Quarterly Market Update: Unraveling the Tapestry

Apr 10, 2024 | Market Updates

At the outset of 2024, many analysts are anticipating a bull market that is bringing with it promising positive momentum. However, as usual, there are contrarians who are worried that the overvaluation in the technology sector is a pattern we’ve seen before; is this reminiscent of the early 2000 tech bubble? We at GreenUp Wealth Management do not think this is the case. In fact, we see the optimism being indicative of an improving macroeconomic environment hinted at sustained growth in stocks. This type of macroeconomic climate, combined with a continued, gradual lowering of interest rates, suggests that we can expect continued all-time highs in stocks as sustainable, even with the current expensive valuations.

Some folks may make emotional decisions to take profits and go to cash based on the current market valuation. But current stock market levels require a closer look. We can interpret an elevated Price to Earnings ratio (one of the most widely used gauges to determine if investments are overvalued or undervalued) in one of two ways. The S&P 500 price to earnings ratio recently peaked at 20.7, 16.9% above its 10-year average of 17.7. That is aggressive growth, and it could be a sign of an overvalued market at risk of correction. But it could also be an indicator of market confidence, thanks to a significantly more accommodating economic environment on the horizon.

At Greenup Wealth, we don’t shy away from positive momentum. In this Quarterly Market Update, we will discuss why we have positioned our portfolios with an optimistic, if measured approach— with a keen eye on shifting policy landscapes— through Q2 and into the rest of 2024.

Monetary Policy Adjustment: A Dual Approach

It is no surprise to anyone that inflation is a concern for the American people and the Federal Reserve. With costs increasing by 19.5% since January 2020, the scars of past inflationary cycles remain woven into the Federal Reserve’s memory. However, as we tease out the implications, it becomes clear that even with interest rates anchored above market expectations, the Federal Reserve is proactively planning to relax these threads, signaling a shift from tightening to an easier monetary landscape. At the same time, the Federal Reserve is deciding how much and when to stop the shrinkage of its balance sheet. Both of these policy shifts are 180-degree turns from monetary policy in 2022-2023; effectively, putting a welcome end to this Fed regime’s restrictive policy.

The Federal Reserve utilizes a dual approach to monetary strategy; hinging on two pivotal actions: calibrating the federal funds rate and managing the Fed’s balance sheet through quantitative tightening. An analysis of the Fed’s actions provides the narrative for the momentum we currently see in our financial markets.

Calibrating Interest Rates

The United States’ current monetary policy (the Federal Reserve’s use of tools to influence economic activity) represents an undeniably restrictive knot, with the terminal rate peaking at 5.25%. Yet, as we follow the thread toward January 2025, we anticipate a gentle loosening to approximately 4.50%, and a continued orderly decrease in interest rates ending at 2.50% by 2027. Lower interest rates provide much-needed relief to small businesses and homeowners, who as a cohort tend to have higher debt ratios. Decreases in the federal funds rate offer an economic stimulus at the risk of higher-than-expected growth, which could, in turn, accelerate inflation.

To limit unwanted inflation, it is logical to expect the Federal Reserve to project each movement and to aim for a slow and even pace. A logical assumption is the Federal Reserve will target a 0.25% decrease in federal funds rates per quarter. To stay on the schedule outlined by the Federal Reserve Dot Plot, the Federal Reserve will likely start cutting interest rates this summer.

While the Federal Reserve is expected to maintain a slow and steady pace to decreasing interest rates, an important note is the mandate to decrease interest rates is self-imposed. Should inflation measurements read higher than expected a pause in future rate cuts would be warranted until inflation moderates to an acceptable growth rate.

The Road to Easing: A Deliberate Wind-Down

As we trace the thread back to the Federal Reserve’s balance sheet peak in April 2022, we see a steady unraveling from that $8.9 trillion value. This methodical wind-down, called quantitative tightening (QT), has decreased the Federal Reserve’s balance sheet by over a trillion dollars in assets since inception. However, this part of the weave is more opaque, without a defined endpoint and no historical precedent on which to rely. Even so, the Federal Reserve has indicated through its meeting notes the desire to wind down QT in the next 6-24 months.

While quantitative tightening (QT) is a new technique from the Federal Reserve, quantitative easing (QE) is not. While we do not know the destination, the next steps are fairly straightforward. Reflecting on past events, we observed market responses to the cessation of quantitative easing—the Fed’s bond-buying program designed to invigorate the economy. QE is, essentially, the opposite of QT … confusing, I know.

Notably, the termination of quantitative easing announced in 2011 and 2014 resulted in the S&P 500 marking modest declines of -0.21% and -0.81%, well below the average S&P 500 performance of 11%. These precedents suggest that the announcement of a reversal in policy, moving towards stimulus, may likely be met with a favorable market reaction.

