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WEEKLY MARKET WRAP

Published March 28, 2024Published March 28, 2024
Angelo Kourkafas
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 2. Path Market News and Insights
 3. Path Stock Market News
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MID-'90S VIBES

> Key Takeaways:
> 
>  * As most central banks are eyeing the start of rate cuts in the months
>    ahead, investors are hoping for a soft landing for the rally to continue. 
>  * We think the mid-1990s provides a relevant analogue to today's investment
>    backdrop. Easy financial conditions and an uptick in productivity could aid
>    economic growth and support sentiment. But a pivot to rate cuts could also
>    fuel speculation.
>  * We expect this environment to be supportive for both stocks and bonds, but,
>    in our view, the greater opportunity lies within equities, particularly in
>    areas of the U.S. market that have lagged and carry lower valuations.

In 1995 Toy Story was released, Gangsta's Paradise was the No. 1 song on
Billboard, and the Dow closed over 5,000 for the first time. Supporting the
start of a multiyear historic rally in stocks at that time was a successful Fed
pivot to rate cuts after a series of aggressive hikes, which was later labeled
as a textbook example of a soft landing. The economy escaped a Fed tightening
cycle without entering a recession and with the labor market staying strong.

Fast forward to today. Both investors and the Fed are hoping to achieve a
similar outcome, as most major central banks are eyeing the start of rate cuts
in the months ahead. We examine the similarities and differences in the
macroeconomic backdrop between now and the mid-'90s and offer our views of where
the opportunities lie.

Cutting rates when financial conditions are easy is a good recipe for a soft
landing.

 * Mid-'90s: To prevent an overheating economy from driving up inflation, the
   Fed under Alan Greenspan doubled interest rates from 3% to 6% in a little
   over a year between 1994 and 1995. The S&P 500 declined 1.5% in 1994, the
   economy slowed for a couple of quarters to below-trend growth but stayed
   clear of a contraction, and inflation held steady, hovering around 2.5% -3%1.
   Subsequently, the Fed eased monetary policy in 1995 by cutting rates three
   times, a similar number of cuts to what Fed officials project for 2024.
   Financial conditions are a gauge of market stress and capture factors such as
   stock prices, the U.S. dollar, market volatility and credit spreads. When the
   Fed cut rates for the first time during that cycle in 1995, financial
   conditions were already easy, and the rate cuts further aided economic growth
   and supported sentiment. What followed was a soft landing.

Source: Bloomberg, Edward Jones Chart description

The graph shows that the S&P 500 performed well in the mid-'90s as the Fed was
able to achieve a soft landing. Past performance does not guarantee future
results.


Source: Bloomberg, Edward Jones

The graph shows that the S&P 500 performed well in the mid-'90s as the Fed was
able to achieve a soft landing. Past performance does not guarantee future
results.


 * Now: In this tightening cycle, the Fed hiked rates by 5.25% from March 2022
   through July 2023 to tame inflation. While the hikes were more severe than in
   1995, the destination was similar, with the fed funds rates peaking at 5.5%
   (absent a surprise resumption of rate hikes). And like 1995, as the Fed is
   looking to start letting off the brakes, financial conditions are supportive,
   giving credence to the soft-landing scenario. In fact, the Chicago Fed and
   Bloomberg financial-condition indexes both indicate that conditions are now
   easier than they were when the Fed started raising rates two years ago. In
   the past, it is when financial conditions were tight that recessions have
   occurred, which is not the case today1. Stocks are making fresh record highs,
   creating a wealth effect; the U.S. dollar is off its peak; volatility is
   subdued; and credit spreads are near historic lows. 

Source: Bloomberg, Edward Jones. Chart description

The graph shows the Bloomberg financial conditions index which suggests that
conditions are now easier than they were when the Fed started raising rates two
years ago.


Source: Bloomberg, Edward Jones.

The graph shows the Bloomberg financial conditions index which suggests that
conditions are now easier than they were when the Fed started raising rates two
years ago.



Productivity is the secret sauce that can help drive higher growth and lower
inflation.

 * Mid-'90s: In addition to a strong labor market that aided consumer spending
   in the face of Fed rate hikes, a unique characteristic of the second half of
   the 1990s was a sustained rise in productivity. Labor productivity
   accelerated from 0.7% in 1994, to 2% in 1996, and 3.3% in 1998, on the back
   of globalization and the wide adoption of computers and the internet1. For
   perspective, 1996 was the first year when more emails were sent in the U.S.
   than postal mail2.
    
 * Now: Another reason why the mid-'90s analogue is relevant today is the
   enthusiasm around artificial intelligence (AI) and the hope that it will
   drive a similar lasting boost to productivity. Over the past year
   productivity has picked up nicely, helping accelerate economic growth and
   lower labor costs per unit of output. It is premature to attribute this
   encouraging trend to AI, but the adoption of technology during the early
   pandemic years amidst labor shortages is likely playing a role in helping
   companies be more efficient. We don't think that AI will be a magic wand that
   will transform the economy overnight, but we see the potential to enhance
   productivity in the second half of this decade. 

