Upside inflationary surprises helped drive a pullback across the financial markets in April, as interest rates and the U.S. dollar (USD) climbed higher amid a further reduction in the bond market’s expectations for Federal Reserve (Fed) easing in 2024. Global equities—particularly domestic and smaller cap indices—witnessed notable downward pressure over the month, while emerging market equities posted relatively solid performance. Bonds suffered in April after a nearly 50 basis point increase in yield on the 10-Year U.S. Treasury Note led to poor performance in interest rate-sensitive sectors. Despite weakness across the bond market and broader risk markets during the month, credit risk premiums remained well below historical averages and near the low end of their cyclical range. Real asset returns continued to appear mixed, as the rate-sensitive real estate investment trust (REIT) and global listed infrastructure sectors suffered amid the monthly backup in interest rates, while commodity futures posted a second consecutive solid monthly gain.
Economic Update
Stagflation Worries Return as Inflation Proves Sticky and Growth Has Cooled
At the beginning of the year, inflation seemed to be on a declining trajectory, and the lagging effects of monetary policy still moving through the system were widely assumed to be working, which led market participants to pencil in Fed rate cuts throughout 2024. The Fed’s updates to their “dot plot” policy rate projection table at their December 2023 and March 2024 meetings painted a similar picture, setting an expectation for three 25 basis point cuts throughout the year.
However, contrary to the past two years in which the U.S. economy grew at a healthy clip despite the most meaningful Fed tightening campaign in forty years, the advance estimate of first-quarter gross domestic product (GDP) showed a slowdown in business activity. For the first three months of 2024, the U.S. economy grew at an inflation-adjusted annualized pace of just 1.6%, the slowest quarterly growth rate since the second quarter of 2022.
Moreover, while growth moderated during the quarter, inflation reaccelerated. The Fed’s preferred inflationary gauge, the core personal consumption expenditure (PCE), increased to a 3.7% annualized pace, the hottest quarterly print since the second quarter of 2023, and nearly double the Fed’s 2% target. This combination of upside inflationary surprises and aggregate economic growth data surprising to the downside in recent months has driven a notable divergence between the Economic Growth Surprise and Inflation Surprise indices, renewing fears of stagflation.
A longer-term view of this data shows that not only has incoming economic data missed sell-side estimates to the downside in recent months, but the degree of underwhelming data has appeared the most pronounced since May 2020, a period when the U.S. economy was clawing itself out of the depths of the global pandemic lockdowns.
While it is likely premature to extrapolate the first three months of the year as the beginning of a trend, the Fed may find itself in a quandary if these pressures persist, the timing of which could prove problematic given the looming November presidential election. Should the lag effects of monetary policy changes fail to return inflation to the Fed’s 2% target, market participants may begin to sniff out the potential for an extension on the current “higher for longer” period.
On the other hand, if the Fed begins slashing rates before inflation has returned to its 2% bogey, the risk of inflationary expectations becoming “unanchored” will come to the fore, in turn serving as a tailwind behind the recent rise in Treasury interest rates and the global exchange rate value of the dollar. The combination of these forces may likely contribute to economic volatility for many of the U.S.’s key trading partners.
In summary, after strong performance across most major asset classes and categories in the first quarter, volatility returned to the financial markets in April, as cooling economic data and stubborn cost pressures reminded global investors that despite being unlikely, the risk of a stagflationary regime cannot be altogether dismissed.
Market Summary
Global Equity
Equity markets’ momentum came to a halt in April as index returns retreated from previous highs set in March. After finishing with its best-performing quarter since 2019, the S&P 500 Index suffered negative absolute returns in April, alongside the other major world indices. This performance caused large cap U.S. equity year-to-date returns to fall back below double-digit levels. One trend that has continued throughout the year, however, has been the underperformance of small cap stocks due to the extension of rate-cut expectations.
Rate cut expectations were delayed further as Jerome Powell and the Fed sought to navigate mixed economic signals. Even with the recent market decline, 10 out of 11 sectors posted gains on the year, with real estate being the only sector to produce a negative total return.
Mixed earnings results continue to significantly impact markets, specifically surrounding the “Magnificent 7” stocks. Notably, the market has punished earnings misses in recent quarters more severely than it has rewarded earnings beats.
European equities ex-UK outperformed their U.S. counterparts in April. Returns were led by Europe’s “Magnificent 7” (Novo Nordisk, ASML, Schneider Electric, Safran, LVMH, Hermes, and Ferrari). As a composite, these stocks have outperformed the U.S. Magnificent 7 since 2020. Also, euro zone business activity has continued to rally since late last year, as evidenced by the Purchasing Managers’ Index (PMI) surpassing 50 in April.
Unlike most markets around the world, UK-based equities produced positive absolute returns in April, largely led by the healthcare, materials, and energy sectors. Meanwhile, UK equities are still trading at around a 30% median industry discount when comparing the UK forward price/earnings ratio to the U.S., even with the FTSE 100 index establishing a new all-time high. These low valuations, combined with a recent recession breakout, have promoted increased deal flow in the UK, specifically within the small cap space.
