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Quarterly Letter to Clients


Written by:  Thomas Flaig, CFA

The market began the year with most investors convinced that the Federal Reserve would be lowering interest rates by the end of March.  Although that didn’t happen, investors quickly shrugged off their disappointment and continued to bid stock prices higher.  In fact, all the major market indices (Dow, S&P 500, Nasdaq) managed to reach new record highs during the quarter.  Why?  Because the resilient U.S. economy continues to provide a strong fundamental base for corporate earnings.  As a result, the S&P 500 index (large capitalization stocks) gained 10% for the period while the smaller capitalization Russell 2000 index increased 4%.

While inflation has steadily declined from its peak of 9% in June 2022, it has flattened out around the 3% level over the past several months.  The Fed’s target rate for inflation is 2%, so for the time being they remain content to hold short-term interest rates near 5%.  Until they see additional progress on inflation (or the economy slips into recession), they will most likely remain steadfast.  Investors are currently betting that the Fed will begin lowering interest rates at its scheduled meeting in June and will end the year with a base rate of 4 ½%.  Since this is a Presidential election year, the Fed will probably avoid making any rate changes during the two-months leading up to the election in November in order to avoid any possible appearance of political influence.

The U.S. economy continues to advance, but the services side of the economy remains more robust than the manufacturing side.  Inflation-adjusted GDP growth for the most recent quarter came in at 3.4%, which was in-line with the long-term historic rate of growth for the U.S. economy.  However, the highly watched “Index of Leading Economic Indicators” is currently predicting relatively flat economic activity in the coming months.  Overall employment remains strong, but new hiring activity continues to favor part-time versus full-time as well as public versus private.  Although wages have more than kept up with inflation in recent quarters, companies continue to find new ways to enhance productivity (mainly through new software & automation) allowing profit margins to remain at or near record high levels.

History has shown that Presidential election years tend to generate above average returns for the stock market.  Perhaps this has something to do with the fact that very little gets accomplished in Washington in the months leading up to an election.  This means that CEOs can look forward to steady economic policy for at least the remainder of the year.  Investment strategists are still expecting corporate earnings to expand by approximately 10% in 2024.  This rate of growth coincides with the long-term historic trendline for the market.  Furthermore, corporate merger and acquisition activity has begun to perk up over the past few months.  This is encouraging as it indicates that corporate managers have enough confidence in the economy that they are willing to put additional investment capital to work.