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May 2024 Market Update: Navigating Volatility and Seizing Opportunities

May 2024 Market Update: Navigating Volatility and Seizing Opportunities

May 15, 2024

Key Takeaways:

  • Stock Market Performance: Stocks experienced a setback in April, but the S&P 500 is still up 6% YTD as of April 30th. International stocks are up nearly 5%, while bonds are down over 3%.
  • Fed Policy and Economic Outlook: Recent underwhelming jobs reports and Fed Chair Powell's comments suggest rate hikes are off the table, with rate cuts anticipated later in the year.
  • Economic Concerns: Rising debt costs, high credit card balances, increasing delinquencies, and a weakening jobs market indicate potential economic challenges ahead.
  • Investment Positioning: We have shifted to an underweight equity position, particularly cautious on US stocks, and maintain confidence in international stocks due to their valuation advantages.
  • Bullish on Bonds: We are currently more bullish about bonds than stocks, expecting bond prices to benefit from potential rate cuts and the end of the Fed’s rate-hiking cycle.
  • Managing Risk: Despite market volatility, we focus on long-term success, employing strategies to mitigate risk and tactically allocate capital. Staying the course and avoiding impulsive decisions based on short-term market movements is key.

Market Recap

In this update, we’ll break down what’s been happening in the markets so far in 2024 and explain how we’re positioning your portfolios to make the most of these ever-changing conditions.

Stocks hit a bit of a speed bump in April due to a disappointing jobs report and the Fed’s “higher-for-longer” rate stance. As of April 30th, the S&P 500 is up 6% for the year, international stocks (MSCI ACWI Index) are up nearly 5%, and bonds (Bloomberg Aggregate Bond Index) are down over 3%.

May started with another underwhelming jobs report, adding more evidence that the US labor market is losing steam. Fed Chair Jerome Powell hinted that rate hikes are probably off the table and that rate cuts are coming—it’s just a question of when.

What’s Next for the Economy?

We don’t have a magic crystal ball for the economy or the markets, but we do our best to make sense of current conditions in light of history to make smart investment decisions for you.

At the start of 2024, we expected a slowing US economy and falling interest rates. We’ve been concerned about rising debt service costs, record-high credit card balances (over 20% average rates!), increasing delinquencies, dwindling pandemic savings, and a weakening jobs market, with many full-time jobs turning into part-time gigs.

Given our worries about US stock market valuations and their reliance on a handful of big tech companies, we shifted your portfolios to an underweight equity position in late 2023. Meanwhile, we remained confident in international stocks due to their significant valuation advantage over US stocks. US stock prices are also incorporating lofty expectations for corporate profits, potentially setting them up for downside surprises if they aren’t met.

We were a bit off (or just early) about the economy and rates in the first quarter, as consumer spending stayed strong and Q4 GDP beat expectations. These factors, along with stubbornly high inflation, have delayed rate cuts to late 2024. The market originally expected 6-8 rate cuts in 2024; now, it’s looking more like 1-2, pushing rates higher and dragging down bond prices.

However, we believe our thesis on rates remains sound. Inflation should keep falling towards the Fed’s 2% target. Despite the market’s current enthusiasm for artificial intelligence, economic data is softening. Over time, market prices usually catch up with fundamentals.


Why Would We Expect Inflation to Fall?

Various reasons, but one of the biggest is that housing costs are dropping. New rents have plunged from their post-COVID peaks. However, new rents don’t directly factor into the Consumer Price Index (CPI). Instead, the cost of housing (about 1/3 of CPI) measures changes in consumer spending on the entire housing stock. This means changes in market rents gradually get incorporated into CPI as people move and leases update. The lag between shelter inflation and new rents (as shown in the chart below) suggests shelter inflation has further to fall, which should push overall inflation down.

Opportunities in Bonds

We’re currently more bullish on bonds than stocks and have positioned your portfolios to benefit from any bond market rally.

It’s likely the Fed has wrapped up its rate-hiking cycle, as indicated by Powell’s recent comments. This should cap short-term rates. Longer-term yields, influenced by future economic growth expectations, tend to follow short-term rates over time (see chart below). If short-term rates have peaked, longer-term yields may stabilize or fall sooner if markets anticipate rate cuts, boosting bond prices and your returns.

What If Inflation Stays Stubborn and Rates Don’t Fall?

While it’s not our base case scenario, it’s possible the Fed keeps rates high or even raises them if inflation persists. If that happens, bond prices might not fall enough to offset current yields, meaning your total return would still be positive. Bond yields as of March 2024 are generally around 4.5%, so even a small rate hike (say, 0.50%) wouldn’t likely result in negative returns because starting yields are high. On the flip side, potential rate cuts could significantly boost returns on top of the current yield. In short, the risk of investing in high-quality bonds is currently outweighed by the potential upside.

Are there other reasons to expect a bond market rally?

Yes! We’ve seen a huge amount of capital flow from bonds to money market funds recently due to attractive yields on cash. Historically, when money market assets exceed bond assets, bonds have significantly outperformed over the next 12 months (see charts below).

Managing Risk and Staying the Course

Risk management remains central to our investment philosophy. We’re using various strategies to mitigate risk and tactically allocate your capital to navigate these challenging market conditions. Currently, we’re cautious on equities and bullish on bonds, positioning your accounts accordingly.

Remember, market volatility is normal. While short-term fluctuations can be unsettling, we’re focused on positioning your portfolio for long-term success. Historical data shows that markets tend to recover from downturns and patient, disciplined investors are often rewarded. We encourage you to stay the course and avoid making impulsive decisions based on short-term market movements.

The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.

The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost.

The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.

Additional risks are associated with international investing, such as currency fluctuations, political and economic stability, and differences in accounting standards.

All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.

Investors should consider their financial ability to continue to purchase through periods of low price levels.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

MSCI Emerging Markets – Designed to measure equity market performance in global emerging markets. It is a float-adjusted market capitalization index.

Bloomberg U.S. Aggregate Bond – The Bloomberg U.S. Agg Total Return Value Unhedged, also known as "Bloomberg U.S. Aggregate Bond Index," formerly known as the "Barclays Capital U.S. Aggregate Bond Index," and prior to that, the “Lehman Aggregate Bond Index,” is a broad-based flagship benchmark that measure the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).