Navigating Through Bullish Trends and Federal Reserve Signals
For the first quarter of 2024, the S&P 500 posted its best return since 2019 and one of the best quarterly returns over the last half-century. The 10.16% return for the S&P over the first three months of the year represented the ninth-best quarterly start for the index during the previous 54 years. While we have growing concerns about the market's overall health, a strong Q1 performance for the S&P 500 historically leads to positive returns for the rest of the year. Below are a few data points that paint a more positive picture of the stock market throughout the rest of the year:
Not counting 2024, there have been nine other times when the S&P 500 has achieved double-digit gains during the first quarter. In these years, the S&P has posted an average annual return of 21.36%, with an average return of 7.66% over the last three quarters. Both average returns would have been higher if it were not for the Black Monday Crash of 1987.
There have been twenty years in which the S&P's first-quarter returns gained 5% or more. In these years, the S&P's average annual return was a solid 20.32%, including a 9.99% average gain over the year's final three quarters. Out of these twenty years, the S&P only had one year with a negative return. In 2011, after dealing with the Euro Debt Crisis and then the downgrade of the US Credit Rating, the S&P lost a miniscule -0.03%.
A positive first quarter for the S&P has occurred thirty-five times over the last half-decade and almost always produces a positive market year. Only four out of these thirty-five years have posted negative full-year returns after a positive first quarter. Of these down years, 2011 and 2015 were down less than -1%, while 1981 (-9.73%) and 2000 (-10.14%) produced the only years with meaningful declines.
There have been nineteen years in which the S&P posted a negative return for the first quarter, and as expected, most of these years produced negative or below-average market returns. The average full-year return for the S&P 500 in a year where the first-quarter performance is negative is -2.67%.
The powerful upward movement in stock prices over the last five months has put the market in a very overbought condition. But history tells us that in years where the first three months produce double-digit gains, the full-year return has always been positive. These positive data points will be a strong consideration as we move through the rest of the year. Still, we will keep a flexible market outlook as we expect volatility to continue to increase over the coming months.
April Fool's- Fed Rate Cuts
It appears to us that the Federal Reserve has been playing an evil April Fool's joke on investors by dangling potential rate cuts in front of the market over the last five months. After its December 2023 meeting, the Fed predicted it would make three quarter point rate cuts by the end of 2024. This prediction was based on their expectation that inflation would continue to ease throughout the year and unemployment, which has remained stubbornly low, would begin to rise. The market celebrated the Fed's new outlook for monetary easing, which has been the primary driver of the recent rally. However, over the last couple of months, the inflation data has not fallen to a level the Fed had been anticipating, which has caused them to pause taking action. Their message to the investment community has been very mixed. At the March FOMC meeting, besides maintaining their 5.25%-5.50% rate policy, they once again signaled their expectation of three-quarter point rate cuts in 2024, but also upgraded their outlook for both the economy, inflation, and unemployment. Why would there be a need to cut rates if the economy is doing well? Something is not adding up.
The Fed recently:
Raised their 2024-year end GDP expectations from 1.4% to 2.1%. At this point of their policy cycle it would be expected that a higher interest rate would have caused the economy to contract, not expand.
Raised their year-end expectations for core personal consumption expenditures (PCE) reading to 2.6% from the previous 2.4%. Core PCE is the Fed's preferred inflation gauge, so it's interesting they are calling for rate cuts when they expect inflation to continue to rise.
Lowered their year-end expectations for the Unemployment Rate to under 4.0%. The Unemployment Rate has remained stubbornly stable near record-low levels, so it's difficult to imagine the Fed cutting rates unless the employment situation suddenly gets ugly.
Frankly, looking at the data on our end, maybe the real question is...
"Why isn't the Fed talking about raising interest rates instead of cutting rates?"
Obviously, any administration would be against returning to the "rising rate narrative" in an election year. Then again, it is essential to understand that the issues clouding the Fed's outlook, which directly affects asset prices, are a self-inflicted problem caused primarily by our government's spending habits. We have talked before about the adverse effects that deficit spending by the government and excessive debt issuance have on inflation. Government spending also includes massive increases in government hiring and payroll, which has been running rapidly over the last few years.
April Market Outlook
The month of April has consistently been one of the top months for the market over the last half-century. In election years, performance and rank soften slightly, but the month remains a constant performer. In the 15 years since the Great Recession, the S&P has posted positive returns in 13 of the 15 years, with an average monthly return of 2.55%. The only real blemish for the S&P over this period occurred two years ago when the month bucked its bullish trend, and the index dropped -8.77%. Also, for market historians, April is the last month of the S&P's "best six months" period that ends with "sell in May and go away." As we have previously written, the better strategy has actually been "sell in August" over the last few decades, but of course, nothing rhymes with August.
Even with the market still in a bullish seasonal period and overall fundamentals holding up, we cannot deny that the market remains extremely stretched. Looking at the Investor's Intelligence Sentiment survey, roughly 61% of advisors currently have a bullish view of the market, while bearish advisors have dropped down to 15%. This is the first time since late summer 2021 that the bullish camp has crossed above the 60% level. It's also a far cry from the September 2022 bullish reading of 17%. History shows investors are often wise to become contrarians at such extreme levels.
After five straight months of continuous stock gains, we continue to build on our cautious approach to the overall market. Sentiment is stretched, valuations are extended, geopolitical tensions are heating back up, and, as discussed, inflation is remaining much more persistent than expected. Couple these statistics with the fact that we are closing in on the home stretch of what is likely going to be one of the strangest Presidential Elections ever, and we believe caution will soon be warranted.
Based on our data, for the month of April, we are expecting a brief decline into a low due in mid-April. A short-term pullback or consolidation should not be viewed as the start of a longer-term decline just yet. Instead, we expect that a short-term corrective period will likely supply the necessary energy to produce a significant "blow-off rally" in the overall market. So, we are not throwing in the towel just yet. Still, if we see a rebound later in the month and into May, where it seems like stocks can only go up, we will look at this as a signal to start to go against the crowd and begin to rebalance portfolios to a more defensive allocation.
Stay tuned,
Brad Tremitiere CIO