In Japan, the Nikkei 225 entered a correction phase in early April after topping 40,000 yen for the first time in history. However, the market began to recover in the latter half of the month due to the outperformance of earnings expectations. The weakening yen has provided a short-term tailwind for recent corporate earnings announcements, given that many large cap companies in Japan are net exporters.
Emerging Markets (EM) remained relatively flat over the month, underperforming European equities and outperforming U.S. equity markets. Recent momentum in China’s equity markets continued through April on the back of the Chinese government’s pledge to support the economy. In India, strong market performance from the first quarter flattened out as general election voting began during the month.
Fixed Income
Rates rose in April, with the 10-year Treasury rising 0.49% to 4.69% and the 2-year Treasury rising 0.42% to 5.04%. The 10-year Treasury briefly breached 4.7% during the month—its highest level year-to-date—as the probability of a rate cut before July dwindled. The Personal Consumption Expenditures Price Index (PCE Index) March release came in at 2.7%, still well above the Fed’s target of 2% and tempering rate cut expectations. The resulting rise in short-term rates caused the yield curve to further invert and the 10-year/2-year Treasury spread to widen 0.05%, dropping to -0.34%.
In April, fixed income markets saw tight spreads, with the high-yield option-adjusted spread (OAS) rising slightly by only three basis points to 3.18%, while the investment-grade OAS decreased by three basis points to 0.91%. The Bloomberg U.S. Aggregate Index (Agg) coupon rate finished the month at 3.2%, while the yield to maturity (YTM) reached 5.2%. Debt issuance ramped up in the first quarter of 2024—the highest level since the first quarter of 2021—further pushing out the impending debt maturity wall.
At the May 1, 2024 Federal Open Market Committee (FOMC) meeting, the Fed again opted to hold steady the federal funds target rate, further validating the “higher for longer” narrative that was prevalent for much of 2023. Most economists still expect the Fed to cut rates later this year, but the range of cuts declined from four to one. The CME FedWatch Tool estimates the probability of a cut in June or July as 8.9% and 29.6%, respectively. The Fed's total assets peaked at nine trillion in June 2022 and have since dropped to 7.3 trillion due to quantitative tightening. However, the Fed voted to slow the decline of its securities holdings by reducing the monthly redemption cap on treasury securities.
Real Assets
REAL ESTATE
U.S. Real Estate Investment Trust (REIT) indexes declined sharply in April. In late March, the Fed issued its FOMC statement explaining that because economic activity and job gains had remained strong there would be no change in the federal funds rate and no indication of an interest rate hike in the near future. Higher interest rates have continued to put downward pressure on REITs, particularly in interest rate-sensitive sectors like cell towers, where long-dated contracts are discounted at elevated rates.
Developed Europe REITs have out-performed the U.S. recently, due in part to the European Central Bank having been more confident in cutting interest rates as inflation in the eurozone continued to ease. European REITs have higher leverage, on average, than U.S. REITs, which has led to more optimistic sentiment for the industry if rate cuts are implemented.
NATURAL RESOURCES
April saw a moderate decline in oil prices as measured by the West Texas Intermediate (WTI) spot contract. This downward trend can be attributed to the alleviation of geopolitical risk premium as conflicts in the Middle East persist. Conversely, the Henry Hub natural gas spot contract rose over 12% during the same period, an increase which was driven by anticipations of warmer summer weather leading to heightened demand for natural gas as consumers increase energy consumption to run air conditioning.
INFRASTRUCTURE
As measured by the Dow Jones Brookfield Global Infrastructure Index, global listed infrastructure declined in April. Marine transportation was a standout sector, with global shipping rates and volumes rising during the first quarter. Shipment route diversions around Africa to avoid attacks in the Red Sea led to longer shipment times, which was compounded by strong trade flows from India and China.
Midstream energy infrastructure declined moderately in April but was still up double digits year-to-date, as measured by the DJ Brookfield Global Infrastructure MLP Index. Several midstream companies had strong first-quarter earnings, but stocks fell in line with the slight decline in WTI oil prices during the month.
Diversifying Strategies
Hedge fund performance was mixed in April, with global macro strategies producing the strongest monthly return. Equity-oriented strategies, event-driven strategies, and long/short equity all faced headwinds as equities sold off.
Hedged equity generated losses in healthcare; technology; and quantitative, directional strategies. Equity markets experienced heightened volatility in April, resulting in a choppy trading environment.
April was another strong month for systematic macro strategies. Positive contributions came from fixed income, currencies, metals, and soft commodities. The largest winners were exposures long the U.S. dollar relative to other developed currencies, short fixed income, long coffee, and long copper and gold.
INDICES
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships that provides investors with an unbiased, comprehensive benchmark for this emerging asset class.
