Authored by :
Michael G. Dow, CAIA, CFA®, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research

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The Quick Facts

• The S&P 500 was up 10.6% in 1Q 2024, the best first-quarter market performance since 1Q 2019.
• The broadening of the rally continued in March, with the Russell 2000 Small Cap index up 3.6%, and the MSCI EAFE (Europe, Australasia, and the Far East Index) index up 3.3%, outpacing the S&P 500’s 3.2% gain.
• The S&P 500 broke 22 record highs in 1Q 2024 after macro data showed the economy is on track for a soft landing.
• Value outperformed Growth by 3.2% in March. However, for 1Q 2024, the Russell 1000 Growth Index was up 11.4%, 2.4% ahead of the Russel 1000 Value Index.
• Ten of the eleven Global Industry Classification Standard (GICS) sectors posted gains in 1Q, led by Energy.
• The Federal Reserve (Fed) held interest rates at 5.25% – 5.50% at its March meeting.
• The Fed’s dot plot continues to indicate 3 rate cuts in 2024.
• Longer-run Fed funds estimate ticked up slightly.

Despite the uncertain timing of future Fed rate cuts, economic strength and increasing soft-landing hopes led to the best first-quarter U.S. market performance since 2019, with the S&P 500 up 10.6%. The Magnificent 7 (Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia, and Tesla) accounted for close to 40% of the YTD S&P 500 return of 10.6%.

The broadening of the rally continued in March, with the Russell 2000 Small Cap index up 3.6%, and the MSCI EAFE index up 3.3%, outpacing the S&P 500’s 3.2% gain.

The Fed held interest rates at 5.25% – 5.50% at its March meeting. The language in the Federal Open Market Committee (FOMC) statement was very similar to the January statement, stating that “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” Despite concerning inflation data, the Fed’s dot plot continues to indicate three rate cuts in 2024. However, one cut was removed from the 2025 dot plot, and the longer-term fed funds estimate ticked up slightly, implying that a neutral stance on monetary policy may be slightly higher.

March Asset Class Performance

Fed Chair Powell noted in his press conference that there has been progress on the dual mandate (maximum employment and price stability), but the risks are two-sided. Cutting rates either too early or too late could lead to higher inflation or a recession, respectively. The Fed’s dovish stance—maintaining its view of three interest rate cuts this year while upgrading its economic outlook—has encouraged risk-taking. Also, it has encouraged possible exuberance about productivity and growth opportunities in Artificial Intelligence (AI), which has contributed to the market’s momentum.

At the sector level, ten of the eleven sectors gained in March (Consumer Discretionary was down 0.1%), with Energy the only sector to post a double-digit return (+10.5%). Ten of the eleven GICS sectors posted gains in 1Q 2024, led by Energy (+13.5%), Communication Services (+12.7%), and Financials (+12.4%). Real Estate was the only sector in the red for the quarter at -0.7%.

Value outperformed Growth by 3.2% In March. However, over the first quarter of 2024, the Russell 1000 Growth Index was up 11.4% and 2.4% ahead of the Russell 1000 Value Index, despite higher risk-free rates. Over the last three years, the total return of the Large-cap Value index has lagged the Large-cap Growth Index by 15.1%. The Russell 2000 Index – the world’s most closely followed gauge of smaller companies – was up 3.6% in March, confirming the broadening of the equity rally that started in February. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was up 3.4% in March, 0.2% more than the S&P 500. Over the last three years, the ESG index is up 29.0% and 7.9% behind the S&P 500 on a total return basis. Emerging markets equities also had a positive March, up 2.5%. They are now up year-to-date but well behind U.S. and EAFE (Europe, Australasia, and the Far East) equity returns over the first quarter (+2.4%), last 1 year (+8.2%), and 3 years (-15.6%).

