February exhibited a strong rebound for equities, with the recent rally leading the S&P 500 index and several other major equity indexes to reach new all-time highs to close out the month. All major asset classes saw positive returns for the month, with the exception of the fixed income sector. The Fed’s interest rate policy has remained unchanged as of late, however, bond yields experienced a slight uptick leading to downward price pressure and negative returns as of month-end.
“The equity market rally persists despite the unwinding of anticipation for aggressive rate cuts, as the initial forecasts of six to seven rate reductions have now been revised to expectations of approximately three 25bps rate cuts.”
January inflation metrics (released in February) came in mixed, as headline CPI fell to 3.09% year-over-year, above expectations; and Core CPI, while decreasing slightly to 3.87% year-over-year, was higher than expectations of 3.70%. The shelter (housing) component, which makes up roughly one-third of the CPI index, increased 0.6% in January compared to the previous month, and 6% on a year-over-year basis, contributing to the elevated reading compared to expectations. On a positive note, Core PCE, the Fed’s preferred measure of inflation, dropped to 2.85% year-over-year, down from last months reading of 2.94%.
Additionally, the US economy has exhibited some positive signs of resilience, with the unemployment rate holding steady below 4%. February’s reading of 3.9% was a slight uptick from the prior month’s 3.70%, however the US added 275,000 nonfarm payroll jobs in February, exceeding expectations of 198,000. While the job market shows resilience, there are emerging signs of potential cooling. Nevertheless, the labor market continues to demonstrate strength. This, coupled with the steady (but slowly declining) inflation metrics have provided optimism to investors and has bolstered equity markets.
To close out February, the S&P 500 reached new all-time highs, closing at a level of 5,096 on February 29th. Several other equity indices, such as the Dow Jones Industrial Average and the NASDAQ 100 indices also reached all-time highs to close out February. The equity market rally persists despite the unwinding of anticipation for aggressive rate cuts, as the initial forecasts of six to seven rate reductions have now been revised to expectations of approximately three 25bps rate cuts. This adjustment has led to rising bond and treasury yields, which have weighed negatively on the performance of the fixed-income market. The market rally last year was primarily driven by a handful of dominant names, which has continued to start the year, as the ‘Magnificent 7’ and Mega Cap names like Nvidia (NVDA) have bolstered the broader index returns. We have, however, begun to see a slight shift in the landscape, with a broader range of companies beginning to contribute positive returns again. Notably, the S&P 500 equal-weight index has recently broken above its previous all-time high, surpassing the peak set in early 2022.
Some of this rally seems to be driven by optimism from resiliency in various economic activity. At first glance, the housing market seems strong, with home prices continuing to climb. However, the underlying impact of elevated mortgage rates and reduced housing starts has created challenges in housing supply and affordability. The sustained price appreciation appears to be fueled primarily by limited inventory. Throughout February, mortgage rates climbed to 6.94%, marking a significant increase from the sub 3% lows experienced in 2021. Concurrently, existing home sales for January 2024 totaled just 4 million, trailing behind the 10-year monthly average of 5.28 million. The phenomenon of the “lock-in effect” has emerged as a plausible explanation, with existing homeowners opting to retain their low-interest rates. Compounding the situation, housing starts witnessed a notable decline of approximately 10% from 2022 to 2023, potentially exacerbating supply constraints. This trend has continued in 2024 as housing starts declined from 1.56 million as of December 2023 to just 1.33 million as of January 2024. As a result, housing prices surged by 5.57% in 2023, as indicated by the Case-Shiller National Home Price Index.
The continued rally in equity markets underscores the positive impact that economic resilience and steadily declining inflation has had on investor optimism. While certain segments of the economy have demonstrated resilience on the surface, the underlying data suggests that challenges do persist. Looking ahead in 2024, we anticipate corporate earnings and stock market returns will be strongly correlated to the economic environment and ability of the Fed to balance its fight against inflation with avoiding a recessionary slowdown in economic activity.
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~Diligently Yours,
Your Smarter Way Portfolio Management Team
Please note this is for information purposes only and should not be construed as investment advice or recommendations made by A Smarter Way to Invest. Please contact your Advisor if you have any questions about this market update report or if you would like to discuss your personal financial situation in more detail.
