 0.4% in February and March 2024, investors were concerned that inflation would continue to rise despite the Federal Reserve’s best efforts. Thankfully, that was not the case as the CPI for April was reported at 0.3%, 0.1% less than analysts had expected. CPI for the last 12 months declined slightly to 3.4%, down from 3.5% in March. Core CPI, excluding volatile food and energy prices, also rose at 0.3% for April and 3.6% for the last 12 months. All three major U.S. stock indices rallied on the mild inflation news, as did the Bloomberg Aggregate Bond Index.
Our Takeaway
The easing of month-over-month CPI in April may signal that the “bump” in inflation over the last three months may be subsiding. This has significant implications for the bond market. U.S. bonds have been beaten up since early 2022 with rapidly rising inflation and interest rates. If this pattern of easing CPI continues, the Fed will have the reason they have been looking for to begin to cut interest rates. As of the writing of this newsletter (May 15), CME FedWatch Tool estimates a 30.2% chance of a 25-basis point rate cut at the July Fed meeting, and an 80.5% chance of a rate cut (52.7% for a 25-basis point cut, 17.8% chance for a 50-basis point cut) at their September meeting. If history repeats itself, we would expect such rate cuts to ignite a much anticipated (and needed) rally in the bond market. This is most important to conservative investors who have seen poor portfolio returns over the last 2 ½ years due to a battered bond market. We are reviewing our bond holdings and will be prepared to take advantage of a bond rally should one materialize.
Overall, the U.S. stock market has done well so far this year, notwithstanding the sell-off in April. Largecapitalization (cap) stocks have once again dramatically outperformed mid and small-cap stocks, with large-cap growth stocks thus far providing the best returns. As such, we have continued to overweight large-cap stocks in our portfolios with a slight tilt to growth. We will continue to underweight mid and small-cap stocks.
Although foreign stocks are seen as “cheaper” than U.S. stocks (based on lower P/E ratios), we continue to favor U.S. stocks on a relative performance basis. Developed foreign stocks continue to outperform emerging markets stocks, so we maintain a strong overweight to developed over emerging markets.
With interest rate cuts again on the Fed’s horizon, investors – especially conservative investors – have a reason to be optimistic. Stay tuned.
