United States

Equity market rally continues as corporate earnings beat expectations

After eclipsing new highs in January, the S&P 500® ticked even higher in February and surpassed the 5,000 level for the first time. The index has advanced almost 25% since the lows reached in late October 2023, when the Federal Reserve (Fed) signaled the end of its most aggressive tightening cycle in history. Consensus now expects the U.S. economy to avoid a recession in 2024 as a tight labor market, resilient U.S. consumers and expansive fiscal deficits support corporate earnings and the equity market.

In contrast to January’s mega-cap concentrated equity rally, February’s returns were much broader-based with leadership from smaller capitalization stocks. The S&P 500 rose 5.3%, while the S&P MidCap 400® and Russell 2000® increased 5.9% and 5.7%, respectively. Only the large-cap index made all-time highs in February, highlighting the challenging environment for smaller firms, as both mid- and small-cap indices remain in a drawdown from highs set in 2021.

Given the Fed’s “data-dependent” approach to monetary policy, consensus has shifted its expectations, with the first rate cut now anticipated in June instead of March. Additionally, expectations now signal a reduced magnitude of cuts. As a result, U.S. Treasury (UST) yields moved higher in February with the 2- and 10-year UST yields rising to 4.63% and 4.26%, respectively. The slope of the yield curve, as measured by the spread between 2- and 10-year yields, has been inverted since 2022. In our view, this creates an ongoing headwind for interest rate-sensitive sectors, such as Financials and Real Estate.

While interest rate volatility, as measured by the ICE BofAML MOVE Index, continued to moderate in February; core fixed income declined for the month as interest rates rose. Consequently, the Bloomberg U.S. Aggregate Index remains in the drawdown that began in August 2020. We expect interest rates to remain volatile due to several factors, including the outsized federal deficit and uncertainty about the forward path of monetary policy.

Given the strong performance of equity markets, the dramatic repricing in fixed income resulting from delayed expectations for rate cuts has been somewhat surprising. We believe it is in part due to stronger-than-expected economic data, which remains supportive of higher interest rates. For example, in February, existing home sales topped four million for the first time since August 2023. Additionally, median existing home sale prices accelerated for the ninth consecutive month to 5.1%, the strongest growth rate since October 2022.

Annualized growth for the second reading of fourth quarter GDP declined modestly from 3.3% to 3.2% due to revisions in inventories. However, consumer spending, private investments and government spending were all revised higher. In sum, the U.S. economy grew 2.5% in 2023, driven by robust consumer spending and increased government spending. The labor market continues to defy expectations; weekly jobless claims hover at 215,000, well below the 265,000 peak of 2023. Thus far, the strength of the labor market has supported consumer spending and confidence, which in turn has played a key role in economic growth.

The latest Consumer Price Index (CPI) reading declined to 3.1% in January, down from 3.4% in December; however, it came in above the consensus estimate of 2.9%. Core CPI (excluding the more volatile categories of food and energy) remained unchanged at 3.9%, the lowest level since May 2021 as shelter inflation components remain stubbornly high. The Fed’s preferred inflation gauge, core Personal Consumption Expenditures (PCE), continued to moderate from 2.9% to 2.8%, marking its lowest level since April 2021. While these inflation measures largely continued their downward trajectory, they remain above the Fed’s 2% target (Figure 1).

Figure 1. Headline and Core Inflation Indices
 Sticky inflation remains above the Fed’s 2% target

Source: As of 2/29/2024. Source: Bloomberg L.P.

 

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Fourth quarter earnings season for the S&P 500 proved better than feared, with the blended earnings growth rate (consensus estimates combined with actual results) coming in at 4.0%, more than double the 1.6% estimate at the start of earnings season. While this would be the second consecutive quarter of positive earnings growth for the S&P 500, we remain cautious on corporate profits. Index earnings growth continues to be driven by the “Magnificent 7” — Apple Inc.; Microsoft Corp.; Amazon.com, Inc.; Alphabet Inc.; Nvidia Corp.; Tesla Inc. and Meta Platforms, Inc. Excluding the Magnificent 7, S&P 500 earnings would have declined 5.9%, which would mark the fifth consecutive quarter of negative earnings growth.

Valuations pushed higher in February as equities rallied and moved back toward valuation levels seen during the last market peak in January 2022, before the Fed began to tighten monetary policy. The S&P 500 forward price-to-earnings ratio increased to 20.5 times (x), while the S&P MidCap 400 and Russell 2000 valuations rose to 15.3x and 22.4x respectively. We believe these valuations rest on consensus expectations for lower interest rates, an economic “soft landing” in 2024 and a reacceleration of earnings growth.

Developed International 

Artificial intelligence enthusiasm masks underlying economic weakness

Despite the U.K. and Japan falling into a technical recession and the elusive economic recovery in the Eurozone, developed international equities showed resilience in February, primarily due to the global nature of developed equity markets. Equities in Japan, the U.K. and the Eurozone derive 54%, 80% and 55% of their revenues from international sources, respectively.

