Authored by:
Michael G. Dow, CAIA, CFA®, CPA, Chief Investment Officer
Julien Frazzo, Deputy Chief Investment Officer
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The Quick Facts
- The first down month for equities since October 2023 and the Federal Reserve (Fed) pivot.
- The S&P 500 tumbled 4.1%, given concerns surrounding stubborn inflation and higher rates for longer.
- Ten of the eleven Global Industry Classification Standard (GICS) sectors posted losses, with Real Estate showing the largest drop (-8.4%). Utilities were the only sector in the green in April (+1.7%).
- The “higher rates for longer” narrative also put bonds under pressure in April.
- At its May 1 meeting, the Fed admitted that “in recent months, there has been a lack of further progress toward the Committee’s 2% inflation objective.”
- Gold was up 2.5% in April (+10.8% year-to-date), topping $2,392 at its all-time high.
April was the first down month for equities since October 2023 and the Fed pivot. The S&P 500 tumbled 4.1%, given concerns surrounding sticky inflation and higher rates for longer. Small-caps fared worse than their large-cap peers, with the Russell 2000 small-cap index down 7.0%.
U.S. Treasuries had their worst performance in seven months in April, with mounting evidence of stubborn inflation causing the market to adjust to fewer, if any, interest rate cuts in 2024. Since the beginning of 2024, U.S. inflation readings have stopped improving, and the revival of the narrative of higher rates for longer has put stocks and bonds under pressure.
A hot Consumer Price Index (CPI) print in March, the third in a row, forced the market to push out rate-cut expectations. The U.S. CPI rose +0.4% m/m (3.5% y/y) and core CPI (excluding food & energy) was also up +0.4% m/m (3.8% y/y) in March, as it did for the previous two months. The shelter index increased by 0.4% in March and was the largest factor in the monthly increase in the index for all items less food and energy. These hot readings and the underlying trend are not compatible with the Fed cutting rates.
April Asset Class Performance
The Fed admitted in the statement issued after the May 1 Federal Open Market Committee (FOMC) meeting that “in recent months, there has been a lack of further progress toward the Committee’s 2% inflation objective.” Markets expect the Fed to remain restrictive (i.e., on hold) until the core CPI backdrop improves or something breaks in the economy. Fed Chair Powell argued in his post-FOMC press conference that despite the stickiness of inflation in recent months, additional interest rate hikes were unlikely. The next Fed move remains likely to be a cut. A delayed cut.
Ten of the eleven sectors posted losses in April, with Real Estate posting the largest drop (-8.4%). The Utilities sector was the exception with a positive 1.7% return. Year-to-date, Energy (+12.4%), Financials (+7.7%), and Communication Services (+7.4%) are the top-performing sectors, with two sectors in the red, Consumer Discretionary (-1.6%) and Real Estate (-9.0%).
Value insignificantly outperformed Growth in April. However, year-to-date, the Russell 1000 Growth Index is up 6.7% 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 11.5%. The Russell 2000 Index – the world’s most closely followed gauge of smaller companies – was down 7.0% in April, reflecting the vulnerability of small companies to higher interest rates. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was down 4.4% in April, 0.3% more than the S&P 500. Over the last three years, the ESG index is up 18.9% and 7.2% behind the S&P 500 on a total return basis. Emerging markets equities outperformed in April, with a +0.4% return. However, they remain behind U.S. and EAFE (Europe, Australasia, and the Far East) equity returns year-to-date (+2.8%), over the last 12 months (+9.9%), and over the last 3 years (-16.1%).
Bonds were under pressure in April. The U.S. Treasury curve was up uniformly on the month. Most notable was the 2-year yield, which crossed the symbolic 5% level to close April at 5.04%. The 10-year U.S. Treasury ended April at 4.68% vs. 4.20% at the end of March, 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 46 bps higher on the month at 5.04% vs. 4.25% at the end of 2023. The 2y x 10y yield curve remains inverted by 36 basis points at the end of April. The U.S. Aggregate bond index declined by 2.5% in April and is now down 3.3% YTD. The Municipal Bond Index closed April down 1.2% and 1.6% YTD. U.S. Corporate High Yield is the only bond category still up YTD (+0.5%) despite a negative 0.9% return in April.
