Lingering Inflation Challenges Market Resilience

April experienced a spike in market volatility, culminating in a sharp sell-off driven by economic and geopolitical factors. As of April 23, 2024, the Dow Jones Industrial Average posted a modest 2% year-to-date gain, suggesting resilience in large caps. However, the equally-weighted S&P 500 outperformed with a 2.7% increase, while the small-cap Russell 2000 fell 3-4%, highlighting divergences across market segments.

The market pullback was a natural response to March’s strong economic data, as well as escalating geopolitical tensions in the Middle East. Inflation remained persistent, with the Consumer Price Index (CPI) coming in stronger than expected, though not at an alarming pace. Employment figures remain strong, with over 300,000 new jobs added — a positive for the economy but also a factor that rattled markets due to its potential monetary policy implications. Capping things off, a stronger-than-expected retail sales report prompted the Federal Reserve (Fed) to reconsider its expected policy path. Chairman Jerome Powell noted that given the resilient data, the Fed may not cut rates as much as initially anticipated this year, if at all — a curveball for markets. However, the underlying reality is the U.S. economy remains among the strongest globally.

While the Fed’s preferred PCE metric has been moderating year-over-year since October 2022, the pace of decline has slowed recently. As we have said before, taming inflation after the Fed’s unprecedented rate hiking campaign is like running a marathon — the last two miles are the most grueling. Markets are understandably impatient for quicker progress. However, the Fed may ultimately accept something around 3.5% as the new “normal” inflation rate and wave the white flag on achieving its intended 2% goal. After all, the Fed funds rate seen in the booming 1990s, which was similar to today’s rates, demonstrates that stocks don’t require ultra-low rates to thrive, as long as inflation remains reasonably contained. Today’s levels mark a return to more normal policy after the previous era of artificially-suppressed rates.

Amidst these uncertainties, there are emerging opportunities. Small and mid-cap stocks offer potential for growth, especially if interest rates stabilize or even decline. Furthermore, Master Limited Partnerships (MLPs) have demonstrated resilience, buoyed by rising energy production, increased energy exports, and favorable tax treatments, making them attractive for income-focused investors. The transformative potential of AI continues to be a major focus, promising significant efficiency improvements and cost reductions across various industries, impacting the broader market landscape.

As always, our team at The Wealth Alliance is committed to analyzing trends and adjusting your portfolios to navigate these times effectively. If you have any questions, please contact your financial advisor today.