As we move forward, we remain steadfastly committed to continual improvement. In this spirit, we have introduced a survey tool that we will send out prior to each Wealth Road Map Review Meeting – the objective is to allow for reflection and the construction of an agenda based on your areas of interest. Continued feed back on this tool is greatly appreciated!
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https://calendly.com/klugewealthadvisorygroup/general-meeting-30min
For those that believe “brevity is the soul of wit”, here is the Quarterly Compass Newsletter in five key points:
- Q1 2024 saw continued strong returns after a strong finish to 2023.
- Our outlook remains positive for the next 12 months. This is supported by qualitative and quantitative factors. Examples are below.
- It does not appear that we are in any sort of equity market bubble. This is supported by the fact that valuation metrics for the leading stocks in this cycle continue to fall despite high returns. Examples are below.
- Politics and investment decisions should not mix.
- We are witnessing the start of an adoption/acceptance cycle with blockchain. Having some familiarity with the space is essential going forward.
Quarterly Compass Newsletter – March 31, 2024.
Q1 2024 saw a continuation of the powerful rally in equity markets that started in November of 2023 which has moved equity indexes sharply higher. Key North American markets provided the following returns for Q1 2024: the NASDAQ-100 and S&P 500 gained 8.72%and 10.56% respectively (in U.S. dollars) and the Canadian S&P/TSX Composite rose 3.89% International markets were also positive, with the MSCI EAFE Index up 5.78% (in U.S. dollars). Q1 started on a strong note which continued throughout the quarter. Generally tame U.S. inflation data, strong enough economic data, strong earnings, and continued expectations for rate cuts by the U.S. Federal Reserve (The Fed) later this year all provided tail winds. The rally was broad based and, in the U.S., led by technology, financial, and industrial sectors. Only the real estate sector posted negative returns. All figures are per Refinitiv.
Per Refinitiv, key global fixed income benchmarks, such as the Bloomberg U.S. Aggregate Bond Index posted negative returns during Q1. In its March meeting, the U.S Federal Reserve maintained its key overnight rate and was very direct in indicating that rate hikes are now at an end and that cuts are now a matter of time. In Canada, the Bank of Canada (BoC) maintained its key overnight rate. The maintenance of higher short-term interest rates was somewhat puzzling because the economic/inflation data coming in has not been strong and Canadian debt/GDP is amongst the highest in the developed world. It is worth noting that the BoC’s own data shows that a significant percentage of Canadian inflation is being driven by higher mortgage finance costs – i.e., rate increases causing inflation.
During Q1, commodity prices rose slightly per the Bloomberg Commodity Index. Furthermore, as per Refinitiv – market-based expectations of inflation remain well-contained with longer-term inflation “break-even” rates ranging from 5 to 30 years, all remaining over 2.30% at the time of writing.
Based on questions from clients I have collected a few thoughts:
First and foremost – there continues to be a lot of questions about if we are in some sort of equity market or artificial intelligence (A.I.) bubble. This question seems to be triggered by the large run up we have seen in many technology sector stocks as well as a general wariness with markets having risen to new highs (e.g. S&P 500) and back to old highs (e.g. S&P/TSX Composite).
Before we go any further let’s look at what defines a bubble. According to Investopedia, a bubble is “a situation where the price for something—an individual stock, a financial asset, or even an entire sector, market, or asset class—exceeds its fundamental value by a large margin.” By that definition, the situation that we are now in bears very little resemblance to past bubbles. The stocks leading the way are displaying very fast earnings growth which is exceeding the pace of stock price appreciation. For example, we have seen very rapid share price gain in the shares of NVIDIA and Amazon. This does not mean they are in a bubble. As pointed out by Evercore ISI, NVIDIA’s forward price/earning ratio (FPE – a common valuation metric) has declined ~40% to ~37x from ~60x. Not cheap but for a company that grew its earnings by 388% in fiscal 2024 and is estimated to grow earnings by 89% for fiscal 2025 and 24% in fiscal 2026 (per Refinitiv) it is not likely in “bubble” territory. A similar observation can be made for Amazon where its FPE ratio has not moved higher despite the stock more than doubling since late 2022. This appears to be the exact opposite of a bubble.
From a psychological standpoint, given the way market has traded in the last 4 years (2 >20% draw downs), some degree of wariness is understandable. Old hands in the market would call this “bull market stress,” where fear of losing gains in an up or “bull” market replaces the fear of loss prevalent in a down or “bear” market. The key here is to recognize that “fear” is the operative word – making investment decisions on emotional impulses has a long track record of ending in a “sub-optimal” result. Thinking back to my Q4 2023 newsletter, I brought up the old John Templeton quip that “bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” There is a laundry list of worries out there (inflation, recession, war, Chinese real estate, politics etc.), as such I believe that the unease that some are feeling as the market rises is the wall of worry that the market is climbing. Based on my own experiences as well as those related by research partners, I feel that we have progressed to the skepticism phase.
