2024 Q1 Coleford Quarterly Commentary

As we consider current economic and capital market performance, we are reminded of just how much can change in a short period of time.

Just 12 months ago, global financial markets seemed poised to suffer yet another setback brought on by the failures of Silicon Valley Bank and Signature Bank in the United States, turmoil at Credit Suisse in Switzerland and soaring inflation expectations.  However, doom and gloom predictions did not reflect what happened next as policy responses from governments/regulators were both swift and effective, allowing the economy to push ahead and equity markets to surge, particularly in the five months since November 2023.

In 2023, optimism was fueled on anticipation of significant U.S. Federal Reserve rate cuts, with initial market expectations pricing a 160-basis point reduction. However, these expectations were subsequently scaled back to just 75 basis points – which equates to approximately three rate cuts.

Performance dynamics within the S&P 500 also shifted. Last year, seven stocks, dubbed the “Magnificent 7,” were responsible for the lion’s share of stock market gains. This year, the Magnificent 7 includes the worst-performing stock in the Index (Tesla) and another (Apple) that experienced a 10% decline in market value. Despite less than magnificent performance from these two names, the S&P 500 managed to achieve a 10% increase in the first quarter of 2024 – well above its historical annual average gain – as investors began to reward companies beyond those seven.

In fairness, not all members of the Magnificent 7 were laggards. Nvidia, the global leader in artificial intelligence technology, is a case in point. After a 200% increase in market value last year, this stock experienced an 80% uptick through Q1. Despite sparking fears of a bubble, investors rewarded this company based on its growth in earnings (almost 400% in one year) relative to its share price increases. However, the sustainability of its earnings growth is a matter of significant debate – and a business that is not in the Coleford Equity Portfolio.

The market’s resilience, evident in the S&P 500’s ascent, suggests that the performance of certain tech stocks is giving way to a broader market upturn. This shift underlines the importance of diversified investments, particularly in a landscape where market leadership is evolving.

In our view, investors are witnessing a period of adjustment, where initial extreme expectations of Federal Reserve policy actions have moderated. This recalibration is reflected in a market that is dynamic and responsive to changing economic indicators, sectoral shifts, and corporate performance. While the talk of a bubble persists – and is fueled by the fact that the S&P 500 recently set 20 new all-time highs on its way to surpassing the 5,000 mark – the evidence suggests a more balanced market expansion, driven by a variety of factors including corporate earnings growth, economic policy adjustments, and evolving investor sentiments.

Unlike the S&P 500, the S&P/TSX60 remained 2% below its all-time high achieved in 2022, still a good result, but perhaps a reflection of divergent economic realities in Canada and the United States.

With the S&P 500 achieving significant milestones, the market reflects a complex interplay of factors that challenge the notion of a ‘bubble’ and purport to suggest a robust economic environment conducive to continued growth.

An Election Year in the U.S.

In U.S equity markets, election years typically begin with slow and volatile trading but gain momentum as political certainty improves in the lead up to Election Day in November. Historical performance since 1928 shows that the average full-year price returns for election and non-election years are nearly identical at 7.3% and 7.5% respectively, although the journey to these returns differs significantly. The current year has seen a robust start with a 7% gain by mid-March, suggesting a potentially strong year for stocks in line with past trends.

Average U.S. Stock Performance, 1928-2023

Despite the perceived significance of current U.S. electoral events, company discourse has not heavily focused on the election, with fewer than 10% of firms mentioning it in their most recent earnings calls, the lowest in recent cycles. This subdued attention is possibly due to familiarity with the main candidates, reducing market uncertainty.

EQUITIES

Earnings for the S&P 500 are on a recovery path, after a downward trend reversed following the third quarter of 2023. Corporate earnings are now projected to rise 14% by the end of 2024.

Alongside this earnings recovery, corporate executives are also displaying more confidence/less pessimism. During fourth quarter earnings conference calls early in 2024, only 47 S&P 500 companies mentioned the word “recession.” That’s well below the number of times recession was called out over the past five- and ten-year periods. Despite some concerns about a potential economic slowdown, reduced focus on recession contrasts with the increased use of the term “soft landing,” cited by 37 companies, the highest in three years.

S&P 500 Earnings Growing Again

FIXED INCOME

The beginning of 2024 sparked concerns that central banks might not cut rates as quickly as the market hoped, due to strong economic data, including job growth and persistent inflation. This led bond investors to reduce their expectations for both the size and speed of central bank interest rate cuts.  However, recent developments continue to indicate a pivot towards reducing rates. The Swiss National Bank led this shift, being the first in the developed world to cut rates this cycle, followed by signals from the U.S. Federal Reserve, the Bank of England, and the Bank of Japan that they might follow suit.

Central banks appear to be shifting focus from strictly controlling inflation to addressing economic growth risks. Despite acknowledging stronger economic performance and somewhat persistent inflation, the U.S. Federal Reserve still plans three rate cuts this year underpinned by improvements in supply conditions, particularly in the labour market, which they believe can sustain growth without exacerbating inflation.

U.S. Federal Reserve Chair Powell emphasized the nuanced approach towards monetary policy, indicating a preference for cutting rates in response to labour market weakening rather than aggressively hiking rates to combat inflation. This suggests a more accommodative stance to support economic stability.

Market Continues to Expect Policy Rate Reductions

The readiness of central bankers to reduce rates signifies a strategic shift. Their balancing act aims to nurture economic growth while gradually steering inflation towards target levels, setting a nuanced backdrop for investors navigating a changing financial landscape.

CLOSING THOUGHTS

One quarter does not a year make.  However, in the case of 2024, the first quarter was certainly a period to celebrate in the context of the S&P 500 Index and its resiliency.

It remains to be seen just how long this current upswing will last, when stimulative interest rate policies will finally land and what impact those changes will have on global economic performance.

As we look at what economists call “externalities”, we are always reminded of how quickly conditions can change and how unpredictable those changes can be, but also how important it is to invest with a long-term perspective in companies that have well-defined structural advantages.  These are companies that are built to last and designed to deliver superior shareholder returns through market cycles. For over three decades and countless externalities including those experienced over the past year, this approach has served us well.

The single greatest edge an investor can have is a long-term orientation.”
— Seth Klarman —