March, First Quarter 2024 Review and Outlook

Executive Summary

• Numerous U.S. equity benchmarks reach new all-time highs
• S&P 500 registers historic 5-month gain 
• Corporate EPS is forecasted to rise +11% and +13% in CY 2024 and CY 2025
• Federal Reserve projects lower real rates despite improving GDP and jobs
• Improving market breadth supports the bull market 

Following a robust Q4 characterized by strong momentum and breadth readings, U.S. equities surged to all-time highs in Q1, led by the S&P 500 with a total return of 10.6%. 

Whereas the rally in Q4 was due in large part to a dramatic shift lower in the yield curve on expectations of a dovish Fed pivot, the continuation of equity gains in Q1 came despite the hawkish repricing of monetary policy. Markets began the year expecting roughly seven rate cuts for 2024. Throughout the quarter, that pendulum swung back to three cuts amidst a backdrop of improving economic growth and slowing disinflation. 

Q4 GDP expanded 3.4% versus the initial 2% consensus, with consumer spending a primary tailwind, while consensus Q1 GDP stands at 1.5%, up from 0.6% at the end of 2023. The labor market has been resilient, with nonfarm payrolls up 229k in January and 275k in February. March payrolls are expected to rise another 205k. While some measures of inflation show prices have intensified since the start of the year, the Federal Reserve’s preferred inflation gauge, core PCE YoY, cooled to 2.8% in February from 2.9% in January. Separately, the Conference Board’s Leading Economic Index (LEI) turned positive in February, which ended a 23-month streak of negative readings.

While equities were higher across the board in Q1, the “less dovish” repricing environment impacted performance amongst the various equity benchmarks. Small and micro caps were the top performers over the last two months of 2023 but underperformed in Q1 (Russell 2000 +5.2%; Russell Microcap +4.7%) versus large cap (SPX +10.6%; Nasdaq 100 +8.7%). Despite the delay in timing and the reduced magnitude of rate cuts, markets appear increasingly confident the cutting cycle is coming. Accordingly, the small and mid-cap indices have been the top performers over this longer 5-month period.  

Growth vs. Value       

Large-cap growth (+11.3%) outperformed large value (+8.9%) by 2.4 percentage points in Q1, while small-cap growth (+7.5%) outperformed small-cap value by 4.9 percentage points. Smaller companies that tend to have relatively weaker balance sheets and pricing power have seen disproportionate headwinds from inflation and rising borrowing costs. 

Sector Performance

Ten of the eleven large-cap GICS sectors were higher in Q1. Large-cap sector performance was led by Communications (+15.8%), Energy (+13.7%), Technology (+12.7%), Financials (+12.4%), and Industrials (+11%), while Real Estate (-0.05%) was the only sector in the red. While Technology and Communications continue to be amongst the top performers, the previously underperforming Financials sector has been the 2nd best performer (+31.4%) over the prior five months.  

While markets have moved towards the Fed’s more hawkish stance, the Federal Reserve is still seen as supportive. In the face of improving economic growth and employment expectations, the Fed has been forecasting looser monetary policy by year-end 2024, both in nominal and real terms. At the most recent March FOMC, the Fed’s Summary of Economic Projections (SEP) forecasted inflation (core PCE) to decline to 2.6% by the end of 2024, which is unchanged from their September forecast. Over this same period, the committee revised its year-end FFR to 4.6% from 5.1%, which implies three 25bp rate cuts from current levels. Accordingly, the Fed is projecting looser monetary policy by revising its year-end 2024 real rates (FFR – core PCE) expectations from 2.5% (September SEP) to 2% (March SEP). The Fed’s reasoning for lowering real rates in an expanding economic environment and improving employment outlook is to protect against growth risks and ensure they achieve a soft landing. At the March meeting, Chair Powell suggested that recent inflation data (hotter) has not altered the Fed’s view on the broader disinflation trend. His commentary on QT tapering has been supportive as well. The market and the Fed are now closely aligned in forecasting three cuts, which will most likely come at the June, September, and December meetings.  

Looking Ahead

Q1 earnings season is fast approaching. The street is expecting S&P 500 companies to report YoY EPS growth for the 4th consecutive quarter following declines in the prior three quarters. Following EPS growth of 1.8% in CY 2023, analysts expect S&P 500 companies to report 3.4% YoY EPS growth in Q1, 9% in Q2, 8.2% in Q3, and 17.2% in Q4, according to FactSet. For CY 2024 and CY 2025, analysts are projecting EPS growth north of 11% and 13%.   

The S&P 500’s current streak of gains is nothing short of historic. Q1 marked its second consecutive quarter of double-digit gains for only the 9th time since 1940. Historically, this has been a bullish signal as the prior eight occurrences were all followed by positive 12M gains with average and median total returns of 14.9% and 13%, respectively. In addition, the S&P 500 has gained in each of the prior five months for a price return of 25.3%. This is its tenth-best 5-month gain since 1940, which historically has been bullish for future performance. The prior nine instances of record 5-month performance were all followed by positive 12M gains with average and median total returns of 19.6% and 22.6%, respectively. 

Market breadth was a widespread concern over the 1H of 2023 when the majority of index gains had seemingly been realized by a small number of large cap growth stocks, particularly the Magnificent Seven. 

While large caps and growth continue to show outperformance, breadth has steadily been improving since the summer of 2023.    

The S&P 500’s Advance Decline Line (lower panel) has been making new cycle highs since June of 2023 despite the index not reaching new highs until January 2024.  

Last month, both the S&P 500 Equal Weight Index (upper panel) and the S&P MidCap 400 Index (lower panel) reached new all-time highs.  

The Russell 2000 remains 15% below its prior cycle highs however last month the small cap index broke out from a ~20-month trading range and has since been trending higher. The Russell Microcap is 30% below its prior highs and is testing a key price level that has acted as both support and resistance on numerous occasions going back to January 2022. An upside breakout may signal a resumption of the prior uptrend off the October lows.  

The S&P MidCap Value Index is starting to break out from a clearly defined resistance range (891 – 915; 5% wide) in place since May 2021.  

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.