April 9, 2024
“A compelling narrative fosters an illusion of inevitability.”
Daniel Kahneman
The stock market loves a great narrative and that is what we’ve had since October of 2022. As you recall at that time, inflation had skyrocketed to 9%, interest rates on the 10-year treasury had increased from under 1% to over 4% and the stock market was reeling. But then the market magically bottomed as inflation topped. If rising inflation was hurting stocks and bonds, then investors believed inflation coming down would drive them back up. And with that, a new narrative was born. Though the investment landscape has been shielded by the protective umbrella of lower inflation, it has also helped that the dreaded recession has yet to arrive and that earnings, profit margins, and employment have remained buoyant. Contributing to this are the Infrastructure Bill, the Chips Act, and the massive spending after the introduction of ChatGPT which, collectively, have kept spending robust. The big question now is whether this narrative of lower inflation has run its course.
The last time we had an inflationary period similar to this was in the 1970’s. Back then, inflation moved up sharply until the end of 1974 and then dramatically declined into late 1976. That is very similar to what we are experiencing now as our inflation rate ran up to 9% at the end of 2022 and has declined to roughly the 3% level today. As we look back to 1977, inflation heated up again in a second vicious wave of inflation peaking in the early 1980’s. Will we see inflation bottom over the next few months and then reaccelerate as we saw back then? This is clearly a risk to the current narrative that we are monitoring closely.
In looking at the vibrant returns of this year’s first quarter, we can gather more insight. As we said in our nursery-rhyme themed letter from last quarter, the investment landscape is, “currently in this sweet spot as the porridge, chair, and bed in
the Bears’ house are just right.” That was an understatement as the S&P rocketed to an over 10% gain for the quarter compared to the historical 2.5% average gain it normally sees during this period. In the past when we’ve seen these outsized gains, the next quarter tends to be positive as well. There are also record amounts of money sitting in money market accounts and treasuries providing ample fuel for future positive stock market gains. However, when we’ve seen setups similar to this year, the market tends to not do as well during the second half of the year. We are also mindful of the uncertainties surrounding this year’s Election, the Ukraine War, the Middle East, and Taiwan’s tensions with China. We are mindful of the rising costs to the U.S. of servicing over $34 Trillion in debt in a higher interest rate environment.
The market loves a good narrative and the “Inflation is coming down” narrative has been quite effective. As we move closer to mid to late summer, further gains may be harder to come by as that narrative runs its course as inflation bottoms. We are still constructive and enjoying this market strength. Many more companies are now participating well beyond the usual few suspects of the Super Seven, which is positive. However, if we continue to see vibrant and outsized market strength over the next few months, the historically high money market funds shifting back into stocks, a further ramp-up of future A.I expectations discounted in the market, and inflation ticks back up, we might become more concerned.
Ralph Scott
Chief Investment Officer
Craig Weston
Senior Managing Director
Matthew Nussbaum CFA
Portfolio Manager & Senior Research Analyst
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