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Market Commentary – February, 2024

- March 20, 2024

Navigating the Bull

  • Equity market returns were robust in February. U.S. small cap stocks led the rally, up 5.7%, and the S&P 500 set new highs, marking a rare occurrence of gains in 16 of the past 18 weeks, something not achieved in more than 50 years.
  • The January CPI report indicated higher-than-expected inflation. Coupled with strong economic data, this has prompted investors to scale back expectations for Federal Reserve rate cuts in 2024.
  • While the U.S. economy continues to show resilience, the United Kingdom and Japan recently slipped into technical recessions, adding complexity to the global economic landscape.
  • Despite the recent equity rally, its narrow scope raises crucial questions. Investors are keenly watching to see if the rally will broaden out further and whether the current blend of earnings and monetary policy can sustain elevated market valuations.
As of the last week in February, the S&P 500 Index had been up in 16 of the past 18 weeks—something that hasn’t occurred in more than 50 years

Overview

Equity markets ended February on a strong note. U.S. small cap stocks marginally bested their larger peers, ending the month up 5.7%. The S&P 500 continued to reach new highs throughout the month, as U.S. large cap stocks gained 5.3%. As of the last week in February, the S&P 500 Index had been up in 16 of the past 18 weeks—something that hasn’t occurred in more than 50 years.1 In contrast to strong equity markets, U.S. intermediate-term bonds continued to struggle, with the Bloomberg U.S. Aggregate Bond Index ending the month down 1.4%.

Market expectations for interest rate cuts declined throughout February and ended the month in line with the Fed’s expected three cuts for the year

The January CPI report came in above expectations, and headline inflation eased to 3.1% year-over-year, down from 3.4% in December, but higher than the expected 2.9%. Core inflation remained unchanged year-over-year, at 3.9%.2 Producer prices also rose more than expected in January, increasing by 0.3% month-over-month, compared to the anticipated 0.1%.3 Strong economic data over the past month suggests that inflation may linger at current levels for longer than initially expected. The labor market remained tight, and the unemployment rate stayed near its four-decade low of 3.4%, marginally ticking up to 3.9% in February.4 In response, Fed officials’ communications throughout February consistently emphasized that rate cuts would be considered only with clear evidence that inflation is moving towards the 2% target.5,6,7 Interestingly, market expectations for interest rate cuts declined throughout February and ended the month in line with the Fed’s expected three cuts for the year. This is a notable decline from the six cuts expected at the end of January, the result of strong economic data and stickier inflation, which pushed out hopes for imminent rate cuts.

Although the U.S. economy remained strong, the United Kingdom and Japan both unexpectedly slipped into recession.8,9 The British economy shrank by 0.3% in the fourth quarter of 2023, marking the second consecutive quarterly contraction and meeting the definition of a ‘technical recession’.8 A slowdown in consumer and business spending caused the Japanese economy to shrink for a second consecutive quarter as consumers battled four-decade-high inflation and a weak yen.9 Japan’s economy also dropped to the world’s fourth largest, losing third place to Germany. Despite a weakening economy, Japan’s stock market, the Nikkei 225 Index, hit a new all-time high on February 22, finally breaking the record set nearly 35 years ago.10

Bullish investor sentiment remained above average for 16 consecutive weeks

Navigating the Bull

Throughout February, the S&P 500 continued to reach new highs, and bullish investor sentiment remained above average for 16 consecutive weeks while the S&P 500 rose for 16 of the past 18 weeks.11 With more than 80% of S&P 500 companies having reported earnings by the end of February, the fourth-quarter 2023 earnings season is nearly wrapped up. Fourth quarter earnings growth estimates have increased to 4.0% year-over year, up from an initial 1.5% expected at the end of 2023 due mostly to gains in the communication services and consumer discretionary sectors.12 Looking forward, expectations for first-quarter 2024 earnings growth have been revised lower, falling to 3.6% from an earlier projection of 5.8% at the start of the year.12 Despite the S&P 500 continuing to reach new highs throughout February, bottom-up earnings estimates for 2024 remained largely unchanged. 12

The performance of several bellwether companies highlighted the continued resilience of the U.S. consumer

Although earnings estimates have stayed relatively stagnant, the performance of several bellwether companies highlighted the continued resilience of the U.S. consumer. At Walmart, U.S. same-store sales increased by 4% year-over-year in the fourth quarter, as consumers, though more selective, “have been shopping frequently,” according to CEO John Rainey during the company’s earnings call.13 Further, several travel companies including Marriott and Royal Caribbean noted that demand for travel remained elevated into 2024.14,15 A recent study by the San Francisco Federal Reserve found that the overall level of real household wealth in the U.S. remained above pre-pandemic levels, despite the drawdown in excess savings, which may suggest the potential for ongoing strength in spending at least in the near future.16

