United States
Market rally broadens beyond large-cap growth
Equities delivered a fifth consecutive positive monthly return in March as economic and earnings data continued to come in better than expected, and the Federal Reserve (Fed) maintained tight monetary policy. Through month-end, the S&P 500® was up more than 10% and marked its fourth best start to the year in 30 years as economic slowdown concerns continue to fade.
Equity market momentum widened beyond the concentrated number of large-cap growth stocks that have driven returns for several months. In March, the Russell 3000® Value outpaced its Growth counterpart by the widest margin since December 2022. Additionally, market breadth (as measured by the percentage of stocks above their 200-day moving average) is at the highest level since mid-2021. This provides further evidence of a sustained market rally as monetary policy eases and near-term recession fears fade.
Economic data continue to show a divergence between strong U.S. labor markets and consumers, and subdued manufacturing activity. For example, inflation-adjusted average weekly earnings growth has been positive since June 2023, and the ISM Services New Orders Index reached the highest level since August 2023. In stark contrast, industrial production has delivered negative year-over-year growth for six of the past seven months.
At the Federal Open Market Committee’s March meeting, the Fed left interest rates unchanged once again, marking eight months since its last raise. While the fed funds rate remains at the highest level in more than 20 years, in recent months financial conditions have been easing, rather than tightening. The Bloomberg Financial Conditions Index has returned to levels last seen in 2021, before the Fed began its recent hiking cycle.
As financial conditions eased in March, and the Fed remained on “pause,” valuations richened. For example, for the first time since 2021, the next-12-month price-to-earnings ratio for the Russell 3000® crossed 21 times (x) and is now more than one standard deviation above its 10-year average. Similarly, the Bloomberg Corporate High Yield Index option-adjusted spread fell below 300 basis points (bps) in March, and closed the month at 302 bps, the lowest month-end level since December 2021. At these valuation levels, the path forward becomes highly dependent on strong 2024 earnings results.
Inflation remains sticky, as both the Consumer Price Index and Personal Consumption Expenditures Index data remain well above the Fed’s 2% target. In addition, market-based inflation indicators are more recently showing signs that inflation could actually reaccelerate. For example, the 5-year inflation swap yield and the 10-year breakeven yield (proxies for inflation expectations) reached the highest level since last October. We continue to believe that as inflation remains elevated, high-quality companies with strong balance sheets and consistent earnings growth, should remain attractive for investors.
After a fairly tepid fourth quarter earnings season, consensus expects first quarter results to largely continue in the same vein. For example, the consensus earnings growth rate estimate is currently 3.4%; however, excluding the “Magnificent 7” stocks (Microsoft Corp., Alphabet Inc., Meta Platforms Inc., Amazon.com, Apple Inc., Tesla Inc. and NVIDIA Corp.), it falls to -2.6%. Furthermore, a consensus revenue growth estimate of 3.5% implies margin pressures are expected to remain a headwind as pricing power continues to wane (Figure 1).
Figure 1. S&P 500 Operating Margin (%)
Margins compressed as inflation fell
Source: As of 3/31/2024. Source: Bloomberg L.P.
View accessible version of this chart.
With a modest decline in long-term U.S. Treasury yields in March, fixed income markets delivered their first positive monthly returns of the year. Investment grade credit led returns higher for the Bloomberg U.S. Aggregate Index as issuer fundamentals remain strong, despite elevated borrowing costs and inflation. Below-investment-grade credit, on the other hand, continues to show signs of a weakening credit cycle. During the first quarter, there were more credit downgrades into high yield, than upgrades into investment grade, for the third consecutive quarter.
Developed International
Equity prices maintain momentum as recessionary worries fade
Developed economies across the globe have proven resilient in the face of sticky inflation and monetary tightening, and concerns about the potential for recession have eased. The developed international market rebound from October 2023 continued to gain steam in March as the MSCI World ex USA Index outperformed the S&P 500 for the first time this year, supported by cyclical sectors such as Energy and Industrials.
In the Eurozone, March PMI® data showed further improvement. The composite PMI has improved every month since last August and is on the cusp of returning to expansion territory for the first time since May 2023. That said, the divergence between core (Germany and France) and peripheral Eurozone countries suggests a broad economic recovery has yet to materialize (Figure 2).
