Broker Check

M&R Capital Management 1Q 2024 Market Review

April 05, 2024

The bull market in equities rolled on in the first quarter of 2024, as all the major stock indices notched new highs. The advance was led by the “magnificent seven” and other AI stocks, as the percentage of the capitalization weighted S&P 500 that these stocks represent climbed to 32%, a 50-year high, according to a recent report by JP Morgan Chase. 

Fifty years brings back memories to another period where high market returns depended on very few stocks. These stocks were christened the “nifty fifty,” in the late 1960s and early 1970s. Unlike the “dot.com” era of 1998-2001 which was full of companies with no cash flow, no earnings and even no revenue, all the nifty fifty were very much real companies earning profits. Storied names like Hewlett Packard, McDonald’s, Disney, Raytheon, Wells Fargo, and Merck were prominent performers in that period, with annual returns in 1972 between 45% and 101%. They were considered “one decision stocks,” and investors were encouraged to buy and hold them forever. 

The aftermath of the nifty fifty’s surge in 1972 was not pretty. From early 1973 through the end of 1974, the group declined over 70%, as the S&P 500 lost 44% in a brutal two-year bear market. Some of these once famous names, like Polaroid, Sears Roebuck, Digital Equipment and Joseph Schlitz Brewing, are long gone. But many of the great companies in the nifty fifty, like those mentioned above and others like PepsiCo, Raytheon and American Express, recovered and went on to perform well in the following years. With the benefit of hindsight, we can conclude that while these stocks were very richly valued by the end of 1972, their growth in the ensuing years enabled them to “grow into” their valuation and go on to even higher prices. 

The current market advance is becoming more balanced as non- AI and smaller capitalization stocks are beginning to outperform the tech focused mega cap issues. In the first half of the just finished quarter, tech issues and the “mag seven” predominated, as the Nasdaq 100 gained 6% through February 13th while the equal weighted S&P 500 and small cap stocks in fact lost ground. But since February 13th the equal weighted S&P 500 has gained 7.4% while the Nasdaq 100’s advance has slowed to +4.6%. Small cap stocks as represented by the Russell 2000 index gained 8.57% in the second half of the first quarter. We view this rotation as healthy. 

The bull market in US equities has not extended to the bond market as the ten-year US Treasury returned -3.4% so far this year. In the fourth quarter of 2023 market participants expected as many as six interest rate cuts in 2024, believing that the Fed would respond quickly to slower growth and moderating inflation. Yet growth has been surprisingly resilient and inflation at the 3.5% level remains stubbornly above the Fed’s goal of 2.2%, making the Fed reluctant to move aggressively to lower interest rates. Also, massive and growing Federal deficits have climbed above expected increases in the supply of Treasury securities. For example, in the first two months of 2024 issuance of Treasuries, all of which was short term T-bills and notes, was a mind boggling $4.7 trillion, up 56.8 % from the same two months in 2023! These enormous increases in the supply of treasuries compound the Fed’s problem of “quantitative tightening” in which the Fed sells treasuries to investors to withdraw liquidity from the banking system and slow inflation. This staggering increase in the supply of federal government debt while inflation remains stuck at a higher than desired level does not bode well for US interest rates going forward. We would agree with bond maven Bill Gross who argues that medium and longer-term US interest rates must remain higher to provide holders of 7-to-30-year treasuries a real rate of return of 2%-3% above expected inflation. This implies rates on these maturities of 1.0% or more above current levels. 

With U.S. growth trending higher than expected it does not surprise us that the broader market, including small cap stocks, is performing better, notwithstanding higher than anticipated inflation and growth. While we would not be surprised by a normal pullback in prices in the months ahead, we believe the U.S. stock rally will broaden further, even if the averages slow their rate of advance. That, in the context of a usually supportive election year, suggests gains ahead. 


Wishing you a healthy and profitable year ahead, 

 

 

Sincerely, 

 

 

John Maloney