Market Memo | February 2024

Although momentum slowed in January, the climb upward for large cap U.S. stocks continued with the S&P 500 TR index up 1.68% for the month. Bonds didn’t fare well, with the Bloomberg U.S. Aggregate Bond index down 0.27% for the month. With all the geopolitical tensions in the world and an upcoming election, the market continues to be influenced by rate cut expectations more than anything else.

On the last day of the month, the Federal Reserve’s (Fed) Chairman, Jerome Powell, called a press conference which sent the market down, ending on a negative note. He pushed back against the market expectation of rate cuts starting in March which caused the S&P 500 to fall over 1% for the day. In our opinion, interest rate cuts can’t be pushed back forever, given that interest expense is now the fourth largest budget item for the government (currently $743 billion and rising). The interest expense is growing at a rate faster than the three largest budget items: defense spending, Social Security, and Medicaid/Medicare according to the U.S. National Debt Clock real time indicator.

The Treasury department put out in memo on January 29^th, forecasting borrowings of $760 billion in the first quarter, and $202 billion in the second quarter of this year. With just shy of a trillion in debt coming due at the current rate of interest, the interest expense will continue its upward trajectory. There are ways to stop the increase in interest expenses, including cutting spending enough to reduce the deficit, raising taxes to reduce the deficit, or decreasing interest rates. While a bipartisan tax plan is working its way through Washington D.C., it is by no means a plan that will meaningfully offset the deficit by raising tax rates, much less allow for paying down debt.

Investors are looking past the potential ramifications of the debt and the interest expense for now as the economy continues to defy the odds and show signs of strength, particularly the job market. Unemployment remains low at 3.7%, while productivity increased 3.2% and Gross Domestic Product (GDP) continues to show strength, increasing by 3.3% in the fourth quarter. Due to the economic strength, the Fed feels confident in holding rates higher than market expectations. Following the press conference, the market expectations for cuts in March fell, but May and June continued to have strong expectations for rate cuts from market participants.

Individual sector returns for the S&P 500 showed a continuation of the trends that have been in place over the past twelve months, Communication Services and Information Technology related stock continue to advance, up 5.02% and 3.95%, respectively, while Real Estate and Materials fell by 4.74% and 3.91% respectively. The gap between the worst performing sector and the best performing sector is just over 58%, with Utilities down 8.04% and Information Technology up 50.09% for the period according to data from Morningstar. Valuations for the tech juggernauts are stretched by just about every measure, yet they continue to increase in value. The February earning reports will be highly scrutinized by investors looking for any signs of weakness in these companies. The term “priced for perfection” is coming up more frequently in relation to the Magnificent Seven stocks. However, given the low debt, significant market share, and the ubiquity of these companies they may continue to defy gravity.

The rest of the world’s stock markets continued to perform worse than the U.S. markets in January, with the stocks of developed countries up 0.58% based on the MSCI EAFE NR index, and emerging market countries down 4.64% based on the MSCI EM NR index. Weakness in Germany, which is currently in a recession, and a farmer’s revolt over the removal of subsidies in France has roiled the Eurozone. The war between Ukraine and Russia shows no signs of abating, leading to some divisions and unpredictability in the region that is unnerving investors.

China continues to struggle economically, pressuring returns in all emerging markets. The economy never really experienced a lift after COVID lockdowns ended, the real estate sector continues to struggle, their demographics are not favorable as the aging population continues to grab headlines. In fact, China may be in a deflationary trend. The data from China doesn’t confirm this, but there have long been questions about the reliability of the data coming from the country’s leadership. The Communist party has cut interest rates and vowed stimulus to prop up their ailing stock markets, but the reaction has not been positive. Both foreign and domestic investors continue to flee the Chinese stock market. In a more predictable political climate, this could be seen as an opportunity to invest at cheaper prices. The moves made by the Chinese political leaders has not given investors any reason to have confidence investing in their markets over the past few years.

The U.S. continues to be the best place to invest with stronger growth, lower unemployment, increasing productivity, and the potential for rate cuts this year. Additionally, stocks tend to do well in election years. For those not interested in the volatility of stocks, this also looks to be a good year for bonds and fixed income. Money market funds are still yielding around 5% per year, and most bonds and CDs are providing interest rates above 4%. If the Fed does start cutting rates, the principal value will likely increase in response to lower rates. For now, inflation and interest rate expectations continue to be the driving force across markets and economies around the globe.