Ride The Rally

Approaching the end of the quarter with solid gains for all major stock market indexes, momentum seems to be holding. Investor sentiment is strong, as is the fear of missing out. And the rally has clearly broadening out beyond the handful of top tech & internet stocks that dominated last year. About 70% of the S&P 500 stocks are up for the quarter. For example, last year’s losers (i.e. energy & financials) are up over 10%.

Not so, the bond market. We came into 2024 with bonds pricing in six or maybe seven Federal Reserve interest rate cuts for the year. This scenario was supposed to have been brought about by falling inflation, higher unemployment, and slowing economic growth. Three months in, that scenario hasn’t come to fruition. Bonds have re-priced lower, and traders are thinking we’ll be lucky to get three rate cuts. A popular exchange-traded fund that holds long-term Treasury bonds is down more than 3% for the quarter.

In a CNBC interview this week, Wharton Professor and author Jeremy Siegel said the “economy is not showing signs of weakness.” Indeed, Fed economists recently raised their 2024 economic growth projection to 2.1% from 1.7%. And just as important, Wall Street analysts are raising profit estimates for S&P 500 companies. It looks like corporate profit margins are improving. Consequently, Mr. Siegel concludes, “I don’t think this bull market is over.”

Stronger economic growth typically implies solid consumer & business spending, and that makes it harder for inflation to continue falling. Certainly, the Consumer Price Index (CPI) has been stubborn. After falling from an annual rate of 9.1% in the middle of 2022 to 3.0% in the middle of 2023, CPI stopped falling, and then ticked up to 3.2%. This poses a risk to both stock and bond markets, since lower inflation is a prerequisite for the Fed to begin cutting interest rates. And solid economic growth notwithstanding, interest rates are clearly restrictive. They’re not meant to stay at these levels forever.

So investors are closely watching this tug-o-war between growth and inflation play out. Is it better to have lower interest rates at the cost of slower economic growth, or is it better to have a strong economy with higher rates? For now, the latter seems preferable. We’re getting used to the idea that the Fed may have no sense of urgency about cutting rates and maybe that’s OK as long as those rates aren’t causing a wave of debt defaults, bankruptcies and foreclosures.