Into the Second Leg

The first quarter has handed the baton off to the second quarter; anyone with allergies can tell you that spring is in full bloom. So, let’s check in on the markets and our outlook.

The first quarter ran a strong first leg with many equity indices posting returns well into positive territory. Let’s review the report card: U.S. Large cap stocks continue to perform relatively well. The S&P 500 finished the quarter up 10.56%. [S&P 500] Mid cap stocks weren’t far behind at 9.95%. [Russell 2000] Small cap and [Dow Jones Dividend Select Index] dividend stocks were positive as well, but not as much. The Russell 2000 and the Dow Jones Dividend Select Index were up 5% and 6.1%, respectively. [S&P 500] Growth outperformed value, [Morgan Stanley Capital International (MSCI)] Japan outperformed [MSCI] Europe, and interestingly and encouragingly, the broad S&P 500 outperformed the NASDAQ in the first quarter, indicating it wasn’t just the Magnificent Seven driving returns for the first part of the year. Further, the All-Country World Index posted an 8.1% return. So, in all, it was a very good quarter for equities across many areas.

Bonds were a different story. Both the Bloomberg U.S. Aggregate and the Bloomberg Muni bond Blend Indexes were down a smidge, less than 1%. Generally, [Bloomberg U.S. Aggregate] U.S. Bonds outperformed [Bloomberg Global Aggregate] global, U.S. Treasuries outperformed corporates, and [Bloomberg U.S. Corporate Investment Grade] High Yield bonds fared better than [U.S. Corporate Investment Grade] investment grade. The prospect of interest rates staying higher for longer, or maybe we should start saying “even longer,” has weighed on bond returns.

Shifting our focus to the new quarter, so far in April, the 10-year Treasury yield has surged to a high for the year, hitting 4.5% as strong economic data as well as cautious comments from Fed officials raised concerns that rate cuts could be delayed into the latter half of the year.

Further, recent inflation data CPI and Core CPI came in higher than expected, possibly reshaping expectations. The window to invest in bonds near current yield levels might be open a little longer than originally thought.

For stocks, earnings season is just around the corner, and the consensus first quarter earnings per share growth estimate for the S&P 500 has declined, but analysts still expect a third straight quarter of growth.

Negative pre-announcements are somewhat above historic trends. Given the recent economic strength, the downside earnings risk does not appear significant. But given the appreciation in stocks over the past six months, volatility is likely to increase as bullish and bearish narratives compete.

Earnings will be key to supporting the continuing rally in stock markets that have seen valuations become more stretched during the recent run.

City National Rochdale has increased the bottom end of our 2024 corporate profit growth range and now expects earnings growth of 9% to 12% this year.

Chart 1: 3:11 — It appears the main risk for equities right now seems to be hawkish repricing around Fed expectations.

While many are focused on when the Fed will cut, it is important to note that historically, it matters why the Fed cuts. When the Fed cuts normalized rates rather than for recessionary reasons, the market has responded relatively more positively three, six, and 12 months after the first rate cut.

As many of you likely saw in City National Rochdale CIO Tom Galvin’s recent CNR Speedometers^® video, our forward-looking indicators continue to improve, with recent positive changes to our outlook in Monetary Policy, the U.S. Economic Outlook, Housing & Mortgages, Leading Indexes, Corporate Profit Growth, and Credit Demand & Availability.

To close out, we are expecting modest returns across asset classes in 2024. We remain focused on high-quality stocks and bonds with an emphasis on the U.S. For clients seeking additional capital appreciation, mid and small cap equities appear increasingly attractive.

Keep an eye on economic data releases, inflation readings, and the potential for shifts in the Fed’s messaging and path.