Stocks rose yesterday led by the Dow Industrials. That has been a theme in recent days as valuation, and in some cases, questionable fundamentals, get in the way of some of the high-flying tech stocks. Bond yields dipped slightly in front of today’s FOMC meeting.
As of today, year-to-date, the S&P 500 is now outperforming the NASDAQ Composite. The equal weighted S&P 500 is now outperforming the Dow Industrials. As for the Magnificent 7, so far in 2024 it really has been the Magnificent 2 with Nvidia# up 81% and Meta Platforms# up 40%. Collectively, the other 5 are underperforming the rest of the market. While they seemed to move as one last year, this year there is a wide chasm between Nvidia’s 81% rise and Tesla’s 31% decline. As implied by the comparison of index performance, leadership has broadened out. There are few stocks up 40-80% but there are plenty up 10-20%. Many of the largest retailers fill that bucket with the likes of Wal-Mart, Costco#, Target, Lowe’s#, and Amazon# all up 10-20%. Some of the homebuilders are also in that bucket along with insurance companies, some leading banks, and even Exxon Mobil. While tech performance has been more uneven than last year, there are many like IBM and Oracle# that are up close to 20%. Defense contractors are also strong despite gridlock in Washington limiting funding at the moment.
Trying to tie these leaders together to find a common theme isn’t easy. But some themes stand out. First of all, the classic early cycle companies you expect to see out front early in an economic recovery are on the list. These are interest sensitive companies including homebuilders, retailers, banks, consumer finance companies, and insurance. These gains collectively signal that while credit default rates are rising, investors don’t find them worrisome. The exception would be weaker regional banks with a lot of commercial real estate debt on their books. They continue to lag noticeably.
Another theme is growth. I often note that one buys bonds defensively and stocks offensively. The first question any bond investor should ask is what are the credit risks? Given narrow credit spreads, markets are assuming that even if there is a recession pending, it will only be a modest one. Risk-free bonds today pay roughly 4-5% depending on duration. With inflation near 3% and falling, bonds have defensive appeal. Their downside is that they are not likely to give returns that offset inflation by much. While that isn’t exactly a robust thought, it is better than recent years when bond returns failed to recover the damage caused by inflation.
Stock valuations have been helped since the end of October by the rally in the bond market. P/Es are up as the 10-year Treasury yield has fallen from 5% to a bit under 4.3%. But in recent days and weeks, the bond market has stopped rising while stock valuations continue to increase. That only is sustainable if earnings accelerate. Whether that is a true statement or not will be reflected in management comments associated with first quarter earnings calls scheduled to begin in less than four weeks.
That also leads into a discussion of today’s FOMC meeting. It is a virtual certainty that rates won’t be changed today. Barring a sudden change in direction of inflation data over the next six weeks, few expect a cut in May either. Thus, the key is June. Both recent Fed statements and futures markets point to a first cut in June or July leading to three cuts this year. Chairman Powell today will probably suggest that is as likely a path as any alternative, but with caveats. Obviously, the Fed would like to see inflationary pressures ease a bit faster, particularly for services. Month-over-month, recent data suggests the pace of services inflation may actually be increasing. But the Fed also has to pay attention to its second mandate, full employment and economic growth. The unemployment rate over the past year has risen from 3.4% to 3.9%. A number meaningfully above 4% would raise some concern, particularly in an election year. Second, GDP growth, which has been well above 3% in recent quarters needs to be watched. It is unlikely to suddenly go negative, but if it slips below 2%, it will be concerning to some.
To gauge Fed concerns, investors will turn to the quarterly dot plots issued this afternoon in association with the release of the statement on interest rates. Let me start with the caveat that dot plots are a notoriously inaccurate predictor of future outcomes. Just compare quarter-to-quarter changes in the dot plots to see how quickly views of the FOMC meeting participants change. All the dot-plots can do is present the collective opinions of today’s meeting participants. If growth forecasts moderate, that can determine the current mood for rate cuts and how many might be forthcoming. But nothing more. They reflect mood, not actions. Actions will depend on what is happening on the ground at whichever FOMC meeting the first rate cut takes place. It could be June or July. It might not be until next year. That isn’t a consensus forecast yet. But note that as recently as last fall, markets were looking for up to 7 cuts this year with the first to occur today. If inflation is still sticky in mid-summer amid an economy growing 2% or more, the Fed is unlikely to cut rates against that backdrop. If it gets to September without cutting rates, will it start during the campaign season post-Labor Day?
With that said, if inflation is still around 3% and the economy is still growing at 3%, will that bother investors? Probably not.
But all the above pre-supposes that GDP growth hangs in there. So far, that remains a base case. Yesterday’s housing start numbers support such a conclusion. But, at the same time, there is an economic dichotomy to watch. The top half is doing just fine. They have jobs, continue to spend and are generally happy campers. But the base is struggling. Savings built up during the pandemic have been exhausted. They are starting to live off their credit cards. At 20%+ interest, that can’t last for long. Car loan default rates are going up. On Wall Street, the dollar store companies are hurting, a sure sign of trouble at the bottom of the economic pyramid. The question is will it spread? Bears can give you a million reasons saying yes; bulls will build a case saying no. Both are counterfactuals that one can’t prove today. They will be the concerns that gather more attention in the months ahead.
What the stock market will do today in reaction to today’s FOMC meeting is a mystery that will unfold over the next 48 hours. Logically, the reaction should be mild. There will be no rate change today and I doubt the Fed will hint of one as soon as May. Beyond that is only a hazy guess. The 10-year yield, the one that keys P/E ratios, shouldn’t change a whole lot. That moves on data more than Fedspeak, unless there is a grand pivot as happened last fall when the Fed essentially said rate increases were over. The dot plots will get discussed incessantly on CNBC this afternoon without much else to talk about. For the rest of us, the focus will quickly turn to pending first quarter earnings reports.
Today, Holly Hunter is 66. Spike Lee turns 67 while Bobby Orr celebrates 76.
James M. Meyer, CFA 610-260-2220