Market Commentary | Q1 2024 Halftime Report


In this Halftime Report, Sam Chaplin and Jim Bradley discuss inflation, the economy, and the market outlook. They note that while inflation has been a concern, it is a mix of transitory and persistent factors, with goods inflation proving to be more transitory and service inflation remaining sticky. They also discuss the positive state of the economy, with low unemployment rates, elevated retail sales, and strong GDP growth. In terms of the market, they mention that the focus has shifted from how high interest rates will go to how long they will stay where they are. They also touch on the upcoming election year, noting that while election years can be more volatile, markets tend to like certainty and historically have performed well in election years. They caution against making investment decisions based on political outcomes and emphasize the importance of focusing on long-term trends and fundamentals.


Sam Chaplin:

Hi, everybody. Welcome to the Q1 halftime report from Penobscot Financial Advisors. Thanks for taking the time to join us today. My name is Sam Chaplin, portfolio manager at Penobscot, joined by our founder and chief advancement officer, James Bradley, as always. Good morning, Jim. How are you?

Jim Bradley:

Good morning, Sam. Doing really well and working our way through the depths of winter here, and hopefully setting people up with something that they can bring into the emerging spring with them.

Sam Chaplin:

There we go. Try to keep it positive here. On our agendas, always got the economy, the markets, and a little bit of outlook. Jump right into it, try to keep things moving. Inflation. Jim’s going to talk a little bit of inflation.

Jim Bradley:

Sure and certainly that’s obviously been front of mind for the last, what are we going to say? 18, 24 months. And we’ve got a Fed chair who, when it first started to whip up, used the word transitory, and kind of potentially had to eat his words a bit as it kind of proved a little bit stickier than I think a lot of people had in mind. But certainly in defense of Jerome Powell, there are parts of inflation that truly did, I think, turn out to be transitory. Now, we’re just coming off as we record this piece of an earlier in the week, a little bit of a surprise number to the upside. And the question is, is that an indication that inflation is in general being stickier or is that just kind of noise in the numbers that we can kind of expect from time to time?

We’ve had some surprises to the downside and this was a minor surprise to the upside. And markets kind of got jostled about a little bit as a result because of the fact that I think people were starting to factor in an expectation that rates are going to be relatively aggressively cut, more so than what the Fed led us to believe in their last guidance. So when we look at this slide here about a good one that came from out of Bloomberg regarding whether it’s transitory or whether it’s really intransigent, the answer is a little bit of both. If you look at, there’s two lines here, a blue line and a black line. The blue line shows goods inflation excluding food and energy, and the black line is service inflation. And you can see that service inflation didn’t spike up quite as much but it’s proving to be a good bit stickier as the consumer still is relatively strong and continues to demand services.

Whereas goods was more of a situation where a lot of money flooded into the system. People chased a good number of raw materials and consumer items, but the need for those declined a bit. And the supply chain issues that really drove up prices of goods have kind of ameliorated. I think the answer is both. Is it transitory or is it intransigent? The answer is both. Goods have proven to be transitory and services are still hanging in there a little bit. And then the next slide here is a little bit more involved, but I think the colors kind of show exactly what we’re seeing here. The yellow is service inflation. And the red really represents goods. And you can see that red represents energy, and the rest of it in general is goods inflation. And you can see that lately, energy has actually been more of a deflationary factor.

The red lines kind of head downward instead of upward. They’re not contributing to inflation in the most recent number of quarters. They’ve actually been taking away from it a little bit. The yellow, the service inflation really is all that’s left of what we see as inflation. Is that something to be concerned about? And there’s a lot of different ways of approaching this, but service inflation does tend to come down a little bit more slowly. It tends to quite often include things like shelter, which is a lagging number and sometimes actually is more of a survey number than actually what is being experienced out there in actual prices. And that feeds into this as well. And if you go back to before this burst of inflation, you can see that that’s always been the case. The yellow lines are the majority of what we see in inflation even before inflation became a problem.

So something that we want to be cautious about. We don’t want to get too overly optimistic about inflation diving substantially when you’ve got that sticky service number coming in. But also something to have a little bit of a silver lining around because of the fact that a lot of the leading indicators, a lot of what we see feeding into service inflation have been still showing signs of ameliorating somewhat. And so I guess from the way we’re looking at it and the way we would encourage investors to look at inflation, don’t assume that it’s a done deal. Don’t assume that we’re entirely past it, but also don’t look at what we’re seeing as this slowdown in this one data point that we saw earlier in the week as an indication that it’s on its way back up. We really aren’t charting that kind of a course from our standpoint.