Figure 2. Country Composite PMIs
Surveys indicate a two-speed Euro Area economy
Source: As of 3/31/2024. Source: Bloomberg L.P.
View accessible version of this chart.
Against this backdrop of slow growth, investors have assigned an 88% probability to the European Central Bank (ECB) making its first rate cut of 25 bps this June. While the most recent Eurozone quarterly inflation data showed its largest decline since the first quarter of 2021, the ECB has signaled that it is waiting for declines in areas such as wage growth to provide further evidence that inflation is subsiding.
At its Policy Board meeting on March 19, the Bank of Japan (BOJ) decided to revise its ultra-loose monetary policy. The BOJ ended its quantitative and qualitative monetary easing program, which had been in place since 2016. However, the BOJ’s forward outlook was interpreted as dovish and drove the yen to its lowest level against the U.S. dollar in 34 years, acting as an ongoing headwind for consumers in Japan.
Emerging Markets
Improving fundamentals overshadowed by weak sentiment in China
Emerging markets (EM) rose 2.5% in March but lagged developed international for the fourth time in the past six months. Equities in China pulled back in March as investors lost confidence that policymakers would provide imminent support for the country’s ailing economy.
For the quarter, China continued to be a drag on EM performance, particularly in January due to concerns about the property sector as well as investor disappointment in both the size and pace of government support. That said, global equities with material exposure to China’s economy have diverged sharply from the MSCI China Index (Figure 3). We believe the performance differential highlights the country risk that still looms for some investors, despite upward earnings growth revisions and upside surprise in industrial production in China.
Figure 3: MSCI China vs MSCI World with China Exposure Index
Country risk still looms for investors
As of 3/31/2024. Source: Bloomberg L.P.
View accessible version of this chart.
While developed economies continue to confront elevated inflation, EM inflation primarily surprised to the downside in March. That backdrop has allowed EM central banks, including those in Brazil and Mexico, to cut policy rates in advance of monetary easing from the Fed. Moreover, February PMIs were positive for most major EMs, with ongoing recovery in both manufacturing and services activity.
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Figure 1: S&P 500 Operating Margin (%)
Margins compressed as inflation fell (view image)
Date |
S&P 500 Operating Margin (%) |
3/2024 |
12.5552 |
10/2023 |
13.8411 |
14.6105 |
|
12/2022 |
13.595 |
7/2022 |
15.1052 |
2/2022 |
15.7072 |
9/2021 |
16.5061 |
4/2021 |
11.4927 |
11/2020 |
13.4194 |
6/2020 |
6.0446 |
1/2020 |
13.7184 |
8/2019 |
13.7329 |
4/2019 |
10.8295 |
Source: As of 3/31/2024. Source: Bloomberg L.P.
Figure 2: Country Composite PMIs
Surveys indicate a two-speed Euro Area economy (view image)
Date |
Germany, France (average) |
Ireland, Italy, Spain (average) |
2/2024 |
47.2 |
53.1 |
9/2023 |
45.3 |
50.5 |
3/2023 |
52.7 |
55.4 |
9/2022 |
48.5 |
49.4 |
3/2022 |
55.7 |
55.4 |
9/2021 |
55.4 |
58.4 |
3/2021 |
53.7 |
52.2 |
Source: As of 3/31/2024. Source: Bloomberg L.P.
Figure 3: MSCI China vs. MSCI World with China Exposure Index
Country risk still looms for investors (view image)
Date |
MSCI World with China Exposure |
MSCI China |
2024 |
359.9455 |
115.4286 |
2023 |
276.2847 |
133.1782 |
2022 |
302.0978 |
142.2717 |
2021 |
269.8913 |
215.3068 |
2020 |
141.5188 |
149.9836 |
2019 |
154.9278 |
156.224 |
2018 |
146.4714 |
174.5219 |
2017 |
122.4116 |
123.294 |
2016 |
92.6028 |
99.8031 |
2015 |
111.1621 |
122.1273 |
2014 |
111.8665 |
99.8604 |
2013 |
100 |
100 |
Source: As of 3/31/2024. Source: Bloomberg L.P.
