Commentary from the Investment Committee of Coral Gables Trust
Q1 2024 – Changing of the Guard
The equity market’s ferocious run at the end of 2023 continued into 2024 with the S&P 500, Dow Jones Average, and Nasdaq, all reaching new highs on a regular basis. The S&P 500 led the pack with an impressive quarterly return of +10.55%, followed by the technology heavy NASDAQ at +9.32% and finally, the Dow Jones Average at +6.14%. In 2023, the market’s performance was largely centered around the “Magnificent Seven” primarily due to their outsized returns, earnings growth, and association with the artificial intelligence revolution. Early in 2024, markets are starting to broaden in their participation with growth and value performing more in line with each other. The S&P 500 has a forward price-to-earnings (P/E) ratio of about 16 times excluding the Magnificent Seven, implying that there is a valuation argument to focus attention to other higher quality parts of the market that have not performed in the last few years. The Magnificent Seven stocks now have a market cap of around $12 trillion. The chart below shows the sales and profitability of the next $12 trillion in market cap represented by 42 companies from a broad set of industries ranging from technology, healthcare, financials to consumer companies.
The earnings recession appears to have troughed during last year’s second quarter. Corporate earnings continue to grow and forward guidance will be more important to justify the performance and multiple expansion that markets have enjoyed since late 2023. Significant initiatives like artificial intelligence and re-shoring industrial production have gone from the planning stage to implementation, which has led to sizable growth for companies that benefit from these trends.
February’s employment situation remained strong (as Goldilocks would say, “not too hot and not too cold”), with faster-than-expected hiring, a slight increase in the unemployment rate, and a slower increase in wages. Both the January and February employment reports showed stronger-than-expected payroll gains. February’s report bodes rather well for the Federal Reserve as the data was broadly positive, displaying the resiliency of the labor market that is creating less inflationary pressures through wage gains. Notably, there are still over nine million job openings and still almost 1.5 million higher than before the pandemic. The elevated job openings suggest that payroll gains of 150,000 to 200,000 will continue for the remainder of the year. Investors applauded these recent developments as it appears the economy is trending in the soft-landing direction. If the economy continues to add jobs at a healthy pace without triggering a resurgence in wage growth, then the Federal Reserve can achieve a soft landing.
The prospect of continued economic growth is looking promising, as the latest data suggest real GDP growth of between 1.00% and 2.00% annualized for the first quarter of 2024 and roughly 2.00% year-over-year for 2024 and 2025. Furthermore, the Federal Reserve upgraded its outlook for economic growth for 2024 through 2026. The chart below shows the median Federal Open Market Committee projections for U.S. real GDP growth at the March meeting. Median real GDP projections were higher in 2024, 2025, and 2026 compared to the December projections.
Federal Reserve: Are We There Yet?
The strong job and GDP results might please the anti-recession crowd but for investors looking for several rate cuts in 2024, the wait might have to be longer. At March’s Federal Reserve meeting, the committee left the fed funds rate on hold at 5.25% to 5.50%. Chair Jerome Powell maintained a dovish stance regarding prospects for upcoming rate cuts this year and indicated that the committee sees the fed funds rate gradually heading to around 3.10% by 2026. However, recent inflation readings for January and February have somewhat complicated the situation. Initially in Q4 2023, six rate cuts were starting to be priced in. Currently market consensus is only counting on two cuts or less. Markets have been resilient because there is still a confident majority that believe rates will be cut, it is just a matter of when. The chart below illustrates the median Federal Open Market Committee projections for the fed funds rate at the March meeting.
Fixed Income Markets: Bonds Are Back!
It has been a difficult start to the year for fixed income markets as bonds have come under pressure as the Federal Reserve has pushed interest rate cuts further into 2024. At the end of 2023, when the Federal Reserve first signaled that they may stop raising rates, bond investors placed aggressive expectations on interest rate cuts. Throughout 2024, this sentiment has shifted toward “higher for longer” and interest rates have risen while bond prices have fallen.
The fixed income market, on aggregate, posted a negative first quarter with the Bloomberg Barclays Aggregate Bond index returning a -0.77% and foreign bonds returning -3.26%. Despite the negative returns, investors are achieving higher yields than they were a few years ago and that is typically a good backdrop for better future bond performance. Beneath the surface, there was a divergence in returns between higher and lower quality bonds. Higher quality bonds, such as government bonds and investment grade credit, suffered slightly negative returns as yields rose, while lower rated credit markets performed better, supported by their lower duration and correlation to equity markets. Despite the relative outperformance by lower quality issues, we continue to recommend investors focus on quality and should favor investment-grade corporate bonds and municipal bonds. Additionally, we believe investors should consider extending duration to avoid reinvestment risk in the future.
