Navigating the Markets: April, 2024
- Avantia
- Mar 24, 2024
- 4 min read
Updated: Mar 23
High-Quality Fixed Income – Overweight duration
Contrary to market expectations of a rate decrease in March, the Federal Reserve held firm on interest rates during two first-quarter meetings, reaffirming their dedication to achieving a 2% inflation target. Since the onset of rate hikes in March 2022, the Fed has increased rates eleven times, setting the Federal Funds rate between 5.25% and 5.50%. Concurrently, Federal Reserve Chair Jerome Powell has been trimming the Fed’s balance sheet by $95 billion monthly, leading to a 16.5% reduction in assets, or about $1.48 trillion, from its peak in April 2022.
In its fifth successive meeting in March, the Federal Open Market Committee (FOMC) chose to maintain the status quo on rates. The anticipated decision was overshadowed by the Fed’s unchanged economic outlook in their Summary of Economic Projections. Notably, the median forecast for 2024 rate cuts remained at three, with divergent views among officials—two predicting no cuts, two foreseeing just two, and only one advocating for more than three cuts. This is a marked deviation from December 2023’s projections, where five members expected over three cuts. Additionally, the Fed has upgraded its economic forecasts, such as GDP for 2024, raised inflation projections for the same year, and adjusted the projected timeline for rate normalization in 2025.
Chair Powell acknowledged the persistence of inflation, which has exceeded expectations in recent months. However, he emphasized that the latest figures do not alter the general trend of a gradual decline in inflation towards the 2% goal. He clarified that the Fed would neither overreact to the data from the past two months nor disregard it.
High Yield Fixed Income – Neutral Corporate, Overweight Municipal
Default rates have fallen slightly to 2.53% in March. While still below the 30-year average of 3.53%, we do not expect defaults to rise much in the near term for two reasons. First, CCC-rated debt, which historically has the highest default rate, now represents a much smaller portion of the high-yield universe. Second, most companies refinanced their debt to long-term low rates and have limited debt maturities in the next year. Recently, spreads have widened slightly to 3.24%.
Also, delinquency rates, which are seen as a leading indicator of defaults, have risen over the past several quarters but remain very low at 1.38% (SA). However, Commercial Real Estate Loans are showing deteriorating conditions as the delinquency rate has gone from 0.84% to 1.15% in just two quarters. This is across all banks. According to Morgan Stanley, there are $1.5 Trillion of commercial real estate loans coming due by the end of 2025. We remain underweight to Real Estate as an asset class and within High Yield debt we seek to be in corporate and municipal credit. That said, we do expect regional banks to be a trouble spot in portfolios given their exposure to commercial real estate.
US Equities – Underweight, tilt toward small-cap value
In 2023, the S&P 500 index saw no new peaks, but after a hiatus of over two years, it surged to record-breaking heights, achieving 22 new all-time highs by the close of the first quarter. This set the stage for a potentially historic number of highs. Despite ongoing uncertainties in monetary policy, the stock market remained stable, with the S&P 500 experiencing its smallest quarterly drop in history at just -1.7%. This period also saw gold and the Japanese stock market reach unprecedented levels, with Japan’s market hitting this milestone for the first time since 1989.
The once unassailable ‘Magnificent 7’ showed signs of vulnerability this quarter, as Apple, Alphabet, and Tesla did not keep up with the S&P 500’s overall gain of 10.8%. However, ten out of the eleven sectors within the S&P reported positive earnings. Nvidia, propelled by advancements in AI, soared to an impressive 82% return in Q1, while the fervor for meme stocks was reignited with significant investments in the IPOs of Reddit Inc., Trump Media, and Technology.
One year on from Silicon Valley Bank’s downfall, the repercussions of higher interest rates on the financial health of smaller and regional banks were brought to light once again. The New York Community Bank’s unexpected losses in their multifamily commercial real estate loans served as a cautionary tale of potential further downturns. A significant portion of regional banks’ loan portfolios is comprised of commercial real estate, which has seen a notable rise in defaults. Nevertheless, the broader market appeared to overlook these concerns and associated risks.
International Developed Equities – Overweight, tilt toward Japan
Almost every sector of MSCI EAFE is currently trading at a discount relative to the long-term average. Meanwhile, buyback yields, which have been low historically, are now catching up to those in the U.S. which presents interesting investment opportunities. This is also extending to Japan where the number of buybacks has increased significantly showing that Japanese companies are focusing more on their shareholders. The P/E ratio for the MSCI ACWI ex-US index is 13.0x as of January 31st. This represents a 34.2% discount to the S&P 500 after one corrects for the natural discount of the MSCI ACWI Ex-US to the S&P500.Â
Japan appears to be poised to outperform in the years ahead as their P/E is historically low and the government is enacting policies that are likely to raise the profitability of companies. We also believe the US dollar will continue to fall and provide a positive tailwind for non-dollar assets.
Emerging Markets – Neutral, neutral China, overweight Korea, Mexico, India
Emerging market equities bring increased risk and volatility, but potentially strong returns in the long run. Currently, PE ratios are in line with the long-run average. However, China, Mexico, India, and Korea bring unique challenges and opportunities. China is in the midst of a property collapse and may see additional national stimulus to help its economy. This country represents between 25 and 30% of the index. On the other hand, Mexico is well positioned geographically to pick up much of the "nearshoring" investment opportunities as US companies reduce their exposure to China.