Broker Check

Quarterly Market Outlook – 2Q24

April 28, 2024

First Quarter Takeaways

The market enjoyed a remarkable start to the year. Building on last year’s rally, the S&P 500 gained 10.6%1 in the first quarter led by AI-fueled mega-cap stocks on expectation of lower rates. Investors continued to display optimism for one of the two fundamental narratives we introduced in our prior quarterly outlook – namely that the Fed would be successful in taming inflation without higher interest rates weakening the broader economy. Thus far, the economy has not only been resilient, but exceedingly strong relative to the Fed's restrictive rate policy. Inflation remains on a downtrend but has proven to be persistently sticky and still elevated above the Fed’s 2% target. Consequently, the Fed has delayed its highly anticipated rate cuts and caused the market to quickly adjust expectations. While this has prompted some volatility and profit-taking now into the second quarter, better-than-expected earnings across major companies have given investors a sigh of relief.

While the main story of inflation and interest rates unfolds, several other considerations are on the market’s mind that we will touch on. While it is important to monitor and understand them, it should not be to the detriment of our financial plans. On any given day, “something” will give investors a reason to worry – whether self-induced or perpetuated by the media. As we dive a bit deeper into these topics, it is always through the lens of long-term investing to help better position our portfolios.

The Fed’s Dilemma

Near the end of 2023, market participants firmly placed their belief that the rate hike cycle was over, and that the Fed would begin to cut rates in early 2024. While the market has maintained its optimism now well into the year, rate expectations have changed. With what began the year as six rate cuts has quickly adjusted down to a hopeful two or three as inflation remains elevated. Throughout the first quarter, the market was relatively unconcerned and placed interest rate worries on the back burner as equities reached all-time highs alongside higher rates. As it stands, the Fed has made meaningful progress in taming inflation but will remain data dependent and need clear evidence of inflation declining further before moving to cut rates. Higher-for-longer rates are one of the primary risks to equities in the near-term, not only from a valuation perspective, but from a monetary policy risk perspective, as well. The Fed will meet again May 1 to deliver its interest rate decision, in which rates are expected to be left unchanged.

Resilient Economy

Despite the Fed’s aggressive hiking cycle and higher-for-longer rate stance, the economy has held up considerably well; Economic growth has also been a source of optimism for equity markets in terms of corporate earnings and a soft-landing scenario. The consumer makes up nearly 70% of the economy and has been supported by a resilient labor market attributed to record low unemployment, consistent labor supply, and job demand exceeding expectations. In turn, the consumer has remained adaptable to elevated inflation – supported by built-up savings, declining inflation, and rising wages. Robust consumer spending has ultimately translated into a path of steady economic growth after sharply recovering post-Pandemic in 2021. Most recently, the economy expanded 1.6% in 1Q24 below expectations as elevated inflation demonstrates its ability to still pressure goods consumption and non-residential investment. Going forward, we expect the US economy to remain resilient, supportive of a soft landing, with signs of softening as the Fed maintains its restrictive policy.


Better-than-expected Earnings

Heading into the first quarter earnings season, market participants overlooked the threat of higher-for-longer rates on the belief that strong economic growth would translate into better-than-expected corporate profits. To be sure, the year-to-date rally has been a result of multiple expansion; prices (valuations) increased on the prospect of higher future earnings. The test for the market was then whether earnings estimates would live up to expectations as the S&P 500 hit record all-time highs amidst higher interest rates.  Thus far, about half of the S&P 500 companies have reported results with 77% of those companies reporting positive earnings surprises and 60% reporting revenues above estimates.

A few takeaways:

  • Due to high expectations, companies that have reported negative earnings surprises or unfavorable forward guidance have seen outsized price declines as investors view this as a profit-taking opportunity regardless of the reason why. Notable examples include Adobe (ADBE) and Netflix (NFLX), both of which saw knee-jerk price action to the downside after reporting solid earnings.
  • While most companies have beaten revenue expectations (60%), this is below the 5-year average and demonstrative of how companies have adjusted to the higher inflationary environment – primarily through managing costs to help offset reduced top-line revenues.
  • While the market rally has broadened, the S&P 500 remains significantly concentrated in a handful of mega-cap companies and further upside for the market is reliant on these companies reporting positive guidance. Microsoft (MSFT) and Alphabet (GOOGL) both reported positive earnings led by their cloud computing segments and restored confidence as investment into AI remains a focus for future growth. GOOGL even issued its first-ever dividend. Meta (FB) reported solid earnings but investors questioned the company's strategy related to higher costs and dependence on advertising revenue. Tesla (TSLA) reported disappointing earnings, but was ultimately seen as a positive after overwhelmingly negative sentiment battered the stock price for much of the year. 
  • Amazon (AMZN) and Apple (AAPL) will be reporting next along with tech heavyweight Nvidia (NVDA) near the end of May. At the company level, Amazon is the largest contributor to earnings growth for the Consumer Discretionary sector as is Nvidia for Information Technology. Without Nvidia, the blended year-over-year earnings growth rate for the Technology sector would fall from 22.2% to 9.4%.2


Looking Ahead

Near-term challenges to equities will continue to center around higher-for-longer rates, as much of the recent rally has been a product of rate cut expectations and momentum. We believe inflationary pressures have the likelihood of delaying rate cuts for longer than the market expects and may begin to be priced in as we approach mid-year. While the market grapples with near-term uncertainties, we continue to advocate a long-term, plan-driven approach while taking advantage of market fluctuations. Our portfolios reflect our conviction for US large cap companies with an emphasis on both growth and quality. We focus on investing in fundamentally strong, industry-leading companies with a propensity for growth and strong free cash flows. At the sector level, we continue to hold a positive outlook  for Technology. Within technology, we expect some near-term volatility in the semi-conductor space as rampant demand for generative-AI has created a backlog that will likely translate into a brief slowdown before renewed growth in 2025. In the Consumer Discretionary space, we see opportunity in service-oriented companies as consumer spending remains resilient. As the market rally continues to gradually broaden, we see further opportunities within more defensively positioned growth sectors – namely Health Care and non-cyclical Industrials.

Above all else, we stress the importance of remaining invested and adhering to your financial plan. The below chart demonstrates periods throughout history in which cash-like assets have peaked and the subsequent 12-month returns compared to equities and bonds. While having a reasonable allocation to cash is a good thing, exiting the market or sitting on the sidelines has proven to be an important pitfall to avoid.

As always, thank you for being our clients. Should you have any questions please do not hesitate to reach out.


Respectfully,


Michael Neill, CFA

Sources:

1  10.6% Total Return, Bloomberg LP

2  FactSet Earnings Insights

Chart 1  - Bloomberg LP

Chart 2,3,4 - JPM Guide To the Markets

Advisory services provided by NewEdge Advisors, LLC doing business as Marathon Financial Group, as a registered investment adviser.  Securities offered through NewEdge Securities, Inc., Member FINRA/SIPC. NewEdge Advisors, LLC and NewEdge Securities, Inc. are wholly owned subsidiaries of NewEdge Capital Group, LLC.