Q1 2024

For the quarter, the stock market generated returns ranging from the high single digits to low double digits (depending on the index being used). This good performance accumulated on top of the strong gains earned last year.

It is important to note recent stock price increases are not a reflection of improving business/economic conditions. Corporate managers are telling us that revenue growth will slow in 2024, most often attributing the slowdown to general cautiousness amongst customers. They also expect slowing earnings growth as persistent labor cost inflation is absorbed.

This is not the sort of backdrop that supports strong stock prices, yet the stock market continues to move higher. Why is that?

This past quarter was the first time, in some time, that I do not believe Federal Reserve policy was the cause. Over the past two years, we have seen stocks recover from their 2022 lows as interest rate increases ended. That strength continued through last year, as investors came to believe interest rates might soon be cut.

However, over the course of the 1st quarter, it became evident the Fed may not be cutting interest rates this year. Persistently tight labor markets make interest rate cuts hard to justify, yet the market moved higher.

What we saw this past quarter was the market’s performance narrow around two themes: generative artificial intelligence and weight loss. Odd bedfellows, nonetheless, the strong performance from the stocks underlying these themes was enough to push the whole market higher.

Generative AI stands as the next tidal wave in computing. The early winner in this space is Nvidia whose chips and components are the picks and shovels (i.e., the tools) of generative AI.

Weight-loss, as an investment theme, emerged by accident as drugs being developed to treat diabetes, were found to significantly reduce the weight of anyone who took them. This is a similar story to that of Viagra which was developed for cardiovascular indications and proved to help with another unmet need.

Eli Lilly and Novo Nordisk now have drugs approved to treat obesity and cannot keep up with demand.

Neither of these investment themes emerged in the 1st quarter, but the surge in the stock prices of companies associated with these themes was enough to drive the whole market higher.

JPMorgan reports a measure of the market labeled “stock market concentration”. It is not their design, it’s something a lot of money managers watch to assess the health of the market. In a recent article written by JPMorgan “Stock Market Concentration is on the rise. Will this continue?” (Feb 15, 2024), they show the concentration of the S&P 500 is at multi-decade highs, even higher than during the dot.com bubble of the 1990’s. This means the largest companies comprise a larger weight in the index. We are seeing increases in the prices of those stocks driving most of the index’s absolute returns.

The market loves a good secular growth story. If generative AI and weight-loss drugs are at the beginning of a period of strong growth, investors will flock to those stories. If general economic conditions are lackluster (and here I’m exaggerating, for the sake of a point), stocks will languish.

In short, I’m telling you the market had a good quarter, but the source of the strength narrowed, and it will take a broad recovery in the economy to sustain the market’s advance.

When will that happen? From a business cycle perspective, we are currently seeing mixed signals.

On the positive side, excess inventories are being worked down. We are now looking for that point when companies start to feel short inventory. Maybe that will take another year, maybe sooner; it’s hard to know. The inventory picture is certainly much better than it was a year ago, and inventory cycles are at the heart of business cycles.

On the negative side is sentiment; it’s decidedly cautious out there. How people feel about things matters. Also working against growth is the slow-down in Asia, specifically China. China is not recovering as expected, impacting worldwide growth.

Sitting squarely in the middle of all this is the labor market. On the negative side (for business), we are still seeing a labor shortage and wages are rising. On the positive side, companies are being cautious before letting employees go. They know how difficult it is to replace workers and don’t want to be caught short once things improve. On balance, this is helping to keep aggregate wages and spending from falling off a cliff.

The elephant in the room is the upcoming election. I start by stating that typically elections don’t matter, but policies do. With that in mind, the most important thing to watch will be the post-election negotiations over the 2017 tax reform, which expires at the end of 2025. It’s not a topic we need to address today, but probably the most important thing we’ll need to watch in the next 2 years.

We wish all of you a wonderful spring and early summer.