April 2024: Stubborn inflation spooks markets despite continued strong growth

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After a strong start to the year, stubbornly high inflation and weaker than expected GDP growth reports sent stock and bond returns tumbling in April.^{1 2 3}

Investors appear to have adjusted expectations for the Fed’s first rate cut to later in the year, perhaps even beyond the June meeting, with growing concern that the economy will start to show weakness before rate cuts arrive.

Fed Chair Powell continues to point to relatively strong current economic activity and tight labor markets to justify the holding pattern on short-term interest rates.

Still, with the equity market gains of the last year pushing stock valuations to relative highs, the fear is that economic and corporate earnings growth will not come in strong enough to justify the lofty stock prices. 

The month at a glance

• US equity indices fell for the first month since last fall.
• Fixed income returns were weak as longer term interest rates rose.
• Estimated GDP growth for Q1 rose just 1.6%, weaker than expected, but primarily due to inventory shrinkage rather than any slowing in consumer spending.⁴
• Wage growth remains relatively high, boosting consumption, but challenging the moderation in inflation.⁵ 

Inflation and growth concerns challenge markets

Slower than expected progress on inflation in April created fears that the Fed would further delay interest rate cuts, putting the “soft landing” economic scenario at risk. Those concerns pushed equity prices down across the board for the month as investors reconciled current valuations with potentially slower growth.

• The S&P 500 fell 4.08%, the first monthly decline since October 2023.⁶
• In the US, the declines were seen across size and style sectors.
• Small cap stocks, especially the value style, were the weakest segment once again as economic weakness concerns increased.
• International stocks fared relatively better, with emerging markets equities posting the only positive returns among major global indices.⁷
• Utilities were the only sector to post positive gains in April.⁸
• Technology stocks were the second weakest sector for the month and no longer show the highest returns year-to-date, trailing Energy and Communication Services so far this year.⁹

Equity Returns: April and YTD 2024

S&P 500 Economic Sector Returns: April and YTD 2024

Longer term rates rising

Longer term interest rates continued to rise in April, with the 10-year treasury rate increasing over 40 basis points during the month.¹³ The 10-year rate is now 75bp higher than at the end of 2023. The Fed continues to signal that they are likely to hold off on cutting rates until they see more progress on inflation. That posture has changed investor expectations for far fewer and further out rate cuts than were priced in at the start of the year.

• Rising long-term rates caused a broad sell-off in fixed income in April, wiping out gains achieved in the first quarter.
• Ultra short duration treasuries were the only segment to post positive returns for the month.
• Emerging market bonds fell sharply after strong gains in the first quarter.
• Preferred stocks, which tend to move with equities, fell the most in April.

Fixed Income Returns: April and YTD 2024

Wage inflation can be “sticky”  

April inflation reports showed slowing progress on reaching the Fed’s stated goal of 2% annual growth in prices. While the declines since the high levels reached in 2022 are clear, the “last mile” towards 2% seems elusive. The individual components of broader price indices like the CPI often move to their own cycles, presenting challenges to the Fed and investors when interpreting more general inflation trends. This challenge is a reason the Fed tends to focus on the “core” price indexes that exclude the more volatile food and energy components. Another dimension that the Fed watches closely is the growth in wages. A particular issue policy makers are keen to avoid is the “wage-price spiral” where higher prices lead to higher wages which then lead to even higher prices in a cycle that can be hard to contain. Economists have observed that while wages can rise quickly, they tend to fall more slowly, leading to the comment that wages can be “sticky” on the downside.

One gauge of growth in wages is the Employment Cost Index. That index shows a pattern in the past several years that lines up with moves in overall inflation measures, peaking in the spring/summer of 2022 and then falling later in 2022 and through 2023.¹⁴ The most recent data point (for March 2024, released on April 30th), shows a change from a year earlier of 4.2%, a slight move up from the end of 2023 and still well above pre-pandemic growth rates. One of the challenges of the continued tight labor market is how quickly wage growth can return to the 2-3% range that the Fed likely will see as consistent with 2% inflation on broader measures.

