Q1 2024: Solid economy, but too early to call a soft landing?
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March at a glance
Continued solid economic activity bolstered stock and bond returns in March and for the first quarter.1 2 Given that strength and the slow retreat of inflation, investors seem to have recalibrated expectations for the timing and magnitude of interest rate cuts by the Fed this year. The Fed made no changes to policy rates in March and, in response to the latest inflation reading to end the month, Chair Powell indicated that conditions still meant that the Fed didn’t “need to be in a hurry to cut rates.”3 Although labor markets remain tight and consumer spending robust, risks remain that economic and company fundamentals will not match the expectations built into current elevated asset prices.
- US equity indices hit record highs during the quarter, with gains broadening in March.
- Fixed income rallied across the board in March, but were generally weak for the quarter.
- Commodity markets surged in the first quarter, with the broad indices up over 10%.4
- Monetary policy remains tight as the Fed left policy rates unchanged during the quarter, but longer term rates have been rising since the start of the year.5
- Fiscal policy remains expansionary with Congress passing a $1.2T spending package in mid March.6
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Solid Economy, AI Excitement Boost Equity Returns
In the U.S., strong corporate earnings results combined with solid economic growth to fuel continued increases in stock prices.
- The S&P 500 rose 10.56%, its highest quarterly increase in 5 years.7
- US large cap growth led the way for the quarter, but leadership broadened in March.
- Small cap value stocks rallied in March after posting negative returns to start the year.
- Emerging markets equities ended the quarter on a strong note, with gains in Europe outweighing continued weakness in Asia and China specifically.8
- Cyclical sectors led the way in March led by an over 10% jump in energy stocks.9
- Technology stocks cooled a bit in March, but were up over 12% for the quarter, led by gains from stocks connected to AI advancements.
Source: S&P Dow Jones Indices10, NASDAQ11
Source: S&P Dow Jones Indices12
Later and Fewer Rate Cuts Expected
Fed commentary over the quarter clearly signaled that while interest rate cuts remain likely in 2024, the start and the magnitude of those cuts were later and lower than investors expected at the beginning of the year. Longer term interest rates rose on these shifting expectations, leading to a barbelled results in fixed income markets — riskier, equity-like segments and short duration showing positive returns for the quarter while longer duration segments fell. March saw a pull back in rates and positive returns across fixed income categories.
- High yield bonds and preferred stocks posted the largest gains for the quarter.
- Ultra short duration treasuries showed the next highest returns.
- Intermediate term corporates and treasuries fared well in March, but remain negative for the year.
- Municipal bond returns were flat for March and the quarter.
Source: S&P, JP Morgan
Mixed results in private markets
Cliffwater’s most recent alternative investments report for January 2024 shows mixed results for the three main private investments categories.13 Their universe contains a sample of funds that report NAVs at least monthly. January’s results continued the patterns seen in 2023. In the past twelve months, private credit sector funds saw an average return of 10.92%, more than twice the results of the trailing 3-year period. Private real asset funds fared poorly, falling 5.37% for the full year. Among those funds, private real estate showed the most negative returns. Private equity fund returns cooled a bit from the prior two years, but are still up 9.97% in the past year.
Source: Cliffwater Alternative Fund Report, March 202414
Slow Progress on Inflation
While reports continue to show slowing inflation, the pace of that progress appeared to stall in the first quarter. Prices from a year earlier, especially for the Fed’s preferred Personal Consumption Expenditures measure (PCE), have moved towards the target 2% range, but month-to-month changes in January and February came in higher than expected. This result is not necessarily surprising given that prices (and wages) are often said to be “sticky downwards”, that is they fall more slowly than they rise, but served to change investors’ expectations.15 The table below shows the current state of inflation measures for the most recent periods. Monthly gains still remain elevated and even year-over-year rates are well above the Fed’s stated 2% target.
Source: Bureau of Labor Statistics (CPI), Bureau of Economic Analysis (PCE), Federal Reserve Bank of Cleveland (TIPS) and University of Michigan (Consumer Survey). 16 17 18 19
The reduction in the PCE measures seen in the chart shows how much inflation has fallen from the peaks two years ago. The pattern does not provide much support for a sticky downward path, but it does show that the level of inflation remains above the rate of the past decade. This pattern underlies the Fed’s current posture: pleased with the progress on inflation, but convinced that the job is not done. As long as this is the case, the Fed has clearly signaled that they are in no hurry to start cutting interest rates.