Sam Chaplin:

Yeah, I think one of the biggest takeaways from this bout of inflation is how much the US has transitioned from a goods manufacturing economy to a services economy, that goods inflation did turn out to be somewhat transitory as supply chains resolved themselves, but services kept being high prices and younger consumers are more likely to spend on services than goods too. So that’s another transition happening in the economy. Could talk a little bit more about the economy. The biggest concern with inflation was that it was going to run away. Interest rates were going to have to go really high and there would be kind of this domino effect of bad news for the economy, which would usually start with cutting back on spending by consumers and businesses, more layoffs, higher unemployment, less retail sales, and then ultimately lower GDP because consumer spending is a large portion of GDP.

We haven’t really seen any of that on the headline level here as this chart shows. Unemployment rate staying right near the lows of pre-pandemic. Retail sales, even once being adjusted for inflation, are still elevated relative to pre-pandemic. And GDP also doing really well. Nice upside surprise in the last report there, 3.1% Long-term average is down closer to 2%. So that’s still a very good number. So those are the headline numbers. We always want to be careful of the inputs going into these things. So there are a little bit of caveats, like for example, the unemployment rate is very low but people aren’t working as many hours and not quite as productive in those hours of work. So that will have some effects long-term on GDP. Retail sales or monitoring people shifting from more luxury spending to more necessity spending. And eventually GDP as well, we’re taking a look at that as far as how much of this GDP growth is organic versus stimulus-induced by all the fiscal spending that went on over the past couple of years.

So good news on the headline level, still some reasons for caution below that level. And again, these are lagging indicators so we want to be looking at what’s going to be feeding into them in the future. What this all leads up to from the market’s perspective is that, when are interest rates going to fall? The good news is that with inflation coming down as well as it has been, we’re kind of got to the point where we don’t think rates are going to need to go significantly higher. So the question has really shifted from how high rates going to go to, how long are they going to stay where they are? So that’s good news. Market’s placing a lot of bets on when interest rates are going to be cut. They’ve gotten ahead of themselves a couple times as we’ll see on this next chart.

There were some hopes initially that March would be the month where the first rate cut would happen that sends really good news for the market, cost of capital goes down, all that good stuff. So markets really performed well in the fourth quarter as those rate cut bets built up and we had a really broad-based rally as we’ll see on this next chart since the end of the fourth quarter. Equity performance globally up 14.11%. Bond performance in the blue line up 5.13%, seeing a little less volatility in the bond market now since we kind of got that ceiling on rates that we hope anyway. It seems to be that way. In a really broad-based rally in the equity markets, which is what we like to see for healthy recovery. Earlier on in the year, the recovery was really led by those top tech names that pulled all the indexes upward while many of the other stocks in the economy lagged.

So good news there. As I mentioned before, those rate cut bets are being beat up a little bit recently, pushed out a little further, went from March to May, and now some are thinking June or July. So kind of that May to June areas is where the rate cut bets are piled up right now. And that has to do a lot with those numbers that we looked at the last couple slides ago, where spending is still good, unemployment is still low. Services inflation is still a little bit sticky so you don’t really want to cut rates too quickly into that type of environment where we could see inflation spike again. So that is the concern there.

So the economy is doing well, markets are not on the same page necessarily thinking that they want to see rate cuts but, of course, if you see drastic rate cuts, that probably means the economy isn’t doing well and a little bit of a bifurcation there in the outlook. So in the outlook for this year, one thing we wanted to touch on is the election year. Everybody’s very, very excited for another election year. So Jim’s going to talk about implications that could have for the market or not have.

Jim Bradley:

To just kind of riff on what you were talking about before. And this is going to be a very Jerome Powell positive halftime review because like I say, I think that he was right on some of the transitory elements of inflation. It also seems like although the market took really big bets that he was going to do something different than their quote, unquote “dot plot” that had three rate cuts in 2024 and the market had priced in five or six rate cuts. The slide you just showed is really the result of the market starting to say, “No, he’s probably about right. It’s going to be a poor rate cut year.”

Sam Chaplin:

Bit of a cat and mouse game between the markets and the Fed and stuff.

