Except for a brief pullback in the early part of January, the stock market rally that started in late October continued to roll through the first three months of this year. The S&P 500, as well as most of the major averages, has gained roughly 10% this year. All told, stocks are now up nearly 30% since their closing low back on October 27th of last year. In fact, there have only been nine other years that have had a better start since 1970.
Every sector saw gains this quarter, but the real drivers continued to be a handful of mega-cap tech stocks. Nvidia continued its astounding run with its shares climbing another 82% in the first quarter. 21% percent of the market’s gain was attributed to Nvidia alone. Other big contributors this quarter were Microsoft, Meta, and Amazon.
Over the past few months, the biggest question has been the path of interest rates in the wake of one of the most aggressive monetary tightening cycles in history. The current federal-funds target rate range of 5.25%-5.50% is the highest it’s been since before the 2008 financial crisis. This quarter’s strength and the lower volatility was largely due to the anticipation that the Fed would being lowering rates early this year. But inflation remains well above the Fed 2% target and the economy remains robust. So, it seems curious to us why the market believes the Fed would be eager to ease rates in the environment.
Original estimates had the Fed cutting rates at their March meeting. Now those estimates have the soonest rate cut in July. This has allowed longer treasury yields to inch back up into the mid 4% range.
The scope of this rally now has investors wondering if stocks are overdue for a pullback. Historically, the momentum from exceptionally strong starts to the year usually carries forward to the next quarter. It’s usually not until the second half of the year that there is a meaningful decline. Interestingly, the timing of such a pullback also lines up with the expectations of the Fed cutting rates. Any rate cuts would soften the severity of a downturn in the market.
Taking all of this into account, we expect stocks to remain strong this year. As always, this could be interrupted by some unforeseen geopolitical event, but we don’t see anything on the horizon that is an immediate threat to the economy or the market.
Bond yields, while off their highs from 6 months ago, still remain attractive for income investors. Investment grade corporate bonds and agency mortgages are trading in the mid 5% yields and continue to be our area of focus. Because these yields are right in line with our financial planning models, we’ve been aggressively investing in longer-term bonds, extending our average maturities as our lower yielding short maturities come due. The combination of higher stock portfolios and better yields has greatly improved the financial wellbeing of retirees, which is a far cry from a couple of years ago.