Oil futures, as measured by the WTI Crude Oil $/bbl., were down 1.5% in April to $82 bbl. Gold was up 2.5% in April (+10.8% YTD), topping $2,392/Oz at its record high. Why are gold prices going up? Apollo’s Chief Economist Torsten Slok believes that “geopolitical risk, China demand, and rising U.S. inflation” are the reasons behind the gold rally. Copper was the outstanding commodity in April, up 13.0% (16.2% YTD) to a two-year high. The U.S. Dollar Index, which indicates the general international value of the U.S. Dollar, further strengthened, with the DXY rising by 1.7% in April, bringing the YTD gain to 4.8%. 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 assets suffered from the risk-off mood in April. April’s highlight was the much-anticipated Bitcoin “halving.” However, crypto valuations pulled back as the macro backdrop turned less favorable. Bitcoin’s value tanked 15.5% in April but remains up 40.8% YTD. Ethereum followed the trend with -18.5% in April (+29.8% 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 spiked back up to 120 in April from an 86 low at the end of March, and much higher than the post-Global Financial Crisis (GFC) average of 80, indicating a more uncertain rate environment. The VIX also rose to 19 in mid-April, the highest reading year-to-date, and compared to the post-GFC average of 18.5. A low VIX can create a sense of complacency in the stock market.
Chart of the Month – Nominal Fed Funds and Nominal r*
The “Fed r*” refers to the equilibrium or natural rate of interest, often denoted as “r*.” It represents the theoretical interest rate level at which monetary policy is neither accommodative nor restrictive, meaning it neither stimulates nor slows down economic growth. In other words, it’s the interest rate that would prevail when the economy is operating at full employment and stable inflation over the long term.
Central banks, like the Fed in the U.S., often consider the gap between the actual interest rate and the natural rate as a key factor in determining the stance of monetary policy. If the actual interest rate is below r*, monetary policy is considered accommodative (stimulative); if it’s above r*, it’s considered restrictive (tightening).
Estimating r* is not straightforward and involves various economic factors such as productivity growth, demographics, and global economic conditions. It can change over time due to shifts in these factors and changes in central bank policy frameworks. Central banks closely monitor r* to gauge whether their monetary policy stance is appropriate for prevailing economic conditions.
The Fed has raised rates to a “restrictive” level, that is above the estimate of the neutral rate (or r*) to slow the economy and reduce inflation without causing a recession. This balancing act has recently been made more complicated by a worrisome potential rise in r* – in effect, the Fed is trying to land the plane without knowing where the airport is.
The “Fed r*” refers to the equilibrium or natural rate of interest, often denoted as “r*.” It represents the theoretical interest rate level at which monetary policy is neither accommodative nor restrictive, meaning it neither stimulates nor slows down economic growth. In other words, it’s the interest rate that would prevail when the economy is operating at full employment and stable inflation over the long term.
Central banks, like the Fed in the U.S., often consider the gap between the actual interest rate and the natural rate as a key factor in determining the stance of monetary policy. If the actual interest rate is below r*, monetary policy is considered accommodative (stimulative); if it’s above r*, it’s considered restrictive (tightening).
Estimating r* is not straightforward and involves various economic factors such as productivity growth, demographics, and global economic conditions. It can change over time due to shifts in these factors and changes in central bank policy frameworks. Central banks closely monitor r* to gauge whether their monetary policy stance is appropriate for prevailing economic conditions.
The Fed has raised rates to a “restrictive” level, that is above the estimate of the neutral rate (or r*) to slow the economy and reduce inflation without causing a recession. This balancing act has recently been made more complicated by a worrisome potential rise in r* – in effect, the Fed is trying to land the plane without knowing where the airport is.
Quote of the Month
“Inflation is taxation without legislation.” – Milton Friedman
Major Asset Class Dashboard
RELATED LINKS
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Beacon ‘Pointe of View’ – A Market Update April 2024
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