Despite the monthly gain, developed international lagged both its domestic and emerging market counterparts, led by the Consumer Discretionary and Information Technology sectors. Just five stocks accounted for nearly half of the asset class’s returns in February, with semiconductor firms, ASML Holdings N.V. and Tokyo Electron Limited, leading the rally. While these companies are benefiting from the emergence of artificial intelligence technologies, they trade at a significant premium to the rest of the market.

Economic data remains weak across regions, continuing to act as a headwind for the asset class. For example, the Eurozone composite PMI® remains in contraction territory. However, it improved slightly in February from 47.9 to 48.9, indicating the downturn may be starting to ease. Regardless, the economy is far from showing signs of a broad recovery as manufacturing remains weak, service inflation is sticky and bank lending continues to be tight.

In the U.K., 5.8% wage growth is keeping core inflation elevated at 5.1% — significantly above the Bank of England’s 2% target (Figure 2). This challenging inflation backdrop suggests policymakers will likely remain cautious about easing policy too soon. For context, at the beginning of 2024, consensus expected the European Central Bank would begin cutting interest rates by April; however, by the end of February, those expectations had been pushed back to June.

Figure 2. UK Wage Growth and Core Inflation 
Inflation woes are not relegated to the U.S.


Source: As of 2/29/2024. Source: Bloomberg L.P.

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In Japan, the Nikkei 225 Index finally pushed through its 1989 peak, despite a surprising, negative GDP report for a second consecutive quarter. In U.S. dollar terms, the rally looks less impressive as the yen weakened against the dollar following uncertainty around the timing of monetary policy in both regions.

Emerging Markets

Equities in China surge higher after six months of declines

Despite continued property sector weakness in China and global central bank pushback on imminent policy easing, the MSCI Emerging Markets IMI Index delivered its best monthly return since November 2023. The bounce back was led by China, which had its best month since July 2023.

From a sector and regional performance standpoint, all emerging market (EM) sectors were positive, led by Consumer Discretionary and Information Technology. China, Taiwan, South Korea and India were the top-performing constituents.

EM equity market breadth in February was notably wider than in developed markets. The percent of EM companies above their 200-day moving average ended the month at 50%, the highest month-end level since September (Figure 3, page 4).

Figure 3: EM Equity Market Breadth
China’s February rally supports a broader uptrend


As of 2/29/2024. Source: Bloomberg L.P.

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China, the largest constituent in EM, struggled to restore investor confidence in February. Recent data still show an uneven recovery since the country’s post-pandemic reopening. Real estate continues to be a key area of weakness. While policymakers in China continue to support the real estate market at the margin, there has yet to be meaningful stimulus in our view. For example, the People’s Bank of China has cut the 5-year loan prime rate (a key benchmark in mortgage lending) by a record 25 basis points, to 3.95%, yet equities continued to decline, which underscores tepid investor confidence as global growth remains weak.

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TEXT VERSION OF CHARTS

Figure 1: Headline and Core Inflation Indices 
Sticky inflation remains above the Fed’s 2% target (view image)

Date

CPI

Core CPI

Core Personal Consumption Expenditure (PCE)

1/2024

3.1%

3.9%

2.8%

10/2023

3.2%

4.0%

3.4%

7/2023

-6.4%

5.6%

4.9%

4/2023

4.9%

5.5%

4.8%

1/2023

6.4%

5.6%

4.9%

10/2022

7.7%

6.3%

5.3%

7/2022

8.5%

5.9%

5.0%

4/2022

8.3%

6.2%

5.3%

1/2022

7.5%

6.0%

5.4%

10/2021

6.2%

4.6%

4.5%

7/2021

5.4%

4.3%

4.0%

4/2021

4.2%

3.0%

3.2%

1/2021

1.4%

1.4%

1.7%

Source: As of 2/29/2024. Source: Bloomberg L.P.

Figure 2: UK Wage Growth and Core Inflation 
Inflation woes are not relegated to the U.S.  (view image)

Date

UK Average Weekly Earnings (y/y %)

UK Core Inflation (y/y %)

2% UK Inflation Target

11/2023

5.6

5.1

2

7/2023

8.2

6.9

2

3/2023

5.9

6.2

2

11/2022

7.5

6.3

2

7/2022

5.8

6.2

2

3/2022

10.1

5.7

2

11/2021

3.4

4

2

7/2021

7.3

1.8

2

3/2021

4.3

1.1

2

1/2021

4.3

1.4

2

Source: As of 2/29/2024. Source: Bloomberg L.P.

Figure 3: EM Equity Market Breadth
China’s February rally supports a broader uptrend (view image)

Date

Percent of Stocks Above 200 Day Moving Average

2/2024

49.86

6/2023

51.15

10/2022

28.07

2/2022

40.27

6/2021

63.63

10/2020

49.89

2/2020

37.71

6/2019

62.4

Source: As of 2/29/2024. Source: Bloomberg L.P.