Jim Bradley:

But you’re right Sam, it’s 2024 and this is our first halftime report of 2024. And we don’t have Usher to give us any entertainment after our halftime report. So I’ll just entertain us with the topic that’s on a lot of people’s minds and certainly questions that I’m getting quite a lot as I speak with our constituents, and it has to do with the election, is the election something we should be afraid of? And typically election years do tend to be a little bit more volatile than non-election years, although 83% of the time, markets are up in election years. So there’s good reason to have some level of positivity. Really bottom line what the markets like is certainty, and what they don’t like is uncertainty. And that really kind of shows in this chart, which is interesting. It shows an average all the way back to 1896 of non-election years versus presidential election years.

You can see non-election years are a little bit more steady Eddie to the upside. Presidential election years tends to be a little bit more rattled during the first part of the year, and then it seems like they start to pick up toward the second half. And this is regardless of the party that is looking like they’re going to pull out a presidential election or anything like that. So it’s certainly likely more a result of the fact that as the year goes along, the picture perhaps becomes clearer. This year may be an exception, it may be an unclear result up to and beyond election day. But as the picture becomes clearer, typically, in election years, it picks up from a little bit of sideways movement on average to actually fulfilling the upward trend that every other year has on average tended to fulfill. Another question that I get is there was a pretty substantial consensus early on in the Biden administration that Biden had a leg up on Trump coming back in.

And the next slide that we see here really kind shows how that projection, that feeling, that attitude has kind of shifted. So we’ve seen the Trump line go surpass the Biden line in late September, early October of last year, and that gap has widened. And we’ve seen it in some polls out there. So again, lots of concern that people have about what would the change of the party controlling the White House lead to if it were to be the case and are there investment implications?

And I’d really caution people to not necessarily try to game what they’re seeing politically in their portfolios. Historically, that’s been a real challenge to do correctly. And sometimes it ends up being essentially the opposite of what you might think. This next slide shows if you kind of take a typical quote, unquote “red stock versus a typical blue stock,” and I think people paint with a bit of a broad brush on these items. But something like Smith & Wesson’s stock, which people might, as a knee-jerk reaction, think would be favored by having a more gun-promoting, friendly party in place would do better when a Republican takes office and worse when a Democrat takes office. And we can see on the left hand scale here, the entire opposite happened.

Their stock got a really good boost directly after the replacement of President Trump with President Biden. Interestingly, I’m looking at the right one, this Winder Hill Clean Energy portfolio, which actually one that we used a while back to get some of that renewable energy, which people typically conflate with more of being a blue-party-friendly type of industry, peaked out just before Biden won the last election, replaced Trump and has had a little bit, a really fairly significant headwind since then.

So it’s all just a matter of stay with basics, stay with the fundamentals in your portfolio, look at longer-term trends. Don’t look at what’s likely to shift substantially from a policy standpoint. And at the end of the day, I think markets more than liking red administrations or liking blue administrations, markets like certainty and they don’t like uncertainty. So more than anything else, I think, markets tend to perform best when we have divided government. And that’s certainly something that, from the optimistic side of me looking forward, looks like regardless of who takes the White House is probably going to be facing some degree of division when it comes to their party versus the parties that can control congress.

And so whether or not that’s the case, hard to bet on right now, but something that I think that in this year as an election year, I wouldn’t use it as an opportunity to say things are going to be especially good or especially bad and don’t change your investment philosophy based upon what you’re seeing politically.

Sam Chaplin:

Yeah, completely agree. It’s going to capture all the headlines this year, but there’s a lot of data out there on this, and there really is no statistical significance to who’s in the White House relative to market performance. So something we’d like to caution people against, I think there are more important things to be watching this year. We’ll be watching for any type of geopolitical escalations. Obviously a couple wars going on and out there, tensions building with China, we’ll be watching for the monetary policy we already talked about with interest rates.

And I think once we get some clarity on monetary policy, we’re going to see some more focus on fiscal policy just because we took out massive amounts of debt, interest rates have been going up, that’s going to cause long-term debt problems for the US if we don’t get spending under control or raise taxes on one side or the other. So that is a factor that’s going to have to be reckoned with at some point. I think we got bigger fish to fry at the moment, but once things cool down a bit, that might be the next place that people start watching. And with that, I think we’ll conclude our halftime report here. Thanks everybody for joining us. Feel free to like or subscribe if you want to keep track of these in the future and we’ll see you next quarter.

Jim Bradley:

We’ll see you in May. Thanks a lot everybody.

Sam Chaplin:


The foregoing content reflects the opinions of Penobscot Financial Advisors and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be construed as investment advice or a recommendation regarding the purchase or sale of any security. There’s no guarantee that the statements, opinions, or forecast provided herein will prove to be correct.