By Tim Courtney, Chief Investment Officer
As we transition into the next quarter, our focus remains on three pivotal areas of the market: interest rates, valuations and earnings. Below, we examine how each of these facets intertwines with the other to paint our broader economic picture.
Interest Rates. Lately, the market hasn't been paying much attention to changes in interest rates, which is a major shift from the market’s obsession with them in 2022 to mid-2023. Despite this change, we're still keeping an eye on them. Why? Because inflation is sticking around—prices have gone up 18% over the last three years1 and they're not dropping.
It’s also an election year, which adds another twist. Politicians typically prefer low interest rates because it makes it cheaper for the government to borrow and spend money, while investors want low rates because it can make assets like stocks more valuable. However, if rates are cut too much, it could backfire by causing inflation to spike.2 In 2021, low rates were fun for a while because they helped boost the economy, but when inflation jumped, it wasn't so fun anymore. So, while the market might not be focused on interest rates right now, we will continue to watch them closely.
Valuations. Most of the global market appears reasonably valued. However US large caps, particularly US mega caps, look expensive. With the S&P 500 trading at a 30% premium relative to the last two decades' average3, this valuation surge is primarily driven by a select group of mega-cap tech companies, within an even smaller subset of companies with exposure to AI pushing valuations to extreme heights. This mania has significantly influenced market cap weighted indexes like the S&P 500 as opposed to other weighting strategies like the S&P 500 Equal Weight which is close to normal valuations. It’s too soon to tell if AI can deliver and what the benefits will be. So far, benefits have been relatively few considering to the massive amount of capital that has been poured into the space. We’re keeping a close eye on what happens next.
Earnings. Ultimately, the justification for these high valuations hinges on earnings performance. As we look at the first quarter's earnings reports, we want to see if companies are growing at the speed of their valuations, especially in sectors like tech and AI. The backdrop of 2021's earnings, buoyed by zero percent interest rates and stimulus spending, serves as a reminder of the need for growth to sustain current market levels.
In summary, our attention to these areas—interest rates, valuations and earnings—will be critical as we move into the next quarter of the year. Our investment approach will be informed by these factors, enabling us to adapt to evolving market conditions and prices. The election and potential tax law changes will also play a role in markets as well, and we’ll look into these in coming quarters. If you have any questions, please contact your Exencial advisor.
Sources
- U.S. Bureau of Labor Statistics (3/15/24) — Consumer Price Index for All Urban Consumers
- AP News (2/22/24) — Federal Reserve officials caution against cutting US interest rates too soon or too much
- S&P 500 PE Ratio - 90 Year Historical Chart
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.
