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Monthly Economic Update

After taking a break from our weekend readings, we are back. Today we are

going to bring everyone back up to speed starting with last quarter’s economic

progress, earnings, and our viewpoint looking into Q2. I want to thank both

Sam Milette, who we quote all the time, and Rob Swanke for their commentary

and data herein.

The two big topics that have seemed to captivate market observers for the last

two years are interest rates and inflation. You can’t leave your house without

noticing how the cost of goods has been increasing. In addition, high interest

rates (at least as compared to the last 20 years) are described as being a

burden on the economy. But when we put these things in context, what we

have is actually encouraging.

Simply put, interest rates are not “extremely” high in a historic context. I’d

describe them as being moderately elevated when compared to historical

rates, as well as being elevated as a defense against inflation due to a

“stubbornly strong” economy. Below is a graph of the Fed funds rate over the

last 70 years or so.

As you can see, rates are high. However, rates appear to be much higher

comparatively if you isolate the last 15 years or so, primarily due to rates

staying near zero following the housing debacle and the global economic

meltdown that started in 2007.

While inflation is also historically high, it seems to be much higher than we

remember it being in recent years due to inflation being uncharacteristically

low following the crisis of 2008.

It’s important that we situate this data in its proper context because, if we

agree that these two metrics are high but not extreme, we look to other

related metrics to provide a better holistic picture of current conditions. Among

the most prominent metrics that we consider here at MORWM is

employment. Quite simply, it’s hard to describe an economy as weak when we

are at (or in this case, above) full employment.

Full employment is generally considered to be 96% rather than 100% which

common sense might suggest. This is because, like many things in life, there

will always be a certain amount of employment mismatches. Like the perfect

employee for Oliver Wealth Management who unfortunately lives in the wrong

part of the country. According to the U4 data, we are currently at 96.2%

employment, which is higher than full employment. Is this a concern of

sorts? Absolutely. The simple law of supply and demand dictates that when

there is greater demand, prices go up. Naturally, with full employment, there

is a lot of demand for goods. We’ll also acknowledge that there have been

some pretty tricky issues with the global supply chain following the COVID

shutdown. However, that disruption is largely over, and the demand side of

the supply/demand curve still affects the two-pronged relationship with or

without supply chain disruption.

Below is the historical American unemployment rate. You can see that we are

currently at ~4% unemployment (since we are currently at 96.2%

employment). As we’ve previously written, a small amount of unemployment is

an unavoidable economic reality.

We can plainly state that we are currently experiencing a strong economy. In

fact, it is this very employment data point that encouraged us to dip buy

aggressively in June and October 2022. Though the inflation rate was

considerably higher then (well into “terrifying” territory), it was the

employment rate alone which influenced us to go all-in during the 2022

market downturn. At that time, the low on the S&P 500 was 3,650. Today, it

is 5,200. (P.S. It was not just this one metric. Though it was the most

influential of the metrics we observed at the time, we’re not that obtuse. But it

does make the article more interesting to say that it was.)

Let me wrap up this introduction by saying that it is very important that we

measure the current climate in multiple ways. The weather can be cloudy and

ugly, but still hot with sun rays strong enough to burn a person right through

the cloud cover. It seems this is an apropos analogy especially given the

truckload of geo-political chaos in the world at present.

So, let’s get into the core of our conversation. Sam and Rob, the floor is



March was another positive month for markets, continuing the rally to start the

year. Improving corporate fundamentals and a supportive economic backdrop

drove solid single-digit returns for U.S. markets during the month. This capped

off a strong quarter for U.S. stocks, an encouraging sign that the economic

and market momentum from 2023 has carried over into 2024.

While stocks performed well during the month and quarter, fixed income was a

bit more mixed. Investment-grade bonds were up in March but ended

modestly down for the quarter due to rising interest rates. High-yield bonds,

typically less driven by interest rate movements, ended both March and the

quarter in positive territory.

Looking Back

Strong economic growth. U.S. stocks benefited from stronger-than-expected

economic growth at the end of last year and the start of this year. GDP growth

came in above economist estimates in the fourth quarter, and we saw solid job

growth and consumer spending to start 2024. More than 500,000 jobs were

added between January and February, which was strong on a historical basis

and above economist estimates.

High inflation. The economic growth in the first quarter was largely positive,

but it also caused inflation to remain stubbornly high. While there were modest

improvements in getting year-over-year inflation down in 2024, both headline

and core inflation remained above the Fed’s 2 percent target, and the pace of

improvement slowed. This result caused investors to reassess their

expectations for monetary policy going forward, contributing to the rising

interest rates we saw during the quarter.

Looking Ahead

A shift in market expectations. Given the impressive economic resilience and

still-high inflation we saw in the first quarter, markets have adjusted their Fed

expectations for the rest of the year. We started the year with futures markets

pricing in six interest rate cuts by the end of 2024; we ended March with

futures markets calling for just three interest rate cuts by the end of the year,

which is in line with Fed guidance. This adjustment helped explain the rising

rates we saw during the quarter and may lower the risk of Fed-driven volatility

for the rest of the year.

