First Quarter 2024 Write-Up

For the first quarter of 2024, the Dow Jones Industrial Average, Standard & Poor’s 500 Index, and the Nasdaq Composite gained 5.6%, 10.2% and 9.1%, respectively. After a solid fourth quarter of equity gains, driven by the “Magnificent Seven” stocks, expectations for a more dovish Federal Reserve and the broadening participation among all the other “less magnificent” stocks, the first quarter saw continued robust gains. In fact, the S&P 500 Index chalked its 14th largest first quarter gain since 1928. Volatility (as measured by the VIX Index) was very low at 13.7%, and the largest drawdown during the quarter only amounted to 1.7%. During the quarter, a couple of the Magnificent seven stocks fell from their exalted leadership positions, as Apple declined 11.0% and Tesla plummeted 29.3%. Although the data (see table appended), suggests a likelihood of a good year following a strong first quarter, we remain cautious because almost half of the fast start first quarters listed below were from years that failed to breach multi-year highs. The S&P 500 Index achieved a record high in the first quarter, as its P/E multiple expanded to 24.4x from 22.3x at the start of the quarter. By and large, stocks are not cheap given the current interest rate environment. 

Speaking of interest rates, we saw a bit of an anomaly between the fourth quarter of 2023 and the end of the first quarter of 2024. Stocks advanced in the fourth quarter of last year as investors were constructive about dovish Federal Reserve action. At the end of 2023, the bond market was expecting seven interest rate cuts by the Fed in 2024, including three cuts by the FOMC meeting in June. By the end of the first quarter of this year, the bond market was only pricing in two or three rate cuts. Market expectations had shifted abruptly, but stocks still advanced. The change in attitude reflected three consecutive monthly Consumer Price Index (CPI) reports that came in hotter than expectations. January CPI came in at 3.09%, February at 3.15% and March at 3.48%.

Year-over-year CPI has now been above 3.0% for 36 consecutive months, the longest period since the 1980s. Core CPI, which removes volatile food and energy components, was even worse. This is significant because the market assumes that the Federal Reserve governors pay more attention to core CPI than “regular” CPI. January core CPI came in at 3.09%, February at 3.76% and March at 3.80%. Although Chairman Powell and the Fed governors are cautious, consumer expectations about inflation have barely budged in the last three months. According to the New York Federal Reserve Banks monthly Survey of Consumer Expectations, consumers are expecting 3.0% inflation over the next year, 2.7% over the next three years and 2.9% over the next five years. Consumer inflation expectations are running about half a percentage point above Federal Reserve inflation expectations, judging by the Fed’s March Summary of Economic Projections.  

Last year we wrote about the looming cliff our country is facing regarding Social Security and Medicare. The 2024 Trustees report has not yet been released, but we doubt that things have improved. To summarize from the 2023 figures, the Trustees project that Medicare’s Hospital Insurance trust fund will be insolvent by 2031, Social Security’s Old-Age and Survivors Insurance trust fund will run out of reserves by 2033, and the theoretically combined Social Security trust funds (the Disability Insurance fund plus the Old-Age and Survivors Insurance fund) will be insolvent by 2034. Upon insolvency, Social Security benefits will be reduced across the board by 20 percent under current law, while Medicare Hospital Insurance payments will be cut by 11 percent. Those reductions will grow to 27 percent and 19 percent, respectively, as costs and benefits outpace revenues. Again, under current law, both Social Security and Medicare will be insolvent by the time today’s 55-year-olds reach the full retirement age. There is no triage mechanism under the current law that will soften the blow to the sickest and neediest. There is no political will on either side of the aisle to address this foreseeable collapse.  

There is an autumn event that might insert the now non-existent Social Security debate into the pre-Election headlines. Every year Social Security benefits are increased to reflect real buying power losses due to inflation. These cost-of-living adjustments (COLA) are automatically indexed to reflect the average change in the third quarter Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W is not the same as the normal CPI, but rather a specialized subset of the CPI. The COLA increase does not reflect the full-year increase in retirees’ costs, but rather the July-September increase in costs for clerical staff that are paid hourly wages. It is an odd construct. Most retirees pay more for healthcare than do clerical workers. Most clerical workers pay more for apparel and education than retirees. It is not a great match for Social Security beneficiaries. The 2022 CPI-W increase was 8.7% for 2023 benefit payments. The 2023 CPI-W was 3.2% for 2024 Social Security benefit payments. This means that March benefit payments increased less than March CPI. Additionally, the CPI adjustment for 2024 will include a new Bureau of Labor Statistics methodology for determining healthcare costs to “reduce volatility”. Rather than using insurance premium data, as it did historically, the new BLS CPI computation will use insurers “net change in retained earnings” to estimate healthcare inflation. By this methodology, the BLS reported the health insurance component of CPI decreased 15% over the last year and is 3% below where it was five years ago. This is asinine. Social Security beneficiaries already think that inflation is cheating them. If the COLA increase is below inflation and beyond reasonable explanations, expect fireworks from these voters.

This year Baxter Investment Management is celebrating a century of serving clients. Our longevity is a testament to our extraordinary investors. Any successful investment strategy depends not just on a good plan, but the fortitude to execute it when turmoil clouds rationality. A realistic asset allocation is always the proper first step, but many people who think they are investors never even get that far. A comprehensive investment strategy is the next step, but many people who think they are investors cannot abide with the distractions of volatility. Warren Buffett counsels that the stock market is there to serve you, and not to instruct you. Our investors have always understood that. 

Prussian Field Marshal Helmuth von Moltke (1800-1891) was a stickler for detailed planning, but he also realized that, “No battleplan survives first contact with the enemy.” Or, more colloquially, as Mike Tyson once said,” Everybody has got a plan until they get punched in the  face.” Field Marshall Moltke prepared for a myriad of contingencies and unexpected outcomes, leaving himself both offensive and defensive options in the face of adversity. Iron Mike’s quote continued, “Then, like a rat, they stop in fear and freeze.” Our investors have understood that occasional volatility is the ticket price for generating above-average, tax-efficient returns. Our investors have been very disciplined in enacting strategic investment plans, but also flexible tactically when opportunities present themselves, often disguised as setbacks. Our investors have created the foundation for our century of rewarding and enjoyable work. We are very grateful to our outstanding investors, and hope to see you this summer. 

Sincerely,

Your Team at Baxter Investment Management