Not So Fast

By Paul Broughton, Portfolio Manager

Investors, in general, are bullish as we’re getting started in 2024.  The oft-mentioned soft-landing seems increasingly possible.  Rates and inflation have fallen and appear to be heading in the right direction.  This has led to the S&P 500 reaching a new all-time high this past week.  All this sounds promising, but there are reasons for investors to be on guard for a bumpy ride over the next couple of quarters. 

It’s worth noting that the S&P 500 had a very healthy total return of 26.3% last year.  Most of that return was from the last two months of the year as the market started to price in several rate cuts in 2024.  In the first couple of weeks of January six cuts were fully priced in.  As we look out at the year ahead, we see that the consensus from Wall Street is for 2024 S&P 500 earnings growth of 11.3%.  As well, very few Wall Street firms have the S&P finishing lower for the year.  Unemployment remains near fifty-year lows and consumers continue to spend and look relatively healthy overall.  All positive.   

So, what’s been the catalyst for this recent rally in equities? Lower interest rates.  We saw rates start to move lower in mid-October right before equities started to rally.  The move lower in rates was largely due to the anticipation that the Fed was done with raising rates and would be reducing rates as soon as March.  This led to an “everything rally” in equities.  Small- and mid-cap equities were up 24% and 20% respectively in the last two months of the year.  The S&P 500 Equal Weight was up 18.5% compared to the S&P 500’s 16.2%.  This broadening out of equity performance is very positive for the bull rally to continue.  Lower rates allow companies and consumers to finance their day-to-day operations more readily and, in general, lead to higher asset prices. 

But has the war on inflation been won?  Already?  The move lower in rates and the corresponding move higher in asset prices is mostly predicated on this thesis that inflation has been tamed, or at least, is in the process of being tamed.  But history tells us that it isn’t quite that easy.  The Paul Volcker Fed experienced this in the early 1980s.  The trend in the markets over the last few months has been up and to the right and it feels like this may continue.  And Bulls still outnumber Bears by a healthy clip.  But it’s possible that too much of this rally is based on the Fed embarking on a series of rate cuts that might not happen as soon as expected, nor as many as the market is anticipating.    

Some data points suggest a delay in those highly anticipated rate cuts.  We saw the most recent reading for consumer prices, the CPI Index, come in a bit higher than expected and the same for retail sales – not indicative of a slowing in prices or consumer spending that might warrant an easing in rates.  We also saw high yield credit spreads narrow a bit, remain very orderly, and show no signs of stress in the system.  Does it make sense for the Fed to cut rates when high-yield spreads are rather benign?  Also, the price of shipping has seen a sharp increase due to the conflicts in the Middle East, yet neither the stock market nor the oil market has hardly blinked.  A chart showing the move higher for shipping costs from China to the Mediterranean is below.  One last item that investors should be aware of is that the VIX Index remains low, which indicates that investors feel no need to purchase puts to protect their portfolios against a sell off.  They aren’t fearful.

All this suggests that higher policy rates stay in place longer than the market would like.  The strong equity rally that we’ve recently seen likely needs to pause or rest, as we still need to see the effects of higher interest rates cool some of the consumer spending and for inflation to show continued progress moving lower.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.