INSIGHTS

On April 11, 2024

First Quarter Review and Big Picture Focus

In the first quarter (Q1) of 2024, the S&P 500 Index appreciated by 10.56% — its best return since the Q1 2019. The equity market was fueled by the Federal Reserve’s dovish tone in December coupled with excitement around Artificial Intelligence (AI) technology. In fact, an American semiconductor company became the poster child for “AI” as its earnings exploded, and its market capitalization cracked $2 trillion. Overall, it seemed that equity investors were playing catch up, especially since several market strategists kept hiking their year-end S&P 500 price targets. As the quarter progressed, hopes for an interest rate cut kept getting delayed. Instead, investors began to focus on the resilient economy, and recession talk receded. In our previous commentary, Brentview called for a broadening out of the market. In 2023, investors focused on a select list of companies that captured a substantial portion of last year’s equity returns. In 2024, however, that select list dwindled as some posted negative returns for the first quarter, and one trailed the market.

Carrying their momentum from last year, the Information Technology and Consumer Discretionary sectors continued their outperformance from 2023 and led early in the quarter, especially as AI excitement began to build within the technology sector. Investors started to rotate toward other sectors in March as Energy, Financials, and Industrials finished above index averages. Energy particularly benefited from crude oil prices, which surged 16% in the quarter due to stronger demand and OPEC (Organization of the Petroleum Exporting Countries) curtailed supply. The interest rate-sensitive Real Estate and Utility sectors lagged the broader equity markets, driven by the 10-year Treasury, which began the year at 3.9% but then closed the quarter at 4.2%. The three top & bottom performing sectors of the S&P 500 are shown in Table 1, below. As the quarter reached its conclusion, the order of performance dramatically changed with Communication Services being the best performer. Despite starting strong, the Consumer Discretionary sector became one of the weaker performers during the quarter. In addition, the Real Estate sector was the only sector in the first quarter to post a negative return.

Source: Factset Research | Past performance does not guarantee future results.

From a Dividend Perspective

As seen in Table 2 below, it is noteworthy that within the S&P 500 Index, the best returns in the quarter came from the 0–1% dividend yielding cohort followed by non-dividend-paying stocks. Lower yielders have been more resilient as they tend to have faster dividend growth characteristics. Conversely, the higher yielding cohorts have seen “competition” from higher yielding opportunities outside of the equity market. In addition, inflationary pressures are likely being felt by the more mature slower growers, which also tend to reside in the “above 3%” category. This trend has been occurring since 2022, which highlights the opportunities that are available within the dividend landscape when taking a broader view.

Source: Factset Research | Past performance does not guarantee future results.

As far as broader capital allocation trends go, we have seen a shift toward larger buybacks and modest dividend increases from some companies that have higher weights in the S&P 500 Index. These capital allocation shifts could result in a lower index dividend growth rate over time. Separately two well-known technology/software companies have recently initiated dividends, which has increased the dividend-paying universe.

A Focus on the Big Picture

GDP in the fourth quarter of 2023 finished up 3.4% after several upward revisions. Consensus estimates for the first quarter of 2024 called for 2% GDP growth, though the latest Atlanta Fed GDP Now estimate stands at an upwardly revised 2.8%. The economy has proven to be resilient and the growth more enduring. Today’s market valuation is nearing 21x, as seen in Chart 1, and reflects investor sentiment for a soft landing (thus avoiding a recession). Similarly, comparisons are being made between the market today and the dot.com era of the late 1990s. Although valuations were still higher back then, market returns were also heavily concentrated in just a handful of stocks.

Chart 1
S&P 500 Forward Price/Earnings Ratio

Source: LSEG Datastream and Yardeni Research

While market valuations were higher in the late 1990s, the leadership of technology stocks today is much higher than the dot.com era. The average stock, as measured by the S&P 500 Equal Weighted Index, is near all-time lows. From this observation, the recent broadening of the market returns by sector may have legs this time around.

Lastly, market valuations are above the 5-year and 10-year averages of 19.1x and 17.7x, justified by historically high profit margins as seen in Chart 2. A surprise to many investors, U.S. profit margins have even exceeded the previous high in 1950. Over the last few years, corporations have been able to not only raise prices but also rein in their costs.      

Chart 2
U.S. Corporate Profits

Source: St. Louis Federal Reserve Database (FRED)

CRN: 2024-0411-11607 R

The opinions and views of this commentary are that of Brentview Investment Management and are not necessarily that of Advisors Asset Management.