First Quarter 2024 Market Update

Investment Management

May 23, 2024

“The market is overly confident the Fed hits the soft landing. While it’s certainly a possibility, it is important to recognize that when the market is priced for anything other than the status quo, there is a high cost to being wrong and little reward for being right.” – Global Fixed Income Manager

First Quarter 2024 Market Update

Equity markets continued higher in the first quarter of 2024, recording more than 20 all-time highs  during the period. Investor optimism continued to be driven by the resiliency of the economy that  has not yet shown the signs of significant slowing that many expected due to higher interest rates.  Similar to the prior quarter (and 2023 broadly), market returns were driven predominantly by mega cap technology companies that are viewed as being beneficiaries to the transformational shift taking  place around artificial intelligence (“AI”). However, there was some broadening of market  performance outside of these companies (i.e., outside of the “Magnificent Seven”), which was  welcomed news to those with a more diversified portfolio approach. The continued rally in stocks  has been based largely around the expectation of interest rate cuts by the U.S. Federal Reserve (the  “Fed”), however, the timing, magnitude, and number of rate cuts being forecast by the market has  shifted. Entering the year, markets were pricing in approximately six rate cuts of 25 basis points (e.g.,  0.25%), whereas the Fed has subsequently scaled back expectations, signaling now for three rate cuts  later this year. At its most recent meeting, the Fed maintained benchmark rates at 5.25-5.50%, as  inflation metrics have remained relatively sticky, largely driven by elevated housing costs.  

Domestic equity markets, as measured by the S&P 500 Index, were positive for the period, returning  +10.6% and marking their best start since 2019. In addition to the impressive performance of the last  few quarters, the continuous strength of the market has been noteworthy. As of quarter-end, the  index has now gone more than one year without experiencing a one-day decline of 2% or more, the  sixth longest streak since 1965. Sector returns were more balanced than in prior periods and all  sectors exhibited positive performance except for real estate (-1.1%). Communication services  (+15.8%), energy (+13.7%), and technology (+12.7%) were the best performing sectors, followed  closely by financials (+12.5%). In addition to real estate, other bond-proxy sectors including, utilities  (+4.6%) underperformed the broader market. Given the volatility and dispersion in underlying  performance, we continue to believe that balanced sector exposure is important in today’s  environment. As one of our investment managers recently pointed out, there have been only two  instances in the last twenty years in which a sector in the S&P 500 has been the top performer in  back-to-back years – technology in 2019-2020 and energy in 2021-2022 – emphasizing that a  diversified approach may benefit investors as sector leadership can often change quickly. 

From a style perspective, growth stocks (+11.4%) outperformed value stocks (+9.0%), as measured by  their respective Russell 1000 benchmark indices. Mid- and small-cap stocks underperformed large  caps for the period, reversing the trend of the prior quarter, as continued headwinds from higher  interest rates and economic sensitivity weighed on performance. Outside of the U.S., international developed market stocks posted positive returns for the period, but lagged domestic markets, returning +5.9% as measured by the MSCI EAFE Index in U.S. Dollar (“USD”) terms. Within developed  markets, Japan exhibited impressive performance, topping domestic markets, and returning +11.2%  during the quarter in USD terms (+19.3% in local Japanese Yen terms). Investor optimism over the  country’s economic cycle, corporate earnings that have exceeded expectations and key policies  changes from the Bank of Japan supported its performance. Emerging markets lagged domestic  markets, returning +2.4% as measured by the MSCI Emerging Markets Index in USD terms. Emerging  markets continued to be weighed down by China, whose markets posted negative returns. Valuations  for developed international and emerging market stocks look relatively attractive as they are trading  significantly below their relative long-term averages. Comparatively, domestic markets continue to  look fully valued, and by some measures stretched, with the S&P 500’s forward price-to-earnings  ratios of 21.0x versus its 30-year historical average of 16.6x.  

Fixed income markets finished the period largely negative, as expectations around Fed interest rate  cuts shifted and were scaled back. The 10-year U.S. Treasury began the period at 3.88% and ended  at 4.20%. The rise in yields weighed on prices, with the overall bond market down -0.8% for the  quarter, as measured by the Bloomberg U.S. Aggregate Bond Index. On a more granular level within  fixed income, asset-backed securities (+1.3%) and high-yield bonds (+1.5%) were the standout  positive performers, with most other sub-sectors, including U.S. Treasuries (-1.7% for the 10-year maturity), investment-grade corporates (-0.4%), municipal bonds (-0.4%), and mortgage-backed  securities (-1.0%) all posting negative returns, as measured by their respective benchmark indices. Oil  prices rose during the quarter, other commodities were mixed-to-slightly-positive, and the U.S. Dollar  appreciated against most major currencies. 

Mixed Signals

”The odds of a recession have come down, but our cautious posture persists due to high valuations,  market concentration, looming debt challenges and the lengthiest inversion of the yield curve in history.”  – Domestic Equity Manager

We think that it is a fair summation that most economists, market participants, and investors alike  believed a year ago that an economic recession was imminent, or at the very least, a high probability.  Today, the views of most have evolved to assigning the highest probability to a decidedly different  outcome – a “soft landing” – in which the economy avoids a recession, is able to operate without  significant disruption or systematic distress and returns to a stable equilibrium on the back of interest  rate cuts from the Fed. While we agree that the soft landing (or “no landing”) narrative seems to be  the most likely outcome, we acknowledge that economic signals are more difficult to assess in today’s  environment and continue to be somewhat mixed. 