Employment Cost Index: Percent Change from Year Earlier

Reconciling “higher for longer” rates with equity valuations 

After the Fed’s pivot to an end of the rate rise cycle last fall, equity markets have risen broadly as investors warmed to the soft-landing scenario and began to look forward to the Fed cutting rates. Even with earnings coming in relatively strong, valuations, especially among US large cap stocks, rose steadily. Now, with inflation remaining above target levels and the economy and labor markets still robust, the Fed has reaffirmed that it sees no need to hurry cutting short-term policy rates. That posture has forced investors to reconcile their expectations on interest rates and economic growth expectations with current stock prices. April’s stock returns were a part of that reconciliation process.

Looking more closely at where those valuations stand relative to the past 30 years illustrates what investors are grappling with. The chart below from JP Morgan Asset Management, shows that all the typical valuation measures for the S&P 500 are well above their long-term averages through the end of March.¹⁵ April’s sell off will drop each of these measures, but the larger issue will remain — US large cap equities are at the high end of their valuations and will require either a drop in prices or continued strong earnings growth to justify the current prices.

S&P 500 Valuation Measures

Still, as the chart shows, there is no magic to the “one standard deviation” bands as valuation can push through and remain above them for extended periods. This is often the case when the high valuations are accompanied by strong or rebounding economic conditions. Indeed, another view from JP Morgan shows that the relationship between current valuations (using the price-to-forward earnings measure) and subsequent S&P 500 total returns can vary quite a bit, especially in the short-term.¹⁶ In general, higher valuations are associated with lower subsequent returns, but for a one-year window the relationship is not strong. There are plenty of times where next year’s return was very high or very low regardless of the current valuation. On a longer-term (5-year) view, the relationship is clearer, but still shows periods where subsequent returns can be positive or negative for all but the very highest valuations periods.

Valuation Measures and Future Returns

Another way of summarizing these charts is that the starting valuation is not a great market timing indicator. In fact, the current valuation positions (in the red symbol) have historically seen both positive and negative subsequent returns over the next one and five years. The other observation is that more of the points on the chart are above zero than below, so that a long-term position in equities is well supported. Standard rebalancing that will tend to buy low and sell high will take advantage of the relationship shown in the charts in a way that doesn’t bring the risk of trying to time the market.

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^[1] https://www.spglobal.com/spdji/en/index-family/equity/  

^[2] https://www.spglobal.com/spdji/en/index-family/fixed-income/

^[3] https://www.bea.gov/news/2024/gross-domestic-product-first-quarter-2024-advance-estimate

^[4] https://www.spglobal.com/spdji/en/index-family/commodities/broad/headline/#overview

^[5] https://www.bea.gov/news/2024/gross-domestic-product-first-quarter-2024-advance-estimate

^[6] https://www.bls.gov/news.release/eci.nr0.htm#:~:text=Compensation%20costs%20for%20civilian%20workers%20increased%204.2%20percent%20for%20the,period%20ending%20in%20March%202023.

^[7] https://www.spglobal.com/spdji/en/index-family/equity/us-equity/us-market-cap/#overview

^[8] https://www.msci.com/end-of-day-data-search

^[9] https://www.spglobal.com/spdji/en/index-family/equity/us-equity/sp-sectors/#overview

^[10] https://www.spglobal.com/spdji/en/index-family/equity/us-equity/sp-sectors/#overview

^[11] https://www.spglobal.com/spdji/en/index-family/equity/

^[12] https://www.nasdaq.com/market-activity/index/comp/historical  

^[13] https://www.spglobal.com/spdji/en/index-family/equity/

^[14] https://fred.stlouisfed.org/series/DGS10

^[15] https://www.bls.gov/news.release/eci.nr0.htm#:~:text=Compensation%20costs%20for%20civilian%20workers%20increased%204.2%20percent%20for%20the,period%20ending%20in%20March%202023.

^[16] https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/

^[17] https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/

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