The first quarter of 2024 saw notable movements in Treasury yields, influenced by economic data and the Fed’s stance. The 10-year U.S. Treasury closed at 4.20% vs. 4.25% at the end of February, 3.88% at the end of December 2023, and from a peak of 5.0% in October 2023. Shorter-term 2-year U.S. Treasury closed flat on the month at 4.62% vs. 4.25% at the end of 2023. The 2y x 10y yield curve remains inverted by 42 basis points at the end of March. The U.S. Aggregate bond index progressed by 0.9% in March but remains down 0.8% YTD. The Municipal Bond Index closed March flat and 1Q down 0.4%. U.S. Corporate High Yield was up 1.2% in March and 1.5% YTD.

Oil futures, as measured by the WTI Crude Oil $/bbl., were up 6.3% in March to $83 bbl. Global economic dynamics, interest rate expectations, and central bank actions fueled Gold’s impressive performance in 1Q 2024. Gold spot was up 9.1% in March and 8.1% YTD, reaching all-time highs and closing at $2,230 per troy ounce. The U.S. Dollar Index, which indicates the general international value of the U.S. Dollar, further strengthened, with the DXY rising by 0.3% in March, bringing the YTD gain to 3.1%. A weaker dollar is generally good news for equity markets and commodities, just as a strong one tends to hold back stocks and other risky investments. Digital asset valuations saw further momentum in March. Bitcoin’s value surged 14.8% in March and 65.9% YTD, reaching $70,000+ a coin for the first time and new all-time highs. This surge continues to be driven by massive demand for Bitcoin ETFs. The approval of several spot Bitcoin ETFs by the SEC (Securities and Exchange Commission) in January 2024 is leading to billions of inflows. Ethereum followed the crypto momentum trend with +8.2% in March and +58.8% YTD.

Interest rate volatility has been constant since the Fed began its rate-hiking cycle in 2022. While equity investors focus on the well-known CBOE Volatility Index (“VIX”), bond investors closely watch the less well-known ICE BofA MOVE (“MOVE”) Index, which measures bond market volatility. The MOVE Index ended March significantly lower at 86, close to the post-Global Financial Crisis (GFC) average of 80, indicating a less uncertain rate environment. The VIX remained very low throughout the quarter, never trading above 16 and closing March at 13, compared to the post-GFC average of 18.5. A low VIX can create a sense of complacency in the stock market and calls for caution, not unwarranted confidence.

Chart of the Month – Real Federal Funds Rate (“Real Fed Funds”)

The Real Fed Funds rate is a crucial indicator for monetary policy. The Real Fed Funds rate is calculated by subtracting the 12-month core inflation – using the Personal Consumption Expenditures price index – from the effective nominal rate. In other words, it accounts for inflation and gives a more accurate picture of the real cost of borrowing. When the real Fed Funds rate is well above zero, interest rates are generally high enough to slow economic activity. Conversely, a real rate well below zero will generally stimulate economic growth. The neutral Fed real policy rate, known as r* (“r-star”) to monetary economists, is neither stimulative nor a headwind to growth. The theoretical r* can only be estimated; it is not known for certain. The Fed’s path to interest rate normalization inevitably leads to r* – and it is only after interest rates are normalized that a “soft landing” ¹  can be declared.

Fed policy is now considered tight, given a strongly positive real Fed Funds rate (near 2.5%; see chart below). Will it be tight or loose by the end of the year? The Fed is expected to begin cutting rates this summer, but monetary policy may still be restrictive by the end of next year, even after three or four cuts. It will depend on the Real Fed funds rate versus the unobservable r*. The Fed’s long-term estimate of the real neutral rate – which neither restricts growth nor accommodates it – WAS assumed to be about 0.125%. It could be higher in the current environment, which means we may be closer to “landing the plane” than previously thought.

The Fed needs to “thread the needle” to safely land the plane at more normalized rates, and they will be doing so without knowing exactly where the destination lies. It may be a bumpy ride.

¹ A “soft landing” typically refers to an economic scenario where a slowdown occurs gradually, rather than a sudden or dramatic correction. It is used in the context of monetary policy, where central banks aim to engineer a controlled decrease in economic growth to prevent overheating and inflation without causing a recession.

Quote of the Month

“Soft landing is not easy. It is a rarity.”  – Daniel Lacalle, Economist

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