Bloomberg Fixed Income Indices is an index family comprised of the Bloomberg US Aggregate Index, Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index, Municipal Index, High-Yield Index, Commodity Index and others designed to represent the broad fixed income markets and sectors. On August 24, 2016, Bloomberg acquired these long-standing assets from Barclays Bank PLC. and on August 24, 2021, they were rebranded as the Bloomberg Fixed Income Indices. See https://www.bloomberg.com/markets/rates-bonds/bloomberg-fixed-income-indices for more information.
The CBOE Volatility Index (VIX) is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500 Index option bid/ask quotes. The Index uses nearby and second nearby options with at least eight days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.
FTSE Real Estate Indices (NAREIT Index and EPRA/NAREIT Index) includes only those companies that meet minimum size, liquidity and free float criteria as set forth by FTSE and is meant as a broad representation of publicly traded real estate securities. Relevant real estate activities are defined as the ownership, disposure, and development of income-producing real estate. See https://www.ftserussell.com/index/category/real-estate for more information.
HFRI Monthly Indices (HFRI) are equally weighted performance indexes, compiled by Hedge Fund Research Inc. (HFX), and are used by numerous hedge fund managers as a benchmark for their own hedge funds. The HFRI are broken down into 37 different categories by strategy, including the HFRI Fund Weighted Composite, which accounts for over 2,000 funds listed on the internal HFR Database. The HFRI Fund of Funds Composite Index is an equal weighted, net of fee, index composed of approximately 800 fund- of- funds which report to HFR. See www.hfr.com for more information on index construction.
J.P. Morgan’s Global Index Research group produces proprietary index products that track emerging markets, government debt, and corporate debt asset classes. Some of these indices include the JPMorgan Emerging Market Bond Plus Index, JPMorgan Emerging Market Local Plus Index, JPMorgan Global Bond Non-U.S. Index and JPMorgan Global Bond Non-U.S. Index. See www.jpmorgan.com for more information.
Merrill Lynch high yield indices measure the performance of securities that pay interest in cash and have a credit rating of below investment grade. Merrill Lynch uses a composite of Fitch Ratings, Moody’s and Standard and Poor’s credit ratings in selecting bonds for these indices. These ratings measure the risk that the bond issuer will fail to pay interest or to repay principal in full. See www.ml.com for more information.
Morgan Stanley Capital International – MSCI is a series of indices constructed by Morgan Stanley to help institutional investors benchmark their returns. There are a wide range of indices created by Morgan Stanley covering a multitude of developed and emerging economies and economic sectors. See www.morganstanley.com for more information.
The FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs.
Russell Investments rank U.S. common stocks from largest to smallest market capitalization at each annual reconstitution period (May 31). The primary Russell Indices are defined as follows: 1) the top 3,000 stocks become the Russell 3000 Index, 2) the largest 1,000 stocks become the Russell 1000 Index, 3) the smallest 800 stocks in the Russell 1000 Index become the Russell Midcap index, 4) the next 2,000 stocks become the Russell 2000 Index, 5) the smallest 1,000 in the Russell 2000 Index plus the next smallest 1,000 comprise the Russell Microcap Index, and 6) U.S. Equity REITs comprise the FTSE Nareit All Equity REIT Index. See www.russell.com for more information.
S&P 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation, among other factors by the S&P Index Committee, which is a team of analysts and economists at Standard and Poor’s. The S&P 500 is a market-value weighted index, which means each stock’s weight in the index is proportionate to its market value and is designed to be a leading indicator of U.S. equities, and meant to reflect the risk/return characteristics of the large cap universe. See www.standardandpoors.com for more information.
Information on any indices mentioned can be obtained either through your advisor or by written request to information@feg.com.
DISCLOSURES
This report was prepared by FEG (also known as Fund Evaluation Group, LLC), a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Fund Evaluation Group, LLC, Form ADV Part 2A & 2B can be obtained by written request directly to: Fund Evaluation Group, LLC, 201 East Fifth Street, Suite 1600, Cincinnati, OH 45202, Attention: Compliance Department.
The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it. FEG, its affiliates, directors, officers, employees, employee benefit programs and client accounts may have a long position in any securities of issuers discussed in this report.
Index performance results do not represent any managed portfolio returns. An investor cannot invest directly in a presented index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.
Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material or guarantee the accuracy or completeness of any information herein, nor does Bloomberg make any warranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed by law, Bloomberg shall not have any liability or responsibility for injury or damages arising in connection therewith.
Neither the information nor any opinion expressed in this report constitutes an offer, or an invitation to make an offer, to buy or sell any securities.
Any return expectations provided are not intended as, and must not be regarded as, a representation, warranty or predication that the investment will achieve any particular rate of return over any particular time period or that investors will not incur losses.
Past performance is not indicative of future results.
Investments in private funds are speculative, involve a high degree of risk, and are designed for sophisticated investors.
All data is as of April 30, 2024 unless otherwise noted.