As Goes January (and February and March), so goes the year?
The January Barometer is a market hypothesis stating that returns in January predict those for the rest of the year. This concept has some statistical backing, being correct about 60% of the time, meaning the market falls for the remainder of the year about 40% of the time. While your Charter Oak team does not invest or make decisions based on this hypothesis, it is good to review where we have been in the first quarter and where we think we are going.
January and the entire first quarter of 2024 have been good for the stock market. Let's review where we are in the first part of 2024.
What is driving these returns?
Corporate Earnings
Earnings Growth: For Q1 2024, the estimated (year-over-year) earnings growth rate for the S&P 500 is 3.6%. If 3.6% is the actual growth rate for the quarter, it will mark the third quarter of year-over-year earnings growth for the index. American corporations continue to innovate, create, and make things consumers want. Our European and International counterparts are doing relatively well and trying to catch up to the resurgence we have seen in the U.S. over the last 18 months. Earnings growth has been stronger than expected.
Federal Reserve on pause
The Federal Reserve's last rate increase was on July 26, 2023. In December 2023, they signaled strongly that the next move is almost certainly lowering interest rates, maybe as early as June or September. This matters for the stock market because there is more certainty about the cost of capital (borrowing money) and what the Fed will do. The stock market likes certainty, and historically speaking, a federal reserve pause is the best time for stock market returns.
Economic Growth
U.S. Economic growth remained strong in 2023. As we can see in the next graph, it remained strong quarter after quarter, defying many experts' calls for a recession. That recession never materialized, as unemployment remained historically low, and the consumer continued to spend. The Federal Reserve Bank of Atlanta publishes an estimate of quarterly GDP growth. Their estimate for first-quarter GDP growth is 2.8%. This is only an estimate, but it predicts well for continued GDP growth.
Will the rest of the year continue as the first quarter? We do not know, nor do any financial pundits or experts. However, we invest our clients’ assets based on their long-term financial goals. The economic environment and market returns have been welcomed over the last year and a half. While we are still optimistic about market returns, we know the remainder of the year may be more challenging, and that takes us to another favorite topic at Charter Oak: bonds!
Bond Math
Stay with us. We know bond math is not a way to increase readership, but it is incredibly important in finance!
Many of our readers will recognize the graphic below from JP Morgan. We have used this in our client review meetings to highlight where interest rates are today. The Federal Funds rate, set by the Federal Reserve for banks to borrow and lend with each other, is currently at 5.38%. This is the highest interest rate in almost 25 years. You must go back to 2020 to find rates this high.
So, what does that mean for our clients? It means bonds are working for you again! Let's review some bond basics and how they work.
What is a bond?
A bond is a loan that the buyer of the bonds makes to the bond issuer. The U.S. Government (and governments worldwide), corporations, local governments, and municipalities all issue bonds when they need money for projects. Like a loan, most bonds pay periodic interest and then repay the initial loan to the buyer at a stated time, known as the maturity date.
How do bond prices work?
As we can see on the next graph, bond prices have an inverse relationship to interest rates. As interest rates fall, bond prices increase. To explain, consider a corporate bond purchased at 6% in January 2024. If, as expected, interest rates fall over the next two years, and in January of 2026, a similar corporate bond is issued at 4%, all else being equal, the 6% income of the bond looks much better than the 4%. Thus, the bond price would increase and could be sold at a premium.
What are the other characteristics of a bond, and why do we like them in our client’s portfolio?
Capital Preservation
Bonds have much less volatility or risk than stocks. Stocks will always be the engine of growth for our clients, but we know we can also get historically high rates with fewer fluctuations in value. As our graph above highlights, current bondholders will also experience capital appreciation if rates do fall.
Income
Bond income is now real. $100,000 in conservative treasury bonds can earn our clients over $5,000 in income for the year, and corporate bonds are getting us even more. While the stock market will go up, down, and sideways, we know we can earn income while we wait.
Diversification
One of the most important tenets of investing is not having all your eggs in one basket; diversify. Bonds are one of the best ways to diversify, especially when we have higher rates, as we do today. If the economy slows and rates decrease, stocks may pause or decrease slightly. Bonds, on the other hand, will increase in value as rates fall. This is the power of diversification! An important psychological tool to investing – generating consistent returns allows investors to stay in the market and not panic during downswings – the best way to generate and maintain wealth over time.
As always, it is our pleasure to help. Please contact your Charter Oak Advisor with any questions. We look forward to meeting with you soon and discussing your individual situation, how you are reaching your goals, and how we can help you live your best life with financial freedom.
