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Commentary

Market Commentary – April 2024

10 April 2024
Old Oldsmobile
WCF Staff icon

“Not Your Father’s Oldsmobile.” 

— Advertising Slogan; 1988.

Oldsmobile, one of the five divisions under the General Motors flag, was catered to “mature” drivers.  “Not Your Father’s Oldsmobile” emerged to tap into a younger consumer.  Unfortunately, it did not work.  After producing 35 million cars over 107 years, the Olds brand was shut down in 2004.   

We would argue that today’s stock market has done a much better job of shedding the stodgy image.  The question isn’t so much whether investment strategies have evolved, attracting a new generation of investors, but how the old guard will respond.

Diversification

Perhaps the greatest contribution to the science of investing came from Professors Sharpe and Markowitz for their work on Modern Portfolio Theory.  Risk reduction could be achieved through asset class diversification—owning stocks of different sizes and geographies, bonds, and cash.  Some investments zig while others zag.  Blending and rebalancing should lead to a smoother ride.  WCF,  along with institutional investors such as Yale and Harvard, embrace these strategies. 

Despite the pervasive acceptance, diversification between asset classes has mostly served as a source of friction for the past two decades.  The S&P 500 has generated negative returns in only four of the past 22 years.  In each of those down years, small-cap stocks performed worse, with foreign stocks also down.  Foreign stocks have done as well as large-cap U.S. stocks in only four of the past 16 years.  In 2022, a challenging year for stocks, bonds were also down. 

Narrow Markets 

The S&P 500 index has delivered twice the returns of the average large-cap stock in the past three years. (1)  Why the difference?  The S&P 500 Index puts more weight on larger stocks.  The top 18 of the 500 names represent 40% of the index performance.  Lyle Mays and Pat Metheny once produced an “album” titled,  As Falls Wichita, So Falls Wichita Falls.  The S&P 500 shares that fate with a handful of technology stocks.  Last quarter we referenced the disproportionate impact of the Magnificent Seven stocks.  Both Tesla and Apple are down by more than 10% in 2024 so the extra weight falls onto an even narrower list of uber-winning mega-cap stocks.

Valuation

Strong performance from the S&P 500 attracts more capital.  New dollars invested, especially through index funds, puts more money into those same larger companies, creating a virtuous cycle.  Today, only one of the 10 largest companies, those most responsible for outperformance, trades at a price-to-earnings ratio (P/E) of less than 26—a figure well beyond the historical valuation of the markets.  Consider the hyperbolic performance of the S&P 500 since October 2023.  The S&P 500 has risen 27% even though the earnings forecast has barely budged from $245 last fall to $248 today. (2)  Nearly the entire market performance can be traced to an expanding price-to-earnings ratio, simply a willingness to pay more for the same earnings.  The market now trades for 21 times forward earnings—a far cry from cheap.

Speculation 

The Russell 2000 is the most widely accepted benchmark for small capitalization U.S. stocks.  In 1998, less than 20% of those 2000 stocks were unprofitable.  Today, that figure has reached 41% as seen in the chart below. (3)

2024Q1 Graph 1 - Russell 2000

An alternative benchmark for small-cap stocks, the S&P 600, requires profitability for membership.  In the long run, profitable companies “should” outperform losers, which has borne out over the past 3, 5, and 10 years.  However, the Russell has achieved higher rates of return for the past year and this year to date. (4)   We have no rational explanation for this other than a rising risk appetite of investors.

Recap

  • Diversification into small-cap U.S. stocks and foreign stocks has provided little reward in the past decade.
  • Large-cap U.S. stocks have outpaced other equity markets.
  • Attribution for the superior results include the magnitude of the U.S. monetary policy response to both the Great Recession and the Covid-19-related lockdown, but also from the recent fervor surrounding A.I.
  • The 27% rise in the S&P 500 since October was fueled by the specter of lower interest rates (the market expected six cuts this year in January and higher profits). (5)

However

  • Getting inflation from the current 3.2% down to the target of 2.0% has proved challenging. (6)
  • The six interest rate cuts once expected in 2024 have now been reduced to only three. (7)
  • Earnings growth expected for 2024 has been pushed back to the second half of the year, rendering them less visible.
  • The S&P 500 closed the quarter at 5,254.35, or 21.18 times the expected earnings, compared to historically lower metrics (16.1 times for the past 15 years; 17.7 times for the past 10 years). (8) 

Implications

Diversification between asset classes, rather than being a quaint, obsolete strategy, makes great sense today.  Think not clunky, unreliable Oldsmobile as much as the timeless lines of a Porsche 911 Carrera.  Allowing the S&P 500 to simply “run” would represent a vote in favor of momentum investing and acceptance of the corresponding valuation risk. 

Rebalancing the portfolio, especially into lagging small-cap and foreign stocks, signifies a willingness to buck the trend and buy less expensive stocks.  In fact, the previously referenced S&P 600 trades at 14.1 times expected earnings—31% lower than the S&P 500 and “though not quite the largest discount in history, it’s close.” (9) 

One key argument for maintaining non-U.S. equities includes the reawakening of Japan.  The Japanese stock market experienced “the mother of all bubbles” by the end of 1989.  At that time, Japanese stocks made up 50% of the MSCI EAFE Index. (10)  As seen in the chart below, the Nikkei Index took 25 years to bottom out from that peak valuation and the process proved to be a considerable drag on the EAFE Index. (11) 

2024Q1 Graph 2 - Nikkei Stock Average

Today, Japanese stocks constitute 24% of the MSCI EAFE Index. (12)  The relative valuations between the S&P 500 and the MSCI EAFE reflect Japan’s changing dynamics.  In 2002, U.S. stocks traded at 16.9 times earnings while the MSCI EAFE traded at a premium multiple of 21 times. (13)   Today, those two figures have switched places. 

In addition, foreign stocks represent a hedge against weakness in the U.S. dollar.  Though beyond the scope of today’s note, a reasonable observer might conclude that the massive debt that has accumulated in the U.S. could eventually pressure our currency.

Investment strategies should be “classic” and withstand the test of time, much like the design of the 911s as seen below (1969 and 2022).  No single tactic will excel in every market environment.  As it turns out, Oldsmobile’s demise had more to do with the lack of reliability of the vehicles they designed and produced than the age of the company.  WCF remains highly convinced that the benefits associated with broad diversification will live on—explicitly due to its long-term reliability.

2024Q1 Photo 3 - Old Porsche in garage

2024Q1 Photo 4 - Modern Porsche speeding on road


  1. S&P 500 returns 39.11% over the past 3 years. Equal weighted market returns 19.53%. YCharts.com
  2. Both EPS forecasts from Yardeni.com
  3. Bloomberg.com
  4. YCharts.com
  5. “Goldman Sachs expects the Fed to cut interest rates 5 times this year, starting in March.” CBSNews.com; January 15, 2024.
  6. “Economic News Release,” Bureau of Labor Statistics; March 12, 2024
  7. “When will the Fed cut interest rates? Not so fast, some officials say, as inflation stays stubborn.” Bankrate.com; March 29, 2024
  8. “S&P 500 Forward P/E Ratio Rises Above 20.0 For First Time In 2 Years”: FactSet.com
  9. “The Stock Market Rally Keeps Going.  Here’s What Could Halt It Later This Year.” Barron’s; March 25, 2024.
  10. “Digging into the EAFE Index: Lessons for International Investing.” Seeking Alpha; March 9, 2009.
  11. FRED; Federal Reserve Bank of St. Louis.
  12. MSCI.EAFE.com
  13. RBCWealthManagement.com