Nvidia’s price-to-earnings (P/E) ratio declined from over 200 times trailing earnings last summer to around 75 in February

Some speculate that an AI-driven “bubble” might be forming, largely due to the stellar performance of a handful of mega-cap technology companies.17,18,19 Despite clear signs of excitement (and, arguably, frenzy) surrounding the new technology, the current rally may be built on more solid underpinnings than the tech bubble of the early 2000s. For instance, several high-flying companies may ultimately merit their otherwise stretched valuations if they can continue to deliver the same level of strong earnings growth that they have had in recent quarters. Despite ending February up more than 65% year-todate and adding $275 billion in market cap and 16% to its share price after announcing earnings, Nvidia’s price-to-earnings (P/E) ratio declined from over 200 times trailing earnings last summer to around 75 in February.20 If we use earnings estimates for 2024, Nvidia trades at a P/E of around 35 times. Similarly, Amazon and Meta are not cheap stocks with trailing P/E ratios of about 60 and 33, respectively, but these multiples are among their lower valuations of the last several years as they have consistently delivered good growth.21,22 Investors have also been more discerning with their rewards: Tesla is down nearly 20% year-to-date, and Apple and Google are down 3% and 1% year-to-date, respectively, due to poorer-than-expected earnings announcements.23,24,25 Finally, the narrow leadership that historically has been a hallmark of toppy markets may be beginning to broaden out. The equal-weighted S&P 500 rose 3.0% over February, ending the month only 0.1% below its all-time high. Small caps rallied in the last week of February, climbing 3% to produce a solid 5.7% for the month.

The narrow leadership that historically has been a hallmark of toppy markets may be beginning to broaden out
The timing and magnitude of interest rate cuts remain uncertain

However, it may not all be smooth sailing. Even though more of the market is enjoying strong returns, the breadth of this rally remains a concern. Only four names (Nvidia, Microsoft, Meta, and Amazon) have driven more than 50% of the S&P 500’s 7.1% gains for the year. In U.S. small cap stocks, one company (Supermicro Computer; a U.S. information technology company) was responsible for nearly all of the Russell 2000’s year-to-date gains of 1.5%. Supermicro Computer ended February up more than 200% yearto-date. Further, the timing and magnitude of interest rate cuts remain uncertain. Federal Open Market Committee (FOMC) meeting minutes show that while the Fed still expects to cut interest rates in 2024, committee members are wary of cutting too soon.26 Three cuts have already been priced out for this year, and higher interest rates continue to affect several key areas of the market. Mortgage rates ended February back above 7% for the first time since December, and average credit card interest rates remain elevated, at 21.5%.27 Rising oil prices have led to average gasoline prices rising across the U.S., with the national average for regular gasoline rising by 7% over the past month.28

Commercial real estate coverage ratios (or loss reserves to delinquent loans) declined to the lowest levels in more than seven years

Commercial loan delinquency rates are also worrying. Commercial real estate coverage ratios (or loss reserves to delinquent loans) declined to the lowest levels in more than seven years as the value of delinquent loans has more than doubled over the past year, from $11.2 billion to $24.3 billion.29 Banks may lose as much as $60 billion on bad commercial real estate loans in the next five years, almost double the $31 billion currently held in loan loss reserves.29 For instance, New York Community Bank (NYCB) is down more than 70% this year and just received a one-billion-dollar cash infusion. The bank announced in late January that it was anticipating significantly higher loan losses due in part to its exposure to commercial real estate.30 The story worsened at the end of February when the company disclosed weaknesses in its internal controls and a tenfold increase in its fourth-quarter loss, hitting $2.7 billion.30 Before its precipitous fall, NYCB was a top-ten position in the SPDR S&P Regional Banking ETF (KRE) and had a market cap of $7.5 billion. NYCB now has a market cap of $2.5 billion.

Unrestrained government spending is counteracting the Fed’s efforts to tighten monetary policy

Further, more than $480 billion has been added to total government debt since the start of 2024, compared to the $108 billion in the first two months of 2023. In early February, the Congressional Budget Office projected that the U.S. budget deficit would likely rise from $1.6 trillion to $2.6 trillion over the next decade.31 Unrestrained government spending is counteracting the Fed’s efforts to tighten monetary policy, which may force the Fed to keep interest rates higher for longer.