Source: Bloomberg, Edward Jones Chart description

The graph shows that labor productivity is on the rise over the past 12 months.
A sustained increase in productivity during the second half of the 1990s helped
boost economic growth and lower inflation.


Source: Bloomberg, Edward Jones

The graph shows that labor productivity is on the rise over the past 12 months.
A sustained increase in productivity during the second half of the 1990s helped
boost economic growth and lower inflation.



The caveat: Additional liquidity might fuel speculative bubbles.

 * Mid-'90s: Easy financial conditions, the Fed's successful pivot in 1995, and
   a second round of rate cuts in 1998 provided the fuel for the strongest bull
   market in history1. But they also encouraged speculation that ended with the
   tech bubble popping in 2000. Four mega-cap tech stocks known as the Four
   Horsemen (Microsoft, Intel, Cisco, Dell) led the euphoria over
   internet-related stocks, which expanded to many unprofitable dot-com
   companies that saw meteoric gains. The party ended with the Fed hiking rates
   in 1999 and 2000 to cool the economy and prevent inflationary pressures from
   building.
    
 * Now: The narrow market leadership over the past 12 months captures investors'
   enthusiasm around an elite group of mega-cap tech stocks known as the
   Magnificent 7 (NVIDIA, Microsoft, Alphabet, Amazon, Meta, Apple, Tesla) that
   are enablers of AI. This group of companies accounted for the bulk of last
   year's market gains and currently trades at an elevated forward
   price-to-earnings (P/E) ratio of 31. But that is still much lower than the
   nosebleed valuations of the Four Horsemen in 1999, which had an average P/E
   of 851. And unlike the late '90s, the outsized gains last year in mega-cap
   tech have been supported by strong earnings delivery in both absolute terms
   and relative to the rest of the market.
   
   In our view, the recent broadening of the market gains, with the equal-weight
   S&P 500 outperforming its market-cap peer, and with value-style investments
   outperforming growth over the past month, is a sign that the bull market is
   not exhausted. We think conditions are more like the 1995-1998 period rather
   than the 1999-2000. The average stock in the S&P 500 trades at a reasonable
   16.7 P/E, with more stocks and sectors participating in the rally. To that
   point, 10 of the 11 S&P 500 sectors are higher over the past three months.
   For comparison, three months before the burst of the tech bubble, seven of
   the 11 sectors were lower1. 

Source: FactSet, Edward Jones Chart description

The graph shows that the forward price-to-earnings ratio for the S&P 500 and the
Equal Weighted S&P 500. Valuations are elevated for the mega-cap tech stocks but
are more in line with recent history for the "average" stock as represented by
the S&P 500 Equal Weighted Index.


Source: FactSet, Edward Jones

The graph shows that the forward price-to-earnings ratio for the S&P 500 and the
Equal Weighted S&P 500. Valuations are elevated for the mega-cap tech stocks but
are more in line with recent history for the "average" stock as represented by
the S&P 500 Equal Weighted Index.



If not a bubble yet, what can derail the rally?

As laid out above, despite the strong gains over the past five months, we see
less of an imminent risk of a broad market bubble. One thing worth noting is
that leading up to the 2000 market peak, S&P 500 returns exceeded 20% for five
consecutive years between 1995 and 19991. However, a credible risk that could
disrupt the market calm would be any further bumps in the inflation outlook,
which would force the Fed to either push back or pull completely the expected
Fed rate cuts for this year.

Unlike the mid-'90s period where inflation was threatening to rise but stayed in
check throughout both the Fed tightening and easing phase, this time the Fed
will be sensitive to any disappointments given the inflation spike over the past
three years. Consumer and producer prices in January and February surprised to
the upside. While the downtrend in core inflation remains intact, a third upside
surprise might trigger the Fed to reconsider its approach. For our base-case
scenario, we expect the "last mile" of inflation to take longer and require some
patience, but we see further progress ahead. Supporting factors may include a
moderation in shelter and used car prices, as well as a broader cooling in
services inflation driven by slower wage growth.

Opportunities in today's market

 * Given the uninterrupted nature of the stock-market rally since last November,
   a pullback and consolidation phase should be expected. But the combination of
   resilient economic growth, a reacceleration in corporate profits, and the
   upcoming start of a rate-cutting cycle at a time when financial conditions
   are already easy is likely to help sustain the expansion and bull market. We
   expect this environment to be supportive for both stocks and bonds, but, in
   our view, the greater opportunity lies within equities, particularly in areas
   of the U.S. market that have lagged and carry lower valuations.
 * More specifically, mid-cap stocks look particularly interesting.
   Historically, they've been among the strongest-performing asset classes 12-18
   months following the last Federal Reserve rate hike, but they've lagged since
   the Fed's last hike in July of last year. Mid-caps tend to be more cyclical
   than U.S. large-cap stocks but higher quality than small-cap stocks. Thus, we
   believe mid-caps may provide portfolios a good balance in the coming months,
   particularly as investors' confidence about the economic outlook increases,
   helping to release the catch-up potential of the asset class.
 * On the international front, while some of the uncertainty around China has
   likely already been priced in, we believe the country's underwhelming policy
   support amid slowing growth, as well as a challenging regulatory landscape,
   will continue to weigh on relative performance. We recommend underweighting
   emerging-market equities, staying neutral with international developed
   equities, and overweighing U.S. large-cap stocks.
 * Within fixed income we favor emerging-market debt over U.S. high-yield bonds.
   Emerging-market debt has higher interest-rate sensitivity and historically
   outperforms U.S. bonds in periods following peak Fed policy. 

