Context is everything. Following the ever-evolving market, narrative is key to interpreting the dynamic price action and formulating investment strategies. Challenging 2022 wasn’t just about rising yields to combat supply-driven inflation. It also reflected fears of economic collapse. Fortunately, resilient economies and increasing growth expectations have been driving the bull market since 2023.
The Fed gave way to a ‘pivot party’ to end 2023 and the bond market gave the ‘all clear’ on inflation pricing in six cuts. The prevailing assumption was that policy was “sufficiently restrictive”. Yet, robust economic data prompted alignment with the Fed forecast of three.
The Fed dismissed hotter-than-expected inflation data as just a bump in the road given “some atypical or seasonal factors”. Equities made peace with higher-for-longer rates as the economy demonstrated its ongoing resilience. Against this backdrop, stocks reached new highs in Q1 on the back of decent Q4 2023 earnings.
Fixed income in turn saw a modest downturn with negative returns for government bonds. European sovereigns outperformed as divergent macro dynamics support a more predictable policy trajectory. High-yield bonds delivered, driven by spread compression and easing fiscal conditions. Perhaps the Fed isn’t tight enough. A growing monetary base suggests fiscal stimulus is dominating.
The scoreboard in Q1 looked familiar with the recently commoditised Bitcoin (66.7%), large cap growth (11.4%), and Japanese equities (11.2%) leading, and long-term Treasuries (-3.3%) and commodities (-0.2%) lagging. Big Tech represented a crowded trade driven by strong balance sheets and secular plays, further fuelled by FOMO from 2023’s gains. Heightened concentration and elevated valuations meant markets were increasingly priced for perfection.
Three consecutive hotter-than-expected inflation prints prompted Fed chair Jerome Powell to acknowledge a “lack of further progress”, driving 10-year Treasury yields to 4.67% and delaying the much-anticipated pivot.
After a relentless rally, the pivot hangover saw the S&P 500’s gain down to 7.59% for the year. Geopolitical concerns naturally catalysed the sell-off, but stocks were due a pullback. The reversal of momentum leadership saw the Big Tech-dominated Nasdaq plummet from its 8.72% peak to 1.5% before rebounding to 5.78%, supported by impressive results from giants Alphabet and Microsoft.
If strong economic momentum corroborated by positive IMF growth forecasts continues while inflation proves sticky and corporate and household balance sheets stay healthy, the Fed may indeed spend (most of) 2024 fighting inflation.
However, reflation means higher for longer, not risk-off in a period of fiscal dominance. For stocks to get relief, yields have simply needed to stabilise. Stagflation however, with re-accelerating inflation and lower economic growth, screams risk-off. In Q1, GDP landed at 1.6%, below the forecasted 2.5%, but excluding trade impacts, managed 3.1%.
Personal spending grew slower at 2.5%, while the Fed’s preferred inflation measure rose to 2.7% year-on-year. Crucially, March’s PCE aligned with estimates, growing at 0.3%, matching February’s increase.
As investors seek narratives, the bull run can persevere even amid prolonged high rates, provided growth forecasts rise, earnings meet expectations, and liquidity remains abundant. Episodes of volatility can serve as strategic entry points into long-duration assets for investors as they gradually get comfortable moving away from cash.
Josef Luke Azzopardi is a portfolio manager at BOV Asset Management Ltd.
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