Dear Valued Client,
Last year, the markets surprised many experts – who had predicted a recession – by going on a tear. The S&P 500 finished 2023 up 24%.1 The TSX Composite rose by over 8%.2
That hot streak continued through the first quarter of 2024. The S&P gained 10.2% in Q1, its best start to a year since 2019. 3 The TSX, meanwhile, rose by 5.8%.4
While investors are undoubtedly happy with these numbers, it does pose a question: Are they sustainable?
Here in Canada, the quarter’s healthy performance was partially thanks to commodities and energy. In January, our economy grew by 0.6%, the fastest growth rate in a year.5 Many economists had predicted a more modest 0.4% increase in GDP. But both here and in the United States, the market rally was boosted even more by expectations.
1. That both the Bank of Canada and the United States’ Federal Reserve will lower interest rates sometime in the near future.
2.That the potential of AI will yield major profits for companies down the road.
Because many investors expect that one or both of these things will happen, they want to be positioned to take advantage of them when they do. So, more money flows into the stock market – especially into companies that would seem to benefit most from both developments – and we experience the kind of quarter that we just saw. One where the S&P 500 has its best start to the year since 2019.
But the question remains: Is this performance real…or is it a mirage? Is it sustainable, or just temporary? Are we in a bull market…or a bubble?
There are a thousand ways to guess the answers. For example, here are a few arguments – all based on statistics – for why the market’s Q1 performance is “real.” (Which is to say, sustainable.)
Inflation is much lower than it was last year, prompting the possibility of rate cuts later in the year. Canada’s inflation fell to 2.8% in February after most economists expected prices to rise.6 In the U.S., inflation was at 3.2% by the end of February, whereas in February of 2023, it was at 6%.7 As a result, investors have largely priced in the expectation that both central banks will feel confident enough to cut interest rates in the summer. (Both banks traditionally shoot for an inflation rate of 2%.)
The U.S. economy remains strong, and the Canadian economy is improving. In the U.S., corporate earnings appear healthy, their most recent unemployment rate was 3.9%8, and the Fed’s latest estimate was a 2.5% increase in GDP during Q1.9
The market’s performance is actually broadening. It’s an open secret that a major portion of the market’s gains last year were driven by just a small handful of tech companies. (Most of which are major players in the AI race.) But that portion broadened significantly in Q1. For example, approximately 23% of the companies in the S&P 500 reached 52-week highs.10 And if you gave each company in the S&P 500 an equal weight, the index rose 25% since October.10 (If you gave each company an equal weight in 2023, the index would have only gone up 12% for the year instead of 24%.11) Meanwhile, of the 226 stocks that were in the TSX Composite during Q1, 66% recorded a gain.12
But there are equally compelling arguments for why the market’s performance may not be sustainable:
In the U.S., inflation actually ticked up in Q1. Consumer prices in the U.S. increased by 0.4% in February after rising 0.3% in January.7 This was largely due to seasonal factors – prices usually go up in winter, partially because fuel tends to be more expensive – but it means the Fed must be even more cautious about lowering interest rates prematurely. If investors stop expecting rate cuts in the near future, the S&P 500 may well pull back.
Stocks may be overvalued. When you divide the size of the U.S. stock market against the size of its economy, you can see how fast the stock market is growing compared to GDP. If the ratio is heavily skewed in favor of the stock market, it suggests stocks are overvalued relative to how much the economy is actually producing. Right now, that ratio is near a two-year high.10
The hype around AI may be overblown. Recent technological advances have investors salivating at the possibility that AI will help companies produce more at lower cost…and, by doing so, return more value to their shareholders. But this hype has been going on for well over a year now. How much AI has actually contributed in terms of tangible results is an open question. Developing AI technology is extremely expensive, so if investors decide the return is not worth the expense, the hype may die out.
So, where does that leave us as we move further into the second quarter of the year?
Here at Omell Financial Group, we pay attention to all these statistics but are beholden to none. We use statistics to be alert to any possible opportunities and to be wary of any potential pitfalls. In other words, we use statistics to help us be prepared for possibilities…not to make predictions.
Cuurently, there are reasons to feel optimistic on a number of fronts. We will continue to position ourselves so we can take advantage if that optimism bears fruit. But we are perfectly prepared for any sort of market pullback, should it come. As always, though, let us know if you have any questions or concerns. We are always here for you.
Sincerely yours,
Omell Financial Group
1 “Stocks close out 2023 with a 24% gain,” CBS, www.cbsnews.com/news/stock-market-up-24-percent-2023-rally/
2 “TSX ends 2023 on a high note,” Reuters, www.reuters.com/markets/tsx-eyes-higher-open-last-trading-day-year-2023-12-29/
3 “The SP 500 just turned in its best first quarter since 2019,” CNN Business, www.cnn.com/2024/03/28/investing/premarket-stocks-trading-first-quarter/index.html
4 “Toronto market notches second straight robut quarterly gain,” Reuters, /www.reuters.com/markets/futures-inch-up-higher-gold-crude-prices-data-tap-2024-03-28/
5 “Canadian economy starts the year on a rebound,” CBC, www.cbc.ca/news/business/canada-gdp-january-1.7158064
6 “Canada’s inflation rate slowed to 2.8% in February,” CBC, www.cbc.ca/news/business/inflation-february-2024-1.7148177
7 “12-month percentage change, CPI,” U.S. Bureau of Labor Statistics, www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm
8 “The Employment Situation – February 2024,” U.S. Bureau of Labor Statistics, www.bls.gov/news.release/pdf/empsit.pdf
9 “GDPNow,” Federal Reserve Bank of Atlanta, www.atlantafed.org/cqer/research/gdpnow
10 “Warren Buffett’s favorite market indicator is flashing red,” CNN Business, www.cnn.com/2024/03/27/investing/premarket-stocks-trading/index.html
11 “S&P 500 Equal Weight Index” https://www.spglobal.com/spdji/en/indices/equity/sp-500-equal-weight-index/#overview
11 “TSX Performance Review, Linde Equity, www.lindeequity.com/wp-content/uploads/2024/04/Q1_2024_TSX_Review.pdf
Sourced from Bill Good Letter’s Library
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