Quarterly Perspectives: Q1 2024
Published April 12, 2024.
Transcript
Introduction
Hello, and welcome to Quarterly Perspectives, first quarter twenty twenty four.
My name is Alex Klusner, and I'm a member of the investment strategy team at Buckingham Wealth Partners. I'll be your host for this presentation.
This presentation details quarterly equity and fixed income performance along the framework of absolute returns, relative returns, and future expectations for market performance.
We'll then go on to discuss recent interest rate movements and inflation expectations.
Last, we examine how different asset classes contributed to an overall portfolio return. We hope you enjoy today's presentation. Now let's get started.
We begin our discussion with a high level look at a collection of major asset classes. As we can see from the illustration, US developed international and emerging market stocks were up during the first quarter, continuing the positive trend from the prior quarter.
Returns for US bonds were slightly down for the quarter, while global bonds were up for the quarter. However, bonds are up for the year both domestically and internationally.
Next, I'll draw your attention to the upper right hand portion of the graphic. The US dollar was up three point one percent for the quarter and up one point nine percent over the last twelve months.
Now let's take a little deeper look at what was driving the returns of stocks and bonds.
We'll start by taking a look at how global equities performed for the quarter, and we'll isolate the performance between US and developed international stocks.
The two charts show the performance of different investment styles between the US and international stocks. The bright blue bars represent performance of different investment styles, and the dark blue bars represent the total market performance for the region.
US returns are measured with Russell indexes, and international market returns are measured with the MSCI World ex US Index Series, which represents global developed market performance, excluding the US.
As we can see from the dark blue line on the chart on the left, the US market was up ten percent in the first quarter compared to up five point two percent for developed international markets on the chart on the right.
Large neutral stocks and large growth stocks, on average, outperformed the market in the US.
Large growth stocks led the pack domestically, which is a new trend from last quarter on a relative basis.
Internationally, large growth stocks and large neutral stocks tended to outperform the market as well, with international large growth stocks posting the best performance for the quarter among international developed regions.
But no matter the recent trends, it's important to remember that we shouldn't make longer term projections based on short term performance.
Now we take a longer view to see how different investment styles have performed for standard periods ending March thirty first twenty twenty four.
Looking at annualized returns in the US, we can see that markets have shown resilience, especially over the trailing one year period when faced with significant headwinds, such as an ongoing war and geopolitical conflicts outside of the US, uncertainty surrounding the future path of interest rates, and an upcoming US presidential election.
Despite these potential issues, US markets returned twenty nine point three percent over the last year and have been nearing or exceeding ten percent per year during longer time horizons.
Large growth stocks have the best performance for the trailing one year period, gaining thirty nine percent, which beat the US market by nine point seven percent.
We can also see that small and value stocks have generally been out of favor during these time periods.
Consequently, we expect that portfolios that have a small value tilt, such as those that we typically design for clients, will have underperformed portfolios that are market cap weighted or tilted to large growth stocks at these longer investment horizons.
Keep in mind that the very long term evidence demonstrates that on average, small stocks outperform large stocks and value stocks outperform growth stocks.
But size and value factors can still go through extended periods of underperformance like those shown above.
Turning to international markets, we see that large cap value stocks have led the pack over the one year period. At the longer time horizons, we see varying performance among different styles with value stocks, large cap stocks, and growth stocks, each posting leading performance over the trailing three, five, and ten year periods.
Relating to the prior slides, we see that international markets have underperformed the US market by fourteen point seven percent during the last twelve months, as well as at longer horizons with the three, five, and ten year performance trailing by five point seven, seven point two, and seven point six, respectively.
It's also worth noting that the US total stock market has had an exceptional ten year run with the bulk of it being driven by richening valuations and strong corporate real earnings growth. And a recent AQR research paper suggests that to expect a repeat of this performance over the next decade, even with an aggressive increase in earnings growth, investors would have to continue to bid up valuations far above where they were at the height of the tech bubble.
Nonetheless, given the higher US return over longer time horizons, we expect portfolios concentrated in US stocks to have outperformed a globally diversified portfolio.
However, as we'll see in the next slide, these relative performance numbers aren't reason enough to abandon international stocks.
Thus far, we've discussed quarterly performance on a relative and absolute basis. Now let's take a look at current stock market valuations and how they relate to future expectations of market performance.
The charts on this slide show how expensive stocks are by measure of the price to earnings ratio, a very common metric used to value equities.
The higher the ratio is, the more expensive the asset class is overall.
Thought of another way, these values depict how expensive one dollar of earnings is.
For example, as we can see in the chart on the top left, the average dollar of earnings for the total US stock market costs roughly twenty three dollars and fifty cents.
Internationally, as we can see in the chart on the top right, earnings are cheaper at just over fifteen dollars per dollar of earnings on average. The values represented here use the historical fund and ETF data to establish the price ratios, and the average PE is reflected by the dotted line on the chart. These averages start in the first quarter of two thousand four for US stocks and in the fourth quarter of two thousand six for international stocks.
Noting the strong market performance during the last twelve months, we see both broad US and international markets are now trading above their recent historical averages.
We can also see that small value stocks in global developed markets appear cheaper relative to their recent historical averages.
All else equal, we'd like to pay less for a dollar of earnings.
These valuation ratios aid in setting expectations about the future.
Low valuations today imply higher future returns and vice versa.
The recent strength of broader US market performance means that it's reasonable to expect lower returns than in the past when valuations were below their long term historical averages. The opposite is true for international markets and small value stocks globally.
It's reasonable to expect higher returns than in the past when valuations were above their long term historical averages.
I'll emphasize that this is a long term relationship and that short term outcomes will likely be dominated by unexpected market forces.