The challenge investors face while navigating this bull market was perhaps best captured by JP Morgan Chase CEO Jamie Dimon, speaking at a conference in Miami at the end of the month:
“Confidence is up. There’s more M&A chatter. [The] equity market’s open a little bit. Spreads are getting close to historical lows, which means there’s a lot of money chasing a high-yield deal. Markets are high and people feel it. So far, so good. [But] the way I look at it, remember in 1972, you felt great too, and before any crash, you felt great, and then some things changed. I do think there are things out there which are concerning; we’ve got to keep an eye on them.”32

West Texas Intermediate (WTI) crude oil rose by 6% over February, closing the month at $78.3 per barrel, its highest price since November 2023

Markets

Returns were mixed across asset classes in February. As discussed above, U.S. small cap stocks marginally outperformed U.S. large cap stocks. The former rose 5.7%, and the latter gained 5.3% over the month. Emerging and frontier market stocks also had a good month, ending February up 4.8%. U.S. intermediate-term bonds ended the month down 1.4%, while the 10-year Treasury yield ended the month up 40 basis points, rising to 4.25%. Gold remained above $2,000 per ounce throughout February, yet ended the month roughly flat, down 0.3%. West Texas Intermediate (WTI) crude oil rose by 6% over February, closing the month at $78.3 per barrel, its highest price since November 2023. Midstream energy ended the month up 4.3%. After climbing by 42% over the month, bitcoin ended February only 7% away from its all-time high.

Gold remained above $2,000 per ounce throughout February, yet ended the month flat, down 0.3%
Stickier inflation challenges the economic outlook

Looking Forward

Inflation and policy dynamics are becoming increasingly intricate. Stickier inflation challenges the economic outlook by potentially leading to fewer rate cuts, higher bond yields, lower equity multiples, and subdued real growth. It also places further stress on regional banks, who have come under scrutiny as commercial real estate loan portfolios struggle under the higher interest rate environment. While the Fed may be forced to keep rates high for longer, rampant fiscal spending is more than counteracting their attempts to rein in inflation.

Fiscal spending appears to be on an unsustainable trend. The reality of continued elevated Treasury issuance and the resulting increase in net interest outlays suggests a looming challenge for bond markets and underscores the risks of a “higher-for-longer” interest rate environment. As policymakers grapple with the dual objectives of managing national liabilities and sustaining government spending, the importance of diversifying investment portfolios, including allocations to traditional “safe havens,” becomes ever more important.

Persistently high valuations since 2016 raise questions about the future of equity returns

On the equities front, persistently high valuations since 2016 raise questions about the future of equity returns. If the valuation trends of the last decade represent a new norm, investors might expect forward returns near, albeit slightly below, long-term averages. However, if historical averages over the last century are more indicative of what normal is, equity returns could be considerably lower. While equity valuations are a key concern, we find ourselves more focused on fixed income and credit markets for signs that either the economy is slowing in earnest or bond investors are no longer willing to fund uncontrolled government spending at current interest rates.

  1. Barron’s: https://www.barrons.com/articles/s-p-500-index-record-high-cb2af6fe
  2. BLS: https://www.bls.gov/cpi/
  3. BLS: https://www.bls.gov/ppi/
  4. BLS: https://www.bls.gov/cps/
  5. Federal Reserve: https://www.federalreserve.gov/newsevents/speech/waller20240222a.htm
  6. Federal Reserve: https://www.federalreserve.gov/newsevents/speech/jefferson20240222a.htm
  7. Bloomberg: https://www.bloomberg.com/news/articles/2024-02-06/mester-says-fed-should-gain-confidence-tocut-later-this-year
  8. BBC: https://www.bbc.com/news/business-68285833
  9. Reuters: https://www.reuters.com/markets/asia/japans-economy-slips-into-recession-weak-domestic-demand-2024-02-15/
  10. CNBC: https://www.cnbc.com/2024/03/04/japans-nikkei-hits-record-high-above-40000-jesper-koll-on-moreupside.html
  11. AAII: https://www.aaii.com/sentimentsurvey
  12. FactSet: https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_030124.pdf
  13. Bloomberg: https://www.bloomberg.com/news/articles/2024-02-20/walmart-wmt-offers-muted-earnings-guidanceseeing-consumer-caution
  14. Marriott: https://news.marriott.com/news/2024/02/13/marriott-international-reports-strong-fourth-quarter-and-fullyear-2023-results
  15. Yahoo Finance: https://finance.yahoo.com/news/royal-caribbean-group-reports-strong-175736529.html
  16. Federal Reserve Bank of San Francisco: https://www.frbsf.org/research-and-insights/publications/economicletter/2024/02/rise-and-fall-pandemic-excess-wealth/
  17. Wall Street Journal: https://www.wsj.com/finance/stocks/nvidia-stock-price-bubble-worries-73d7b8d1
  18. Wall Street Journal: https://www.wsj.com/finance/stocks/is-there-an-ai-bubble-the-nifty-fifty-show-it-isnt-that-simple-11a0f07a
  19. Fortune: https://fortune.com/2024/02/28/is-there-ai-stock-bubble-lessons-from-dot-com-crash-stock-valuations/
  20. YCharts: https://ycharts.com/companies/NVDA/pe_ratio
  21. YCharts: https://ycharts.com/companies/AMZN/pe_ratio
  22. YCharts: https://ycharts.com/companies/META/pe_ratio
  23. Barron’s: https://www.barrons.com/livecoverage/tesla-q4-earnings-report-stock-price
  24. CNBC: https://www.cnbc.com/2024/01/30/alphabet-googl-q4-earnings-report-2023.html
  25. CNBC: https://www.cnbc.com/2024/02/01/apple-aapl-earnings-report-q1-2024.html
  26. Federal Reserve: https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20240131.pdf
  27. FRED: https://fred.stlouisfed.org/series/TERMCBCCALLNS
  28. AAA: https://gasprices.aaa.com/
  29. Financial Times: https://www.ft.com/content/4114454c-a924-4929-85f4-5360b2b871c6
  30. New York Times: https://www.nytimes.com/2024/03/01/business/new-york-community-bank.html
  31. Financial Times: https://www.ft.com/content/b6693fee-cd97-4ea9-895d-036aae6eefaf
  32. CNBC: https://www.cnbc.com/2024/02/26/jamie-dimon-is-cautious-about-everything-as-he-sees-risks-to-a-soft-landing.html