The chart above displays how the corporate bond yield curve compares to the U.S. Treasury curve. Investors are currently compensated with more yield when adding duration to portfolios along with assuming modest credit risk. After more than a decade of low yields, we believe high-quality investment corporate credit is a compelling choice for investors looking to generate income over the next five to ten years.
International Markets: Opportunities Beyond Our Borders
With several international indices reaching all-time highs, investors should not ignore what is happening overseas. Japan’s Nikkei Index hit a new high for the first time in 34 years and European markets followed suit, surpassing their high last reached in January 2022. While challenges exist for the international economy, the direction of travel is paramount. As for Europe and Japan, the return of inflation and positive interest rates have been an earnings growth game changer. In addition, corporate governance reforms are helping international markets focus on shareholder value. Despite historical returns favoring domestic stocks, international stocks have a better starting valuation and may outperform over the long-term. Extended outperformance of either U.S. or International stocks can mask the need to maintain diversification. Regardless of what returns look like in 2024 and beyond, we believe international stocks play an essential role in a portfolio for reasons beyond relative performance. The MSCI ACWI ex-US index returned +5.76%, the MSCI EAFE index returned +5.94%, and the MSCI Emerging Markets returned +2.09% for the first quarter of 2024. The chart below illustrates that the outperformance of U.S. stocks over international stocks tends to be cyclical.
U.S. vs. International Equity Returns (%)
Thoughts on Asset Allocation
What’s next for the market after a strong start to 2024? From a historical standpoint, when the S&P 500 returns more than 10% in the first quarter, the second quarter rises 78% of the time with an average return of 3.30%. Furthermore, the economic backdrop remains supportive, with a soft landing looking more likely than a recession. While we expect bouts of market volatility amid ongoing jitters around the pace and magnitude of interest rate cuts, inflation readings and presidential election rhetoric, corrections are a normal part of investing and the relative calm of last year is the exception to the rule. Our Trust Investment Committee believe portfolios are well positioned to benefit from market broadening and a higher interest rate environment.
Our current investment managers are poised to benefit from attractive longer-term investment themes. They continue to focus on strong companies with clear earnings growth trajectories, pricing power and the ability to maintain market share in all environments. Listed below is a subset of our equity and fixed-income managers that performed exceptionally well during the quarter against their benchmarks.
*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns.
We look forward to speaking with each of you about our investment philosophy and strategies and your portfolios performance.
RESOURCES
Quarterly Report: Q1 2024
Q1 2024 – Changing of the Guard
The equity market’s ferocious run at the end of 2023 continued into 2024 with the S&P 500, Dow Jones Average, and Nasdaq, all reaching new highs on a regular basis. The S&P 500 led the pack with an impressive quarterly return of +10.55%, followed by the technology heavy NASDAQ at +9.32% and finally, the Dow Jones Average at +6.14%. In 2023, the market’s performance was largely centered around the “Magnificent Seven” primarily due to their outsized returns, earnings growth, and association with the artificial intelligence revolution. Early in 2024, markets are starting to broaden in their participation with growth and value performing more in line with each other. The S&P 500 has a forward price-to-earnings (P/E) ratio of about 16 times excluding the Magnificent Seven, implying that there is a valuation argument to focus attention to other higher quality parts of the market that have not performed in the last few years. The Magnificent Seven stocks now have a market cap of around $12 trillion. The chart below shows the sales and profitability of the next $12 trillion in market cap represented by 42 companies from a broad set of industries ranging from technology, healthcare, financials to consumer companies.
The earnings recession appears to have troughed during last year’s second quarter. Corporate earnings continue to grow and forward guidance will be more important to justify the performance and multiple expansion that markets have enjoyed since late 2023. Significant initiatives like artificial intelligence and re-shoring industrial production have gone from the planning stage to implementation, which has led to sizable growth for companies that benefit from these trends.
Economic Developments: Healthy Labor Market & Economic Activity
February’s employment situation remained strong (as Goldilocks would say, “not too hot and not too cold”), with faster-than-expected hiring, a slight increase in the unemployment rate, and a slower increase in wages. Both the January and February employment reports showed stronger-than-expected payroll gains. February’s report bodes rather well for the Federal Reserve as the data was broadly positive, displaying the resiliency of the labor market that is creating less inflationary pressures through wage gains. Notably, there are still over nine million job openings and still almost 1.5 million higher than before the pandemic. The elevated job openings suggest that payroll gains of 150,000 to 200,000 will continue for the remainder of the year. Investors applauded these recent developments as it appears the economy is trending in the soft-landing direction. If the economy continues to add jobs at a healthy pace without triggering a resurgence in wage growth, then the Federal Reserve can achieve a soft landing.