Rather than being at the “bubble” end point, it pays to consider that we may be only at the beginning of a larger technological revolution. As pointed out by Fundstrat in a recent presentation, a shortage of labour has, in U.S. history, always produced a technological response. Based on structurally tight labour markets over the last few years (not enough workers), it appears that the response this time is appearing in the form of A.I. and blockchain technology – both of which can radically improve productivity. If we view the emergence of these technologies through the lens of the development path of the internet, then we appear to be in the early adoption phase – kind of like where we were in 1995 when Netscape made its initial public offering (IPO). Every market cycle is different but, again, it seems likely that we have a long way to go before we have reached the “bubble” stage (if we ever get there).
Looking forward, I remain optimistic about the year ahead but want to be direct in stating that we will likely see several corrections along the way. Examples of data points that are contributing to my belief that a positive 2024 is highly likely include:
- From a qualitative perspective – as was the case through all of 2022 and 2023, it seems that investors remain biased towards buying money market securities. There is now over US$6 trillion “parked” in money market funds. Based on data complied by Fundstrat, margin balances also remain well under levels where historical market peaks have occurred. Finally, we have only recently started to see IPOs in the market again. The most prominent being Reddit which is a well-established social media business. IPOs do not become worrisome until we see a rush of unprofitable companies entering the market – we are a long way from that now.
- From a quantitative perspective: on March 1, 2024, we experienced 4 positive months in a row for the S&P 500. Based on data from the Stock Traders Almanac, this pattern has occurred 14 times since 1950, and has been positive 100% of the time 12 months later with a median gain of 21.2%. Interestingly this dovetails very closely with the signal that I highlighted in my Q4 2023 note where Ned Davis Research did a look back and found that as of December 14, >40% of the S&P 500 stocks were “overbought” – although this has only happened 4 other times in history, the average return 1 year later was +27.5%. In addition, historically, there has been a strong tendency for “the year to play out in January” – a positive/negative January usually leads to a positive/negative year. Again, based on data compiled by the Stock Traders Almanac when January is positive for the S&P 500, then the rest of the year is positive approximately 86.5% of the time.
To be clear – new signals/indicators can quickly invalidate any examples I have highlighted above. No one signal/indicator is supposed to be used in a vacuum. They are meant to form part of a composite picture and give us a “reasonable working assumption” to gauge the evolution of circumstances.
Another common topic of conversation has been speculation about the market impact of one or another party winning in the upcoming U.S. and Canadian election cycles. Election outcomes form part of the environment and are a factor but it is important to remember that there are larger and longer-term trends in the economy and market that are in play. Examples of larger trends that are minimally impacted by elections include demographic and technological trends. Leaders can impact outcomes but by the nature of election cycles, leaders usually have a limited time to “move the needle” – especially in the U.S. where political power is distributed through the three competing branches of government. All investment/asset allocation decisions need to be made with the “big picture” in mind.
The last thought I would like to share in this piece relates to recent developments in the world of Bitcoin and other digital assets. Q1 2024 saw the U.S. launch of Bitcoin exchange-traded funds (ETF’s) in the U.S. This was accompanied by a substantial rise in the price of Bitcoin over the course of the quarter. There is also now gathering momentum for the regulations in the U.S. to approve the launch of ETF’s based on another crypto currency called Ethereum. I believe that the whole blockchain/crypto currency world will continue to receive more attention going forward. Not least because, based on the introduction of these ETF’s and the Bitcoin halving cycle, it seems likely that the price of Bitcoin will continue to climb due to increased demand and lower new supply. .
This does not mean that everyone should rush headlong into the space – investments in these areas are extremely risky and carry the risk of total loss. That said, through either crypto currency or blockchain these technologies will start to impact our daily lives. Having some familiarity with the space is essential going forward. To that end, please find below a link to an Introduction to digital assets by Fidelity Digital Assets: Introduction to Digital Assets (fidelitydigitalassets.com)
We have taken several actions in the portfolio entrusted to us since our last update. First, we have conducted our routine year end rebalancing in late January. This was done in Q1 2024 and not Q4 2023 to defer capital gains recognition. Also, given the sharp appreciation of NVIDIA this quarter we trimmed the position to be in line with targets. With client input and where client objectives and risk tolerance aligned, we also introduced a 1% weight in the Canadian traded Fidelity Advantage Bitcoin ETF to take advantage of the adoption cycle and supply/demand dynamic that is evolving.
As always, the focus of the Kluge Wealth Advisory Group is on preparation and not prediction. Irrespective of any views, we always acknowledge and prepare for a wide range of events and outcomes. As we move through 2024, the picture painted by my Risk Dashboard remains optimistic about the path forward. As a result, we recommend that investors consider reducing cash and investing in both high-quality equity and fixed income, to the extent that risk tolerance and objectives allow.