Continued earnings growth. Improved earnings growth for U.S. companies

partly drove the stock market rally to start the year. Earnings growth for the

S&P 500 came in well above analyst estimates during the fourth quarter of

2023. And further earnings growth is expected ahead, with analysts calling for

earnings growth in all four quarters this year. Over the long run, fundamentals

drive market performance, so this anticipated return to consistent earnings

growth could be a positive sign for investors in 2024.

Political and international risks. Despite the solid start to the year for markets

and the economy, some risks remain for investors. The continued conflicts in

Ukraine and the Middle East could spark further uncertainty in these regions

and pressure the shaky global supply chains. The November election will also

be worth watching, as we’ll likely see further political uncertainty as we

approach the end of the year. Ultimately, while these risks are real and should

be acknowledged, they’re not necessarily pressing at this time.

Optimism in the Air

Looking at the first-quarter earnings season, markets are certainly taking an

optimistic view, with S&P 500 valuations just over 20x forward earnings

estimates. Of course, these are not quite the levels we saw at the beginning of

2022. But with interest rates much higher than they were then, we’ll likely

have to rely on earnings growth to drive the S&P 500 higher from its current


FactSet consensus analyst estimates are for 11 percent growth in 2024 and 13

percent growth in 2025. So, there is certainly reason for optimism from an

earnings perspective. Much of this growth is expected to be driven by margin

expansion, as revenue is anticipated to see growth of only 5.1 percent and 5.9

percent for 2024 and 2025, respectively. Margins had slipped to a postpandemic

low in 2023, so a bounce back could be reasonable. But margins are

still well above their 20-year averages. Companies have been investing to

improve productivity, and additional AI investments could also pay off to help

improve margins.

Setting the Tone for the Year

Last year, we had low expectations for much of the year. In the second half of

the year, we saw earnings beats, but those would be offset to a degree by

lowered expectations for the following quarter or by pushed-out growth

expectations to future quarters. The bar remains low in the first quarter, with

earnings expected to grow by only 3.2 percent over the last year. Still, this is a

higher bar than we’ve seen for the past few quarters.

Earnings expectations then pick up significantly for the rest of the year and

are expected to see growth of 9.4 percent, 8.5 percent, and 17.5 percent in

the second, third, and fourth quarters, respectively. Forward guidance by firms

will play an important role in how the markets view earnings given the

markets' high expectations for the next few quarters. Beating the first-quarter

number alone likely won’t be enough to see a significant boost in stock prices.

Keep an Eye on the Growth Sectors

Growth companies and sectors have been driving much of the gains in stock

prices and earnings over the past year. Tech, consumer discretionary, and

communication services make up 71 percent of the Russell 1000 Growth Index

and nearly 50 percent of the S&P 500. Each of these sectors is expected to see

first-quarter earnings growth of more than 15 percent and will play a major

role in whether we see a positive quarter for earnings.

These sectors also have some narrow leadership. Earnings growth from Nvidia

(tech), Meta (communication services), and Amazon (consumer discretionary)

are expected to make up half or more of the growth of their sectors. Analysts

expect the consumer discretionary sector to report a loss without accounting

for Amazon’s growth. Valuations will also play a role in returns, with tech

trading at a 54 percent premium to its 20-year history on a forward P/E basis.

Consumer discretionary is also trading at a 27 percent premium.

Source: FactSet Consensus Analyst Estimates (as of April 5, 2024)

Don’t Overlook the Value Sectors

Earnings season will kick off on Friday with several of the big banks reporting.

Like several other value sectors, expectations aren’t high for financials. Last

quarter began with some surprise losses from the banks due to FDIC charges,

but those were quickly forgotten as other sectors reported earnings beats. This

quarter, it will be important to watch how the banks are provisioning for credit

losses on consumer credit and commercial real estate to look for cracks in the

health of an otherwise strong economy.

Materials and energy are expected to see significant losses in the first quarter,

but they make up less than 7 percent of the S&P 500. Health care is an

interesting one to watch. One of the larger weights in both the Russell 1000

Growth and Value Indices, earnings are expected to fall by 7 percent in the

first quarter but grow by 14 percent for the year. Several pharmaceutical

companies are expected to start seeing losses bottom, which could be an

inflection point for the sector. On the whole, however, the sector is still trading

at a premium to its long-term averages. Energy and real estate are the only

two sectors trading at slight discounts to their 20-year averages.


Our takeaways

In consideration of the prevailing metrics and Q1 activity, MORWM remains

cautiously optimistic regarding both the markets and the economy. We’ve

witnessed improvement in corporate fundamentals, and we look forward to

economic growth stimulating further market appreciation. That being said,

because we’ve seen momentous market appreciation over the last year and

half, we expect considerable market volatility and a potential 10% correction

very soon. We have no idea when that will happen, but rest assured that when

it does, we will happily take advantage of that dip (assuming that employment

remains robust). After all, as Shelby Davis once said: “You make most of your

money during bear markets, you just don’t realize it at the time.”

In closing, we wish everyone a wonderful weekend.

-Your team here at MORWM


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