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Markets & Economy

Observations: Market Concentration and the Fed’s Policy Outlook

Our Co-Heads of Investments discuss whether the equity market rally is finally broadening and whether the Fed’s forecast for three rate cuts makes sense.

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Observations: Market Concentration and the Fed’s Policy Outlook

Adam Sparkman

Welcome. And thank you for joining us today for Thornburg observations and global equities and fixed income. Again, I’m joined by Ben Kirby and Jeff Klinghoffer, the firm’s co-heads of investments. Gentlemen, in the last video. We discussed market sentiment and outlook after what was a very strong first quarter. Today I want to follow up the conversation discussing a little bit of topics on market concentration. If we get more breadth from here and then also kind of the Fed’s rate forecast for the rest of 2024.

So, Ben, maybe sticking with equities to start, I think really the surge that we saw across the S&P 500 during 2023 was primarily driven by the Magnificent Seven and maybe a small handful of other kind of large cap growth stocks. Many of those stocks continued to perform really well into the first quarter of the year. The strong rally that we had, but we also saw some non-tech sectors.

We saw financials, utilities and industrials all put up double digit returns during the first quarter. With that in mind, do you think that that’s a sign of, you know, a really a turn in the concentration that we saw last year and the opportunity for this rally to really broaden out from here?

Ben Kirby

Yeah, you’re right. So, 2023 really was a pretty narrow market, as you alluded to. But actually, since the market bottom in October 30th of 2023, both the equal weighted and the market cap weighted S&P are up about 25%. So you’ve actually had a period where the average stock is kept up with the big mega caps over that time period.

That being said, look, there are a lot of other really interesting investments out there besides just the Mag seven.

So those companies are that they have great balance sheets, they have cash flow, they have growth, a lot of things going for them. There are other investments as well in the equity market that are really attractive and interesting.

It is great to see the market broaden out. It really does help active managers have more places to invest, more places to add value.

We think that probably continues mostly because the valuation discrepancy between those high growth companies and the rest of the market has gotten so wide. There’s a lot of room for the other companies to catch up.

Adam Sparkman

So, Jeff, last month, the Fed left their target rate unchanged. I think that was pretty expected by investors, but they’re still projecting three rate cuts for 2024, even amid pretty robust economic data and stickier than expected inflation. Given the current setup, do you think that this is a realistic forecast?

Jeff Klingelhofer

I think you’ve got to take it one level further, right? I mean, we talk a lot of times about that Fed mandate. And just to remind our viewers, the Fed does indeed have three mandates, right? So, there’s maximum employment and there’s price stability. The two we always talk about. And so, from that lens, really, the Fed has done a wonderful job, right? Unemployment has stayed very, very low. The consumer’s been supported. They’ve also managed to go from an inflationary environment of near 10% down to just under 3%, pretty close to their 2% target. Now, when we enter in that third mandate, which technically is moderate long term interest rates, but I’ve argued for quite some time, is one of social stability compressing the wage gap.

We’re seeing this play out, but as you alluded to what this is doing, those high incomes service workers are indeed creating a very sticky form of inflation. And what the Fed has tried to do is pivot to saying, well, we’ve got inflation under control, so it makes sense. We should lower rates and hope to continue the soft landing that we’ve talked about here for some time.

But I think the challenge that is, as you look forward, all of this sticky inflation is, again, we’re starting to see inflation, if anything, maybe inflect back up. So, my view and I’ve said this a number of times, it would be a policy mistake at this point for the Fed to cut rate. It would be setting us up for the potential repeat of that late seventies, early eighties where we did see inflation spike come down, said cut proactively, and all of a sudden, we saw that spike up.

So, my base case is I don’t think we’re going to see the Fed cut three times this year. I think we might get one token cut, but really, I don’t think they should be cutting at all, given the strength of the underlying economy, the strength of the consumer, and even in the face of higher rates, what are continuing to be relatively easy financial conditions for your average corporate, government or consumer.


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