DISCLAIMER

Magnus Financial Group LLC (“Magnus”) did not produce and bears no responsibility for any part of this report whatsoever, including but not limited to any microeconomic views, inaccuracies or any errors or omissions. Research and data used in the presentation have come from third-party sources that Magnus has not independently verified presentation and the opinions expressed are not by Magnus or its employees and are current only as of the time made and are subject to change without notice.

This report may include estimates, projections or other forward-looking statements, however, due to numerous factors, actual events may differ substantially from those presented. The graphs and tables making up this report have been based on unaudited, third-party data and performance information provided to us by one or more commercial databases. Except for the historical information contained in this report, certain matters are forward looking statements or projections that are dependent upon risks and uncertainties, including but not limited to factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle.

Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results and historical information provided displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be inferred that these results are indicative of the future performance of any strategy, index, fund, manager or group of managers. Index benchmarks contained in this report are provided so that performance can be compared with the performance of well-known and widely recognized indices. Index results assume the re-investment of all dividends and interest and do not reflect any management fees, transaction costs or expenses.

The information provided is not intended to be, and should not be construed as, investment, legal or tax advice nor should such information contained herein be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. An investor should consult with their financial advisor to determine the appropriate investment strategies and investment vehicles. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. This presentation makes no implied or express recommendations concerning the way any client’s accounts should or would be handled, as appropriate investment decisions depend upon the client’s specific investment objectives.

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DEFINITIONS

Asset class performance was measured using the following benchmarks: U.S. Large Cap Stocks: S&P 500 TR Index; U.S. Small & Micro Cap: Russell 2000 TR Index; Intl Dev Large Cap Stocks: MSCI EAFE GR Index; Emerging & Frontier Market Stocks: MSCI Emerging Markets GR Index; U.S. Intermediate-Term Muni Bonds: Bloomberg Barclays 1-10 (1-12 Yr) Muni Bond TR Index; U.S. Intermediate-Term Bonds: Bloomberg Barclays U.S. Aggregate Bond TR Index; U.S. High Yield Bonds: Bloomberg Barclays U.S. Corporate High Yield TR Index; U.S. Bank Loans: S&P/LSTA U.S. Leveraged Loan Index; Intl Developed Bonds: Bloomberg Barclays Global Aggregate ex-U.S. Index; Emerging & Frontier Market Bonds: JPMorgan EMBI Global Diversified TR Index; U.S. REITs: MSCI U.S. REIT GR Index, Ex U.S. Real Estate Securities: S&P Global Ex-U.S. Property TR Index; Commodity Futures: Bloomberg Commodity TR Index; Midstream Energy: Alerian MLP TR Index; Gold: LBMA Gold Price, U.S. 60/40: 60% S&P 500 TR Index; 40% Bloomberg Barclays U.S. Aggregate Bond TR Index; Global 60/40: 60% MSCI ACWI GR Index; 40% Bloomberg Barclays Global Aggregate Bond TR Index.