The prospect of continued economic growth is looking promising, as the latest data suggest real GDP growth of between 1.00% and 2.00% annualized for the first quarter of 2024 and roughly 2.00% year-over-year for 2024 and 2025. Furthermore, the Federal Reserve upgraded its outlook for economic growth for 2024 through 2026. The chart below shows the median Federal Open Market Committee projections for U.S. real GDP growth at the March meeting. Median real GDP projections were higher in 2024, 2025, and 2026 compared to the December projections.
Federal Reserve: Are We There Yet?
The strong job and GDP results might please the anti-recession crowd but for investors looking for several rate cuts in 2024, the wait might have to be longer. At March’s Federal Reserve meeting, the committee left the fed funds rate on hold at 5.25% to 5.50%. Chair Jerome Powell maintained a dovish stance regarding prospects for upcoming rate cuts this year and indicated that the committee sees the fed funds rate gradually heading to around 3.10% by 2026. However, recent inflation readings for January and February have somewhat complicated the situation. Initially in Q4 2023, six rate cuts were starting to be priced in. Currently market consensus is only counting on two cuts or less. Markets have been resilient because there is still a confident majority that believe rates will be cut, it is just a matter of when. The chart below illustrates the median Federal Open Market Committee projections for the fed funds rate at the March meeting.
Fixed Income Markets: Bonds Are Back!
It has been a difficult start to the year for fixed income markets as bonds have come under pressure as the Federal Reserve has pushed interest rate cuts further into 2024. At the end of 2023, when the Federal Reserve first signaled that they may stop raising rates, bond investors placed aggressive expectations on interest rate cuts. Throughout 2024, this sentiment has shifted toward “higher for longer” and interest rates have risen while bond prices have fallen.
The fixed income market, on aggregate, posted a negative first quarter with the Bloomberg Barclays Aggregate Bond index returning a -0.77% and foreign bonds returning -3.26%. Despite the negative returns, investors are achieving higher yields than they were a few years ago and that is typically a good backdrop for better future bond performance. Beneath the surface, there was a divergence in returns between higher and lower quality bonds. Higher quality bonds, such as government bonds and investment grade credit, suffered slightly negative returns as yields rose, while lower rated credit markets performed better, supported by their lower duration and correlation to equity markets. Despite the relative outperformance by lower quality issues, we continue to recommend investors focus on quality and should favor investment-grade corporate bonds and municipal bonds. Additionally, we believe investors should consider extending duration to avoid reinvestment risk in the future.
The chart above displays how the corporate bond yield curve compares to the U.S. Treasury curve. Investors are currently compensated with more yield when adding duration to portfolios along with assuming modest credit risk. After more than a decade of low yields, we believe high-quality investment corporate credit is a compelling choice for investors looking to generate income over the next five to ten years.
International Markets: Opportunities Beyond Our Borders
With several international indices reaching all-time highs, investors should not ignore what is happening overseas. Japan’s Nikkei Index hit a new high for the first time in 34 years and European markets followed suit, surpassing their high last reached in January 2022. While challenges exist for the international economy, the direction of travel is paramount. As for Europe and Japan, the return of inflation and positive interest rates have been an earnings growth game changer. In addition, corporate governance reforms are helping international markets focus on shareholder value. Despite historical returns favoring domestic stocks, international stocks have a better starting valuation and may outperform over the long-term. Extended outperformance of either U.S. or International stocks can mask the need to maintain diversification. Regardless of what returns look like in 2024 and beyond, we believe international stocks play an essential role in a portfolio for reasons beyond relative performance. The MSCI ACWI ex-US index returned +5.76%, the MSCI EAFE index returned +5.94%, and the MSCI Emerging Markets returned +2.09% for the first quarter of 2024. The chart below illustrates that the outperformance of U.S. stocks over international stocks tends to be cyclical.
Thoughts on Asset Allocation
What’s next for the market after a strong start to 2024? From a historical standpoint, when the S&P 500 returns more than 10% in the first quarter, the second quarter rises 78% of the time with an average return of 3.30%. Furthermore, the economic backdrop remains supportive, with a soft landing looking more likely than a recession. While we expect bouts of market volatility amid ongoing jitters around the pace and magnitude of interest rate cuts, inflation readings and presidential election rhetoric, corrections are a normal part of investing and the relative calm of last year is the exception to the rule. Our Trust Investment Committee believe portfolios are well positioned to benefit from market broadening and a higher interest rate environment.
Our current investment managers are poised to benefit from attractive longer-term investment themes. They continue to focus on strong companies with clear earnings growth trajectories, pricing power and the ability to maintain market share in all environments. Listed below is a subset of our equity and fixed-income managers that performed exceptionally well during the quarter against their benchmarks.
*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns.
We look forward to speaking with each of you about our investment philosophy and strategies and your portfolios performance.
Index of Commentary
Q4 2024
Q3 2024
Q2 2024
Q1 2024
For additional information, please contact:
Mason Williams
Managing Director
Chief Investment Officer
Michael J. Unger, CFP®
Vice President
Investment Officer