Source: Edward Jones. Chart description

Our opportunistic portfolio guidance represents our timely investment advice
based on current market conditions and a shorter-term outlook. We believe
incorporating this guidance into a well-diversified portfolio may enhance your
potential for greater returns without taking on unintentional risks, helping
keep your portfolio aligned with your risk and return objectives. We recommend
first considering our opportunistic asset allocation guidance to capture
opportunities across asset classes.
Our opportunistic asset allocation guidance is as follows:
Equity — overweight overall; overweight for U.S. large-cap stocks, U.S. mid-cap
stocks; neutral for international large-cap stocks, U.S. small-cap stocks,
international small- and mid-cap stocks; underweight for emerging-market equity.
Fixed income — underweight overall; overweight for emerging market debt; neutral
for international bonds, cash; underweight for U.S. investment-grade bonds, U.S.
high-yield bonds.


Source: Edward Jones.

Our opportunistic portfolio guidance represents our timely investment advice
based on current market conditions and a shorter-term outlook. We believe
incorporating this guidance into a well-diversified portfolio may enhance your
potential for greater returns without taking on unintentional risks, helping
keep your portfolio aligned with your risk and return objectives. We recommend
first considering our opportunistic asset allocation guidance to capture
opportunities across asset classes.
Our opportunistic asset allocation guidance is as follows:
Equity — overweight overall; overweight for U.S. large-cap stocks, U.S. mid-cap
stocks; neutral for international large-cap stocks, U.S. small-cap stocks,
international small- and mid-cap stocks; underweight for emerging-market equity.
Fixed income — underweight overall; overweight for emerging market debt; neutral
for international bonds, cash; underweight for U.S. investment-grade bonds, U.S.
high-yield bonds.



To wrap up, we think that the mid-'90s analogue is very relevant to today's
investment backdrop and offers reasons for optimism, but, of course, it remains
to be seen whether the Goldilocks scenario will play out this time. Investors
will be rooting for a repeat of the soft landing from 30 years ago but may want
to avoid Buzz Lightyear's famous catchphrase in Toy Story: "To infinity and
beyond!"

Angelo Kourkafas, CFA
Investment Strategist 

Sources: 1. Bloomberg, Edward Jones, 2. Historyofinformation.com


WEEKLY MARKET STATS

Weekly market statsINDEXCLOSEWEEKYTDDow Jones Industrial
Average39,8070.8%5.6%S&P 500 Index5,2540.4%10.2%NASDAQ16,379-0.3%9.1%MSCI
EAFE*2,349.41-0.1%5.1%10-yr Treasury Yield4.20%0.0%0.3%Oil
($/bbl)$83.002.9%15.8%Bonds$97.930.1%-0.6%

Source: FactSet, 3/29/2024. Bonds represented by the iShares Core U.S. Aggregate
Bond ETF. Past performance does not guarantee future results. *Morningstar
Direct 3/31/2024.


THE WEEK AHEAD

Important economic releases this week include the March nonfarm payrolls report
and ISM manufacturing PMI.

Review last week's weekly market update.

--------------------------------------------------------------------------------


ANGELO KOURKAFAS

Angelo Kourkafas is responsible for analyzing market conditions, assessing
economic trends and developing portfolio strategies and recommendations that
help investors work toward their long-term financial goals.

He is a contributor to Edward Jones Market Insights and has been featured in The
Wall Street Journal, CNBC, FORTUNE magazine, Marketwatch, U.S. News & World
Report, The Observer and the Financial Post.

Angelo graduated magna cum laude with a bachelor’s degree in business
administration from Athens University of Economics and Business in Greece and
received an MBA with concentrations in finance and investments from Minnesota
State University.

Read Full Bio

Angelo Kourkafas is responsible for analyzing market conditions, assessing
economic trends and developing portfolio strategies and recommendations that
help investors work toward their long-term financial goals.

He is a contributor to Edward Jones Market Insights and has been featured in The
Wall Street Journal, CNBC, FORTUNE magazine, Marketwatch, U.S. News & World
Report, The Observer and the Financial Post.

Angelo graduated magna cum laude with a bachelor’s degree in business
administration from Athens University of Economics and Business in Greece and
received an MBA with concentrations in finance and investments from Minnesota
State University.

Read Full Bio


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The Weekly Market Update is published every Friday, after market close. 

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MARKET DATA


 * DJIA
   
   39,127.14Down(-43.10)


 * S&P 500
   
   5,211.49Up(+5.68)


 * NASDAQ
   
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