Economic growth has been resilient, with real gross domestic product (“GDP”) increasing at an annual  rate of +3.4% using the most recent estimates from the fourth quarter of 2023 (released in late March).  Labor markets have also remained strong, with wage growth of approximately 4.5% being above  long-term trends and an unemployment rate of 3.9%, both as of February. However, the unemployment rate has ticked up slightly over the last month or two, as some other indicators are  also beginning to show signs of weakness. Job openings, average hours worked, and quit rates have  all come down from their peaks, as has the number of temporary workers. While most believe that  labor markets remain on solid footing, these initial trends bear watching closely to see if they  materialize into further weakness or softening in labor markets. 

Inflation has come down precipitously since its June 2022 peak, however, has remained stickier  recently as pricing pressure from items such as gasoline and food have resumed upward trends – up  15% and 6%, respectively, since December. Importantly, even though inflation metrics have been  falling, it does not mean that prices are dropping, only that they are going up less quickly. Consumers  are continuing to feel the burden of higher prices, which has begun to show up in metrics such as  decelerating goods consumption (growth rates down from 3.0% to 1.6% quarter-over-quarter), U.S.  credit card balances increasing to $1.1 trillion (up 45% from pre-COVID levels), declining savings rates  (recent 3.7% low), and credit card and auto defaults increasing (combined at a 10-year high). 

Broadening Market Performance 

“We are certainly not suggesting that the market is due for anything resembling a post dot-com crash.  The leading companies today are both more profitable and more reasonably valued. However, we do  see one interesting parallel – an obsessive focus by the media and the investment community on a  narrow segment of the economy.” – Hedge Fund Manager

Despite rising yields (which typically have a negative effect on asset prices) and the delay of Fed rate  cuts , markets resumed their march higher in the first quarter. Performance outliers continued to be  mega-cap technology companies, including the “Magnificent Seven”, a basket of stocks that propelled  markets higher in 2023 including Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and  Tesla. The group returned +13% for Q1, whereas the index excluding them (i.e., the other 493 stocks in the S&P 500) returned just +6%. We saw this quarter, however, that this small cohort of stocks is  not invincible, and like all other companies, is susceptible to evolving fundamentals, market  conditions, and investor sentiment. From a performance perspective, Nvidia continued its leadership  within the group, returning a staggering +83% in Q1 (after a 200%+ return in 2023) as demand for  semiconductors continued to be robust. Tesla was the notable underperformer, down more than – 29% for the period, as deliveries were down. Apple also posted losses, declining by nearly -11%, and  Alphabet underperformed the broader market with returns of approximately +8%. Return dispersion  among this group was another sign that market performance is broadening, albeit slightly, which we  would not be surprised to see continue over the course of the next few quarters. 

Much of the euphoria around the mega-cap technology companies has been the perceived benefits  of the quickly evolving artificial intelligence landscape, including significant first-mover advantages,  wide moats, and in many cases, war chests of available cash on their balance sheets. There is little  doubt within the investment community that AI has the potential to (and most believe it likely will)  greatly change the way we work, interact, and live our daily lives. While durable winners can and  certainly will emerge (Nvidia seems to be the current front-runner), there will likely be staggering amounts of new investment in the space, which will play out over the years to come. We are in the  early stages of a transformational shift, and although it’s hard to ignore the eye-popping returns of  this small cohort of stocks (small by number, but not by market capitalization), we encourage investors  to utilize a wide lens when constructing an investment portfolio, striking a balance among many  factors and being cautious about overconcentration. 

Final Thoughts

Markets started 2024 with an impressive rally, fueled by sustained investor optimism around  continued economic resiliency, a belief that easier fiscal policy was around the corner, and enthusiasm  around innovative trends in technology and AI. The heavily predicted recession has yet to materialize  and the biggest decision likely to affect markets through the remainder of the year is controlled by  the Fed Chairman, Jerome Powell. The timing, pace, and magnitude of Fed rate cuts are all being  watched extremely closely. Although other sources of potential volatility exist today – geopolitical  tensions, conflict in Europe and the Middle East, a presidential election, etc. – it is highly likely that  the Fed’s policy path forward will be the most important for markets.  

While the economy and markets appear to be generally supported, we acknowledge that volatility  has started to creep back into markets during the first few weeks of the second quarter and we would  not be surprised to see this trend continue. In light of the current environment, we continue to  emphasize a need for thoughtful diversification and a well-balanced portfolio, while continually being  mindful of risks. Risks cannot be entirely avoided, however, being thoughtful around the  management of those risks is paramount. We remain intently focused on portfolio construction,  identifying and sourcing unique investment opportunities, and achieving the best risk-adjusted returns for clients over extended periods of time.  

As always, we welcome the opportunity to discuss your portfolio in detail, and appreciate the trust  and confidence that you have placed in Prairie Capital. We look forward to connecting throughout  the course of the year. 

Important Disclosures

Past performance is not an indication of future results. This publication does not constitute, and should  not be construed to constitute, an offer to sell, or a solicitation of any offer to buy, any particular security,  strategy, or investment product. This publication does not consider your particular investment  objectives, financial situation, or needs, should not be construed as legal, tax, financial or other advice,  and is not to be relied upon in making an investment or other decision. 

Certain information contained herein has been obtained or derived from unaffiliated third-party sources  and, while Prairie Capital Management Group, LLC (“Prairie Capital”) believes this information to be  reliable, makes no representation or warranty, express or implied, as to the accuracy, timeliness,  sequence, adequacy, or completeness of the information. The information contained herein, and the  opinions expressed herein, are those of Prairie Capital as of the date of writing, are subject to change due to market conditions and without notice and have not been approved or verified by the United  States Securities and Exchange Commission (the “SEC”), the Financial Industry Regulatory Authority  (“FINRA”), or by any state securities authority. This publication is not intended for redistribution or  public use without Prairie Capital’s express written consent.