Stocks had an impressive first quarter, rising across all segments with US large cap stocks continuing to lead the pack.  Performance has broadened out from the “Magnificent Seven” stocks (MSFT, AAPL, NVDA, AMZN, GOOG, META, and TSLA) with many stocks outside of this group hitting all-time highs on a regular basis. 

If we were to choose one word describing economic and market trends recently, it would be “resilient”.  US GDP continues to grow and the calls for a pending recession have faded to the background.  Jobs and consumer spending, incredibly important factors for our economy, continue to reflect growth and, yet don’t appear to be significantly slowing.  Lastly, corporate earnings estimates are anticipating nearly double-digit growth over 2023. 

Another area of resiliency, but one that is less positive, is inflation. Partly due to the continued strength in jobs and spending, inflation has remained elevated above what is considered normalized at 2% to 2.5%.  Since October 2023, investors have been looking to inflation metrics to provide a sense of when, not if, the Fed would cut interest rates.  Initial expectations were for several interest rate cuts based on the assumption of curtailed inflation and lower economic growth leading to the threat of recession.  Neither of these events have occurred, and as a result, expectations for the magnitude and timing of Fed cuts have been lowered and shifted out into the future. 

It has long been our expectation that the Fed will be very measured and wait for clear data regarding controlled inflation before acting. If current economic trends hold, the Fed will continue to be cautious before making significant changes to rates.  Inflation will be the predominant factor, but any sense of deterioration in the US economy could also create the need for a shift as well. 

Turning to the health of companies, expectations of double-digit S&P 500 earnings growth have been relatively steady since the beginning of the year.  As companies report year end results and outlooks for the coming year (most in January), there is a natural tendency to provide outlooks that are conservative and achievable.  Often, this leads to a reduction in estimates for the coming year with the hope that companies can exceed these levels.  This hasn’t been the case this year, and while numbers haven’t increased substantially, they haven’t fallen much either.

On the other hand, steady earnings expectations combined with a market that has risen substantially has elevated S&P 500 valuations to above average levels.  Valuation tells us little to nothing about the market trends over the next 6-12 months.  What we pay for an asset, however, is very important to the long-term returns we can expect.  As a result, we would suggest that, at current valuations, we would expect lower than historical average returns in the S&P 500.  Other stock segments, like US small caps, international developed, and emerging markets, have more favorable valuations which may suggest better long-term returns.  This is not guaranteed, however, as this differential has been apparent for some time, yet US large cap stocks have continued to outperform these other segments. 

As we look to the year end, the set up for bonds is relatively attractive.  Bond performance has been down year to date as interest rates have crept upward.  We believe current bond yields are relatively high and our opinion is that rates will be similar to slightly down from these levels.  As a result, bonds could achieve both a high relative yield as well as exhibit some price return if rates fall.

In the stock market, investing at higher-than-average valuations (like we are experiencing now) calls for prudence but not avoidance.  Selling everything and waiting for a “better re-entry point” is a very difficult proposition as stocks typically get cheaper when news is getting worse.  While buying low and selling high is easy to say, in practice it is very difficult to accomplish as buying low means buying when you likely feel the worst.  On the other side, but equally as dangerous, chasing returns and increasing risk based on the “fear of missing out” can also be a recipe for disaster. 

The best way to avoid both pitfalls is to incorporate an investment plan that suits your investment objectives, risk tolerance, and time horizon.  A well-designed investment strategy incorporates both protection against difficult times but also assets that participate in the prosperity that investments provide over the long term.  The strategy should be flexible and nimble to take advantage of opportunities but also maintain diversification and stay consistent with the objectives put forth in the plan.