Market Sentiment: The Weave of Confidence

Continuing to unravel market sentiment reveals an expectation for less restrictive policies to be embroidered throughout 2024, transitioning to a neutral and then accommodating monetary environment by 2025. These adjustments are pivotal, like the skilled hands of a weaver strengthening the overall fabric, promising fruitful outcomes for those positioned early despite potential volatility.

Corporate Earnings and Economic Resilience

The economic tapestry is further enriched by the thread of corporate earnings, which forecasts a pattern of 10-15% annual growth today through 2026. If true, the vibrant thread of corporate America should strengthen; intertwining with emerging technologies like Artificial Intelligence, promising to bolster profit margins and fuel growth. The most recent earnings quarter was supportive of our thesis, exhibiting positive trends of 3.4% growth in earnings and a profit margin of 11.6% vs the previous quarter’s reading of 11.2%.

In step with corporations, the consumer continues to exhibit strength. Strong wage growth at 4.5% paired with a relatively low 3.9% unemployment rate has rightfully created a consumer who is starting to feel better about the overall economy. A healthy and happy consumer will drive strong economic growth and is in line with GreenUp’s year-end S&P 500 target of 5400.

Conclusion: A Cautious Optimism

As we weave our way into late 2024 and beyond, a deliberate pivot in monetary policy, coupled with enduring fiscal support, lays the groundwork for a cautiously optimistic market outlook. While corporate earnings are expected to pick up speed, the market’s valuation does present a note of caution, reflecting heightened expectations. Diversification remains our lodestar, with healthcare and emerging markets like India presenting compelling themes. Fixed income strategies should echo benchmark durations with an increased tilt toward credit risk. In the face of geopolitical uncertainties and a complex yield curve, a measured approach with a keen eye on shifting policy landscapes will be essential for navigating the quarters ahead.

Summary

Despite concerns of an overvalued stock market, GreenUp is bullish in 2024, Here are the key points:

  • Federal Reserve Policy Shift: The Fed is expected to loosen monetary policy by lowering interest rates and ending quantitative tightening (QT).
  • Interest Rates: We expect a gradual decrease from 5.25% to 2.50% by 2027.
  • Market Outlook: Bullish, with a target for the S&P 500 of 5400 by year-end.
  • Stock Market Valuation: Potentially overvalued but justified by strong economic fundamentals. Optimism about the economy and corporate earnings growth (projected at 10-15% annually through 2026) justifies continuing investment.
  • Consumer Strength: Strong wage growth and low unemployment indicate a healthy consumer.
  • Investment Strategy: Cautiously optimistic, with diversification across sectors and a tilt towards credit risk in fixed income.

GreenUp Portfolio Updates

Dynamic Portfolios
We continue to underweight our international equity exposure compared to the benchmark. We are adding 4% to the healthcare sector (XLV) and 4% to our small-cap value exposure (AVUV). In fixed-income, we are underweighting short-duration and overweighing iShares Core US Aggregate Bond ETF (AGG).

Large Cap Stock Model
We are selling Booking Holdings Inc. (BKNG), Deere & Co. (DE), Taiwan Semiconductor Mfg Co Ltd. (TSM), Walt Disney Co. (DIS), Automatic Data Processing Inc. (ADP), and Philip Morris International Inc. (PM). Adding to the portfolio, we are buying Adobe Inc. (ADBE), Tesla Inc. (TSLA), Johnson & Johnson (JNJ), Palo Alto Networks Inc. (PANW), Zoe4s Inc. (ZTS), and Delta Air Lines, Inc. (DAL).

Equity Income Model
We are selling Novartis AG (NVS) and Vale SA (VALE) and adding Siemens AG (SIEGY), reducing the portfolio from ten stocks to nine, and focusing on income generation, sustainable growth, and risk management.

Tactical Equity Model
We are replacing SPDR Dow Jones Industrial Average ETF (DIA) and iShares S&P 500 Value ETF (IVE) with iShares S&P Mid-Cap 400 Growth ETF (IJK) and SPDR S&P 400 ETF Trust (MDY).

Tactical Income Model
We are selling iShares iBoxx Investment Grade Bond ETF (LQD) and replacing it with Invesco Emerging Markets Sovereign Debt ETF (PCY)

Author

  • Daniel Greulich, CFA, CFP®

    Chief Investment Officer | Wealth Advisor | Ann Arbor, MI -- Daniel leads our Investment Committee and partners with Aaron Kirsch, Chief Client Advocacy Officer to design and implement client portfolios with your advisor. Daniel brings 14 years of practical experience as a trader, financial advisor, and money manager at both large and mid-sized financial services companies to GreenUp Wealth Management. In addition, he holds a CFP® designation and is also a CFA charterholder. This combination of experience and knowledge helps Dan confidently guide his clients through the development, execution and monitoring of their customized financial plans.

    https://greenupwealth.com/meet-your-team/dan-greulich/ daniel.greulich@greenupwealth.com Greulich, CFA, CFP® Daniel

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