2024 has been full of surprises. The economic data releases have remained robust, surpassing forecasts and, coupled with central banks’ dovish stances, have ignited the S&P 500 to its best first-quarter performance in half a decade. It seemed like the ‘Fed Put’ was resurfacing. While this looks like it could still be the case for many countries, the United States has found itself charting a divergent course in recent weeks.

The fourth quarter was a wild ride. The summer correction continued through late October when the market became fixated on the potential for central banks to begin cutting rates as inflation cooled. In the United States (US), investors priced in an expectation of six rate cuts for 2024, leading to a substantial shift in the anticipated 2024 year-end Federal Reserve (Fed) funds rate—dropping from 4.54% in mid-October to 3.88% at the end of 2023. Concerns related to the global debt burden seemingly dissipated and bonds came roaring back. Treasury Secretary Janet Yellen played a pivotal role by modifying the Treasury's auction strategy, selling more Treasury bills, and decelerating the sales of 10- and 30-year Treasury bonds following disappointing auctions. This was well-timed given the potential for the Fed to begin cutting rates in the next year. If all goes well, they will be able to roll the T-bills into longer-term Treasuries at lower yields. We do not believe the market will get its six rate cuts without a meaningful recession, though the three being signaled by the Fed may be reasonable.

We believe very few of the risks outlined in this letter are priced into the market, keeping us extremely cautious and persistently patient while getting paid over 5.5% (annualized) in short-term treasuries. The US equity market today is trading at a higher valuation than the risk-free alternative of short-term treasuries. This market dislocation defies logic, especially at a time when risks are building, earnings expectations are optimistic, and tailwinds are turning into headwinds. Market dislocations can remain for periods of time but tend to prove unsustainable in the long term. Momentum works until it does not. When it stops working, get the heck out of the way.

Every investment decision we make is based on the amount of risk we are taking for the potential reward we are expecting. Today, we do not think the risk versus reward profile in most risk assets is attractive.

The first quarter contained two of the three biggest bank failures in US history as well as the downfall of Credit Suisse. Additional risks continued to brew under the surface. Geopolitical tensions increased, OPEC+ production cuts shocked the markets, and the debt ceiling debate was not solved. Markets experienced quite a volatile ride caused by increased uncertainty of the future trajectory of monetary policy. February printed a hot January inflation reading and expectations that the Fed was not done raising rates resurfaced.  However, the banking crisis unwound that expectation. Investors speculated the crisis would fuel tighter lending standards, potentially finishing the Fed’s job for them and allowing the Fed to significantly cut rates later this year.  By month end, the banking sector risk seemed contained and risk assets continued their climb up the metaphoric “wall of worry”. Will one of the bricks come loose? The bond market seems a bit more concerned than the stock market. Time will tell.