By Daniel McGarvey, CFA, Senior Portfolio Analyst, on behalf of Stonebridge Financial Group advisors

2024 has had the best start for stocks since 2019, with the S&P 500 passing the 5,000 level for the first time and returning 10.6% over the first quarter. The economy has been resilient despite some small cracks, and consumer sentiment is rising. The story for bonds has not been as rosy, however, as the Bloomberg Aggregate Bond Index fell -0.8%, and investors continued grappling with changing rate path expectations. The inversion of the Treasury yield curve also exceeded the duration of the late 1970s inversion to become the longest on record.

It has become increasingly evident in this environment that investors must pay close attention to government policies, perhaps even more so than the actual business activities of the companies they are invested in. Under this regime of enormous deficits and ongoing monetary policy uncertainty, the words and actions of policymakers have outsized consequences on financial markets. With Congress recently pushing through a $1.2 trillion spending bill and the Federal Reserve expected to cut rates three times this year, it’s no wonder that markets are expecting more growth. These forces, along with the rise of artificial intelligence (AI), make it hard to bet against the stock market, at least in the near future.

Our concern is what happens if the Fed needs to stay restrictive for longer or what happens when we have to eventually pay the bill for our spending. The fact that gold and Bitcoin values also reached new all-time highs this year might suggest that policymakers cannot control rates, inflation and the currency all at once.

For better or for worse, it appears that the federal government is using all its weapons to make sure a recession doesn’t come before the election, so we have consequently lowered our recession odds and are expecting a soft landing. However, the cost of a forced recession avoidance could come in the form of higher inflation and a devalued U.S. dollar in the next few years. Significant progress toward inflation has been made since the 2022 spikes, but inflation has been known to come in waves. A conceptual antidote to the inflation threat could simply be to enhance productivity, which is one of the promises of AI, but we need to see more conclusive data before depending on that outcome.

The key supports for our economy have been the labor market and consumer spending. Non-farm payroll growth has been solid for years, and the unemployment rate has had a slight uptick but is still remarkably low at 3.9%. Consequently, the average consumer has been spending like never before, although there might be some signs of strain for lower-income households, as evidenced by credit card borrowing nearing record highs and increasing delinquencies (see chart below).

Flows into Early Delinquencies

Some of the economic sectors that have already shown weakness, including manufacturing and housing, appear to be bottoming. The housing market could stay relatively cold for a while if rates are sticky, but there has been a small rebound in existing home sales and housing starts. It is still too early to make calls on our presidential election, but the odds of Trump or Biden winning are near 50/50. There is not a significant historical difference between overall market returns when either party is in office, but it could have ramifications at the sector level due to policies on energy, healthcare, financial regulation, and more. Additionally, the S&P has had a positive performance every presidential re-election year since 1944, which is likely evidence of the fact that incumbent administrations tend to prime the economy.

Regardless of which party wins the election, we expect the trend of deglobalization to continue. The ramifications of this could become more apparent in the coming years in the form of higher defense spending, higher costs of doing business, and supply chain difficulties. Along with the recession-avoidant policies of the many major countries facing elections this year, these factors could become inflationary as well.

Investment Allocation

Although market participation has broadened to include more than the heavyweight technology and communication stocks, we continue to have concerns about the concentration risk of index or growth-based investing. As shown below, if the “Magnificent 7” were its own sector, it would be the largest one but have an outsized sector weight given its earnings. As such, we remain value tilted, with a particular focus on high-quality dividend growers. Dividend growers have historically outperformed after rate-hiking cycles, and value has outperformed inflation in every decade since the 1940s.

S&P Net Income Weight

We also have a smaller size tilt by nature of underweighting the Magnificent 7, and we are attracted by the valuations of small-cap stocks. However, we are hesitant to take on too much extra beta from the bottom of the market.

International valuations are quite palatable, but we are cautious in the near term due to ongoing geopolitical uncertainty. We believe it will continue to be important to have a manager who can pick the right markets and avoid outsized risks.

On the fixed income side, we remain underweight duration given the attractive yield and safety of the short end of the curve, although we are slowly beginning to extend. We will likely extend duration further if the yield curve experiences more dramatic steepening. We are also underweight credit due to the remarkable tightness of spreads.

Lastly, we are still in favor of holding alternative asset classes that can offer diversification and uncorrelated sources of return in times of uncertainty.

Charts and research provided by Strategas Research Partners, LLC and J.P. Morgan Asset Management, Inc.


Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual
professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.

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Daniel McGarvey, Porfolio AnalystDaniel is a Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.