Highlights:
- Strong performance in March contributed to one of the best first quarter returns in the past decade, with the S&P 500 Index advancing 3.2% for the month and 10.6% for the quarter.
- While large-cap technology continued to dominate, other sectors contributed significantly to the rally, with a notable 10% bounce in Energy stocks in March. Except for Real Estate, all S&P sectors saw positive returns for the quarter.
- Inflation remained somewhat sticky, with Personal Consumption Expenditures (PCE) ticking slightly higher to 2.5%; Fed Chairman Powell said the print aligned with expectations.
A strong and broad stock market in March added up to one of the best first quarter returns of the past decade, with the S&P 500 Index advancing 3.2% for the month and 10.6% for the quarter. The S&P 500 set numerous new closing highs, including one on the final trading day of March. This rally was largely a continuation of the bull market of 2023, driven by a stronger-than-expected economy, solid corporate earnings, expectations of Federal Reserve easing, and moderated, if somewhat sticky, inflation. Large-cap technology was still the leading stock market story even as a couple of the former "magnificent seven" faltered this year. But other sectors of the market were major contributors to the rally, including a 10% bounce in energy stocks in March. For the quarter, all S&P sectors other than Real Estate were positive, led by double-digit returns from Communication Services, Energy, Information Technology, Financials, and Industrials.
Bonds were broadly flat for the quarter as yields worked higher. Over the course of the three months, rates in the middle and long end of the yield curve rose close to a half percent. The U.S. Aggregate Bond Index rose 0.9% in March, but was down -0.8% for the quarter. Holders of short-term corporate bonds continued to see the highest yields in decades, with coupons in the 5.5% range.
A much-anticipated inflation report was issued at quarter-end on March 30. The Fed's favorite inflation measure, Personal Consumption Expenditures (PCE), came in at 2.5%, a tick higher than the 2.4% reading in January. However, Fed Chairman Powell appeared to take it in stride, saying the print was "pretty much in line with our expectations." He added that reports that conform to expectations are generally a good thing. Another good sign was the drop in the monthly pace of service price increases from 0.4% to 0.3%, a move which was better than anticipated. A moderation in the rate of service prices was also well received since service inflation has been a major driver of overall inflation over the past years.
So, what are we to make of market and economic prospects going forward? On one hand, there are signs that the positive returns could continue into 2024. Technology companies are expected to prosper behind the AI revolution, even as the broad swatch of U.S. corporations work through how these new technologies will be applied to improve productivity and profits. One example of the spinoff effects from AI is the March Energy Sector rally, fueled by the developing boom in high-energy-demand data centers. Historically, strong first quarters have indicated promising results for the ensuing year, and for reasons that defy analysis, returns are positively correlated with presidential election years. Another boost could come from Federal Reserve rate cuts, which are currently projected as three quarter-point reductions by year-end. On the other hand, the market is trading at a price-to-earnings (P/E) multiple well above its 5-year and 10-year averages, so valuations need to be supported by robust profit growth in 2024. We will soon find out in Q1 earnings reports whether companies are forecasting an acceleration in profitability.