Source: Bureau of Economic Analysis (PCE)20
Too early to call a soft landing?
Since the Fed started the current cycle of tight monetary policy, forecasters have focused on the probabilities of a recession in the U.S. A year ago, most private forecasters widely expected that the economy would already be in a recession. Those views have changed markedly, but several widely used signals continue to flash warning signs.
A negative spread between the 10-Year and 2-Year Treasury yields (an “inverted yield curve”) has often been associated with subsequent recessions. This spread turned negative in July 2022 and reached -109 basis points a year later, the most negative spread since immediately before the early 1980s recession.21 That spread subsequently moved closer to positive, hitting -14 basis points January this year. Since then, the spread has fallen further and stood at -39 basis points at the end of March.
Another gauge of the likely path of the economy is the rolling 6-month growth rate of the Conference Board’s index of leading economic indicators. Specifically, this measure signals a recession when that growth rate falls below -4.4%, which it hit in early 2022. The index itself continues to fall, but the rate of the decline over the rolling 6 month windows has started to climb back from its low, with the latest rate just about at the level where a recession is not in the forecast.
US Leading Economic Indicators: Rolling 6-Month Growth Rate
Source: The Conference Board22
Of primary importance for the direction of US GDP is consumer spending. The latest personal consumption expenditures index for February showed a 4.9% increase from a year earlier, just above the average rate in the 2000s.23 The chart shows the steady return to more normal levels of spending after the massive distortion from the 2020 pandemic. A key question is whether consumers can keep up this level of spending as the stimulus policies that artificially boosted spending in the past several years are removed.
Source: Bureau of Economic Analysis (PCE)24
A soft landing scenario underlies the rise in asset prices, especially in the equity markets. Achieving this outcome requires consumers to keep spending so that corporate earnings remain robust. So far, the U.S. consumer has cooperated albeit at a slowing rate. Continued high levels of spending will require real income growth as still high interest rates keep the cost of borrowing high and savings from prior stimulus programs are drawn down. Tight labor market conditions and generally rising wages have provided some of that growth, so any protracted weakening in job gains or increases in layoffs could certainly be enough to tip the economy into recession, or at least force a reconciliation in asset prices relative to economic and corporate earnings expectations.
Join our next Compound Conversation about the State of the Market, featuring Steve Dean, CFA® and Brad Porter, on Thursday, April 4th, at 11am PT / 2pm ET.
[1] https://www.spglobal.com/spdji/en/index-family/equity/
[2] https://www.spglobal.com/spdji/en/index-family/fixed-income/
[3] https://www.reuters.com/markets/us/powell-update-views-policy-inflation-remains-sticky-2024-03-29/
[4] https://www.spglobal.com/spdji/en/index-family/commodities/broad/headline/#overview
[5] https://fred.stlouisfed.org/series/DGS10
[6] https://www.reuters.com/world/us/us-congress-averts-government-shutdown-passing-12-trillion-bill-2024-03-23/
[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/
[11] https://www.nasdaq.com/market-activity/index/comp/historical
[12] https://www.spglobal.com/spdji/en/index-family/equity/
[13] Cliffwater, Alternative Investments Report, January2024
[14] Cliffwater, Alternative Investments Report, January2024
[15] Keynes, John Maynard. 1936. The general theory ofemployment, interest, and money New York Harcourt, Brace & World.
[16] https://www.bls.gov/news.release/cpi.htm
[17] https://www.bea.gov/news/2024/personal-income-and-outlays-february-2024
[18] https://www.clevelandfed.org/en/indicators-and-data/inflation-expectations
[19] https://data.sca.isr.umich.edu/
[20] https://fred.stlouisfed.org/series/PCEPI
[21] https://fred.stlouisfed.org/series/T10Y2Y
[22] https://www.conference-board.org/topics/us-leading-indicators
[23] https://fred.stlouisfed.org/series/PCE
[24] https://fred.stlouisfed.org/series/PCE
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