Here we have the same analysis but isolating US equities so we can see how valuations compare across different styles.
Recalling the annualized performance slides, we know that large growth has had an exceptional ten year period.
We can see that growth in the prices has exceeded the growth in earnings as the PE ratio has climbed to thirty three point four to close the quarter, which is above its long term average since two thousand four.
Small value, on the other hand, still has a PE ratio of eleven point six and remains under its average since two thousand four.
Although many investors may be interested in chasing the returns of large growth companies, we would point to these valuation charts as one reason to stay the course in a diversified portfolio tilted to small relatively inexpensive companies.
Next, we'll take a look at fixed income performance, the shape of the current yield curve, and how the market is currently pricing inflation.
The charts on the screen show the average performance of different bond maturities at the segments of the fixed income market that we commonly track.
We typically prefer investing in bonds that are shorter maturity and higher quality compared to the broader market.
In the chart on the left side, we see that bonds have longer term maturity ranges and negative performance, but markets favored shorter maturities relative to intermediate to longer maturities.
With the ten to twenty year segment posting the largest loss because of their increased sensitivity to rising interest rates.
The chart on the right shows the performance of different intermediate maturity credit quality bonds.
We see that performance was mixed across the different credit qualities listed for the quarter, with investors favoring corporate and inflation protected securities relative to other credit segments.
Next, we'll take a look at the Treasury yield curve and what it means for returns going forward.
Here we plot the yield curve to show the current yield for treasury bond investments at different maturities.
The light blue line represents current rates. The dark blue line represents rates from the end of the prior quarter, and the gold line represents rates from one year ago.
With the exception of the ultra short term portion of the curve, rates increased for all maturities during the quarter. As stated previously, this trend had a more negative impact on longer dated maturity debt.
Looking forward, expected returns for fixed income remain elevated relative to the pre pandemic era and have increased during the prior twelve months.
For long term fixed income investors, this is likely to be a net positive as new money and maturing bonds are reinvested into higher yielding bonds.
The yield curve remains inverted as it was at the end of last quarter, although less so than this time last year. When this happens, particularly between the two year and ten year points on the curve, it's widely regarded as one of the precursors, but not as a guarantee, to an impending recession.
Finally, we plot the market's forecast of inflation by taking the difference in yields between the US Treasury bonds and TIPS at different maturity levels.
Like the last chart, the bright blue line represents current inflation expectations.
The dark blue line represents inflation expectations from the end of last quarter, and the gold line represents inflation expectations from one year ago.
Current market estimates for future inflation are slightly elevated compared to the prior quarter, but are little changed compared to this time last year.
Even though inflation readings have continued to moderate, the Federal Reserve has been persistent in its stance that it's too early to declare victory over inflation because its two percent inflation objective has yet to be met and will need to show evidence that inflation is able to stay at that target in a sustainable manner.
Even with that said, Fed chairman Jerome Powell stated in early April that it is still reasonable to expect Fed to begin cutting rates this year, as the risks of reaccelerating inflation and keeping rates elevated for too long are continuing to balance out. As of the end of the first quarter, markets have downgraded their expectations for the number of rate cuts in twenty twenty four from six to three for a total reduction of zero point seven five percent in the federal funds rate, with the earliest cut occurring as early as the Fed's June meeting.
As these expectations continue to change, it's important to remember that these levels of inflation are baked into prices today.
The markets are pricing an average inflation rate of approximately two point four percent per year for the next five years, and the market collectively expects inflation to similarly outpace the Fed's target over the next thirty years. Not only are these expectations baked into bond prices, but they're also baked into equity prices. Making a bet on higher inflation would mean that we expect inflation to exceed the current forecast.
Next, let's take a look at how some major asset classes contributed to a sixty forty index mix this quarter and how that index mix behaved during recent history.
This slide, we look at the absolute impact of different asset class returns on the quarterly return of a sample sixty percent stock, forty percent bond index mix. With stock markets moving upward this quarter and bond markets being stagnant, we can see that equity asset classes contributed to the overall increase of the index mix. US large cap stocks were the largest contributor for quarter, while US intermediate bonds detracted slightly from the overall return.
Diversifying stocks across geographies and investment styles as well as allocating to bonds helped avoid undue portfolio concentration risk while allowing for substantive growth this quarter. This resulted in the sixty forty index mix achieving a return of four point three percent versus the US total stock market return of ten percent. The portfolio was able to achieve forty three percent of the stock market's return while only being exposed to sixty percent of the stock market's risk.
Here we see a collection of major asset class calendar year returns displayed on a Quilt chart. Looking at year to date returns in the rightmost column, we see that all asset classes with the exception of US intermediate government bonds and real estate posted positive performance. With the S and P five hundred, a popular headline index primarily tracking US large growth company performance, gaining the most value at ten point six percent.
We can also see that the performance of each individual asset class tile shows no predictable return or relative ranking from one year to the next.
Diversified index mix, such as the sixty percent stock, forty percent bond index mix shown in the white tile, tends to stay away from the extreme returns, both positive and negative on a yearly basis and over time, while also dampening the volatility of returns.
This is an example of the potential benefits of a well diversified portfolio. It also helps us as investors to stay in our seats through any given quarter of market turbulence and not take away from our ability to prosper from the many quarters to come.
And with that, we've reached the conclusion of today's presentation.
Thank you for joining us, and we'll see you next quarter.
Beacon Hill Private Wealth is an independent, fee-only, fiduciary investment advisor providing evidence-based wealth planning solutions that simplify our clients' financial lives. Founder Tom Geoghegan, CFP®, CIMA®, CPWA®, RMA® is also a member of the National Association of Personal Financial Advisors (NAPFA).
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