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Street SMARTS: Q1 Commentary 2024

By Thomas O. Herrick
Chief Market Strategist, Managing Director

Equity markets have advanced along a broad front so far in 2024. The stock market is in a decisive long-term uptrend characterized by an increasing risk appetite. No market is linear, and we fully expect consolidations and pullbacks within the context of any uptrend, but the degree of momentum found in the current uptrend would support a viewpoint of relatively minor or normal pullback activity as opposed to something more dramatic. The most significant vulnerability faced by the equity market currently is the degree of out-performance of momentum factor stocks. The MSCI Momentum Index has out-performed the S&P by 11% this quarter, the widest margin of out-performance since 2008. Significant holdings in this index are Nvidia, Meta, Broadcom, Lilly and Amazon. Any short term weakness likely hits this group hard.

To date, in 2024, the S&P 500 Index has gained 10.43%. The NASDAQ 100 Index is up 8.82%. The Russell Mid Cap Index is higher by 8.20%, and the Russell 2000 benchmark for small caps is higher by 4.67%. A key feature of a sustainable equity uptrend is breadth or wide participation. The number of NYSE stocks hitting a 52-week high reached 300 on March 21st, this also occurred in December. Spikes like these suggest upside leadership is broad-based since many stocks are driving the new highs in major indices, a healthy construct. Getting multiple spikes in new 52-week highs above 300 after not having one for an extended period (all of 2022 and most of 2023) is an additional indication of any early-stage bull market.

The move higher in equity markets has not come with any assist from falling yields but has benefited from declining interest rate volatility. The benchmark 10-year Treasury yield has increased by 32 basis points this quarter. For context, this comes on the heels of a substantial decline in yields late in 2023. The 10-year put in a significant long-term top on yields on October 19th at 5%, closing 2023 at 3.88%, and currently at 4.19%. With that long-term high firmly established, odds favor any move higher in yields as lower highs. Accompanying the 2024 yield increase has been puny bond performance. The Bloomberg US Aggregate Bond index is down 0.77% in 2024.¹

Exiting the earnings recession

"Quarterly (y/y) EPS Growth Trajectory" chart of large and small caps forecasts increasing growth.Data as of January 27, 2024. Source: BofA Equity & Quant Strategy, Jefferies, FactSet.

The equity markets have moved higher primarily on the back of earnings and increasing risk appetite among investors. Earnings are coming out of the trough and investors are under-allocated to stocks. This is a potent backdrop for equity markets as is. A decrease in Federal Reserve short-term rates later this year would be nothing but rocket fuel for this dynamic. Lower rates feed into equity valuations as a positive, especially small caps. The Fed removed its tightening bias as of late last year. Wobbly inflation data in Q1 has led them to adopt a wait-and-see approach to lowering rates. Our viewpoint is that first principles favoring dis-inflation remain in place, notably negative money supply growth and a lot of dis-inflationary shelter data in the pipeline. Expectations of the quantity and timing around rate cuts have come in quite a bit, decreasing market vulnerability on this score.

Those still looking for weak economic growth or a recession to trigger rate cuts are increasingly walking the plank. GDP growth remains solid, propelled by productivity gains. Productivity, which is admittedly difficult to predict, has soared over the last year while inflation has declined. Three major factors have driven productivity: 1. Labor markets have matured with far less churn. Churn within labor markets is very disruptive and lowers productivity. 2. Structure investment has skyrocketed, incentivized by three large infrastructure bills passed in 2022: The CHIPS Act, the Infrastructure Bill, and the poorly named IRA (which is really a clean energy infrastructure bill). There is a lot more to come from this source. 3. Supply chains have normalized. On another positive note, we have yet to quantify the productivity gains from generative AI. This is likely to be the biggest game changer over the next decade, a new industrial revolution estimated to take productivity up by 20 to 30 percent.

This is the fuel for increasing risk appetite

Cumulative Flows: Long Only and ETFs Chart (10/21/22–3/22/24)Source: FactSet

As rates come down, risk appetite will grow. This increasing risk appetite is already apparent. Imagine what happens when all that cash parked in the money market suddenly earns less. Said another way, this is a return to FOMO, fear of missing out. Outsized beneficiaries should be small and mid-caps and, quite possibly, international equities. These portions of the equity market are priced cheaper than domestic large caps, and money will naturally be looking for added exposure beyond high-priced domestic large caps.

We remain constructive on equities — especially smaller companies, and more recently international companies. After a massive late 2023 rally, bonds have stalled as they await additional dis-inflation data. Our base case is constructive on bonds as well. Locking in duration within bonds makes sense at this point in the rate cycle, and investors have been given room to do so. Mortgage-backed securities are also attractive within the bond complex. Diversifying strategies that remain attractive are derivatives-based hedged equity strategies and direct lending private credit, the latter becoming much more attractive over the last 24 months with an increase in base rates. As far as hedging strategies go, over the last three years, CSP Global Hedged Equity has captured 85% of the global equity market upside and outperformed bonds by 1084 basis points annualized¹—demonstrable evidence of diversification benefits beyond long-only stocks and bonds.

Valuations chart shows valuations are more attractive the smaller the company size.
Source: John Hancock Investment Management

¹ Morningstar

Cary Street Partners is the trade name used by Cary Street Partners LLC, Member FINRA/SIPC; Cary Street Partners Investment Advisory LLC and Cary Street Partners Asset Management LLC, registered investment advisers. Registration does not imply a certain level of skill or training.

Any opinions expressed here are those of the authors, and such statements or opinions do not necessarily represent the opinions of Cary Street Partners. These are statements of judgment as of a certain date and are subject to future change without notice. Future predictions are subject to certain risks and uncertainties, which could cause actual results to differ from those currently anticipated or projected.

These materials are furnished for informational and illustrative purposes only, to provide investors with an update on financial market conditions. The description of certain aspects of the market herein is a condensed summary only. Materials have been compiled from sources believed to be reliable; however, Cary Street Partners does not guarantee the accuracy or completeness of the information presented. Such information is not intended to be complete or to constitute all the information necessary to evaluate adequately the consequences of investing in any securities, financial instruments, or strategies described herein.

Cary Street Partners and its affiliates are broker-dealers and registered investment advisers and do not provide tax or legal advice; no one should act upon any tax or legal information contained herein without consulting a tax professional or an attorney.

We undertake no duty or obligation to publicly update or revise the information contained in these materials. In addition, information related to past performance, while helpful as an evaluative tool, is not necessarily indicative of future results, the achievement of which cannot be assured. You should not view the past performance of securities, or information about the market, as indicative of future results.

Nothing contained herein should be considered a solicitation to purchase or sell any specific securities or investment related services. There is no assurance that any securities discussed herein have been included in an account’s portfolio, will remain in an account’s portfolio at the time you receive this report, or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and, in the aggregate, could represent only a small percentage of the portfolio’s holdings. It should not be assumed that any of the securities transactions or holdings discussed were, or will prove to be, profitable, or that the investment recommendations or decisions made in the future will be profitable or will equal the investment performance of the securities discussed herein. A complete list of every holding’s contribution to performance during the period, and the methodology of the contribution to return, is available by contacting Cary Street Partners Marketing.

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