We are not, however, dismissing some noteworthy characteristics of the current market. Currently, the top 10 stocks in the S&P 500 account for roughly 29% of the market’s capitalization.4 This compares with 33% during the dot-com era. Last year, the majority of the S&P 500’s gain was attributable to just a small number of mega-cap technology stocks. There’s no denying that market concentration has increased and leadership has been narrow. This makes the market more vulnerable to swings in sentiment, as well as to company- and sector-specific risks. For example, last week’s better-than-expected quarterly earnings announcement from NVIDIA provided the fuel that sent the tech sector and the overall market surging higher. However, an opposite announcement would have likely had, in our view, an equally negative effect on the broader market. We do have some indigestion toward a market that is so focused and sensitive to the outcomes of a single company or handful of names. These conditions don’t herald an imminent downturn or an outcome anywhere near that which followed the dot-com bubble, but instead highlight the importance of overall earnings in supporting sustainable growth for the equity market.
- The stock market’s recent response to the Fed has been, dare we say, calm.
- Expectations needed to be adjusted – For some time now, we have viewed expectations for Fed interest-rate decisions as the most prevalent catalyst for market volatility. Our reasoning is twofold: 1) Financial markets are incredibly tightly (almost myopically) anchored to Fed policy. This has been the case for the last two years, and we anticipate this will continue to be so in 2024. Monetary policy (particularly tightening and easing phases) is a very powerful driver of economic and market outcomes, so this is not an unreasonable condition. 2) We have felt consensus market expectations were unrealistic when it came to Fed rate cuts this year. It has been our expectation since last fall that the Fed would wait until this summer to begin cutting rates. Up until the last few weeks, markets have been pricing in rate cuts to begin in March. Over the last few weeks, in response to the Fed’s latest policy announcement and the most recent inflation report, markets have moved closer to our view, removing an expected rate cut in March and pushing back both the commencement and magnitude of cuts in 2024.
- Equites have kept a level head – Here in lies the good news for investors: Fed expectations have been recalibrated without the stock market freaking out. This has not been the case over the past year and signals to us that markets are willing to look at the bigger picture. That picture is one in which the economy appears poised to power ahead without experiencing a significant recession, the Fed will eventually begin to take its foot off the monetary-policy brake, and the corporate profit cycle is in an upswing.
Looking back in 2023, there were two prominent episodes during which the market was forced to adjust its expectations toward a less accommodative Fed. At the beginning of February 2023, the market abruptly raised its expectation for the policy rate by 50 basis points (0.50%) following hawkish commentary from the Fed around its commitment to bringing down inflation. The stock market fell more than 7% over the next month. Then in the summer of last year, the Fed instilled a “higher for longer” interest-rate message that sparked a 10% correction from August through October.1
Prior adjustments to higher rates spurred equity-market pullbacks.
