Transcript

Amada Agati:  

Hey everybody.

It's hard to believe it's already time for the March edition of Adding Alpha, but here we are. So let's take stock of where markets are two months into the new year and gauge what comes next.

We're only about 60 days into the new year, but a change in the calendar hasn't really changed any of the key themes relative to last year. 

US large cap growth is still driving markets higher. Small cap and developed international are modestly positive. Whereas emerging markets and smaller cap value are negative year to date. It just continues to be very, very narrow market leadership dynamics.

Another theme that continues, investors are trying to outguess the Fed's next interest rate move. It's a game we think is somewhat foolish, and here's why.

Markets were wrong on rate hikes on the way up, and we already can see it's happening again with rate cut expectations on the way down. Coming into 2024, markets were pricing in rate cuts beginning as early as March. No way do we get a rate cut in March, and we think it's pretty unlikely we're going to get a rate cut in May too.

It's really a be careful what you wish for kind of dynamic. Because if we're cutting that aggressively, something big must have broken down in the backdrop, and the economic data we're seeing just doesn't support that kind of stress in the economy right now.

Where we go from here is largely going to be dependent on inflation and the labor market. Just remember, the last use CPI and PPI readings are a reminder that inflation does not move in a straight line.

So we do think it's premature to really wave the victory flag here in this inflationary battle. That last mile to get to the 2% target for the Fed is just going to continue to be extremely challenger.

Meanwhile in the bond market, we're still in adverted yield curve territory, but we are well off the lows of last year.It's a reflection of the economic backdrop beginning to brighten or at least be a little bit less dark.

We expect longer duration yields to naturally be pressured higher in 2024 based on continued economic growth. It's that soft landing scenario that we think is coming into view for 2024 and recalibrating inflation expectations. While at the same time, we get rate cuts at the shorter end later in the year from the Fed.

Although volatility is likely to continue, we expect to see a steepening and a normalization of the yield curve over the course of 2024. Credit continues to be in lockstep with the stock market with credit spreads for both investment grade and high yield sitting at or below their 10 year averages.

While credit spreads tend to be a canary in the coal mine signal for something is amiss in the backdrop, for the most part, credit spreads continue to be very well behaved, which is good news.

So let's shift gears and talk earnings. We experienced an extended period of negative revisions heading into year end with the S&P 500 growth rate for Q4 expected to be just 1.6%.

All the way back on September 30th, it was over 600 basis points higher. So that's a huge decline. It was one of the worst negative revisionary periods in the last 10 years. And excluding Magnificent Seven, that 1.6% growth rate falls to minus 6.7%.

It's just another example how narrow market leadership is this time through the lens of earnings. Consensus still expects an impressive 11% year on year growth for 2024, which still seems too high and optimistic to us without support from a broader base earnings reacceleration and really participation from the bottom 493 stocks in the S&P 500 index.

Seventy-five percent of the return in the S&P 500 last year was driven by multiple expansion. With the index priced for perfection, at 20 times a forward PE, it's 18.8 times excluding the Magnificent Seven for those keeping score at home.

There's a lot of pressure on earnings to deliver results against a backdrop of already very high expectations. With a hashtag slow your roll economic backdrop as the base case for this year, and the S&P 500 at close to all-time highs, the theme of risk aware continues.

Volatility is likely to be the constant, and it's a buckle up environment for investors in 2024.