Catastrophe, Resilience, and Growth

Market Commentary | Q1 2024 

In the early hours of a crisp morning, the Francis Scott Key Bridge in Baltimore suffered a catastrophic collapse. Seven workers who were on the bridge lost their lives following the head-on collision to the bridge by a container ship. Commerce ground to a halt in one of the largest ports on the East Coast. A key commute artery was destroyed, complicating traffic patterns and congestion in the city and region for years until the bridge can be rebuilt. 

This incident, which could have sent shockwaves through the economy as millions of tons of cargo were rerouted to other ports, can also be viewed as a testament to the resilience of our economic system. Despite the significant impact on Baltimore’s local economy, the broader US economy has demonstrated its ability to adapt and even continue growing. Resilience during moments of market disruption is a core principle of our investment strategy. 

The collapse of the Francis Scott Key Bridge, while devastating, did not paralyze the nation’s economy; similarly, a diversified portfolio is structured to absorb volatility without jeopardizing overall performance. In the first quarter of the year, geopolitical concerns persisted and specific companies stumbled, but global financial markets remained resilient and diversified portfolios continued their growth trajectory.

The current US equity rally started in the fall of 2023 after the Fed signaled that the rate hike cycle was close to over after raising rates by five percentage points from March 2022 to July 2023. As optimism rose that the Fed would soon begin cutting rates, stock prices pushed higher. The recession that was predicted last year never arrived, and job creation has remained robust.  

Through the first quarter of 2024, US economic data has continued to be fairly strong. Investors had been anticipating that rate cuts would reduce borrowing costs, increase consumer activity, and make alternatives to stocks like money market funds slightly less attractive. However, inflation is still above 3%, and expectations for Fed rate cuts have been pared back significantly from six expected cuts at the start of the year to only three expected cuts as of the end of March. Despite the change in rate cut expectations, US large-cap stocks have continued to climb higher.

The S&P 500 Index posted back-to-back quarters of 10% growth for only the eighth time since 1950. While history offers no guarantees, looking at the past seven times would indicate that this portends well for markets over the remainder of the year. Last November, we incrementally increased our allocation to US stocks in client portfolios, which provided a tailwind during the most recent quarter.  

Looking closer, we see that growth remained strong over the first three months in the technology and communication services sectors that benefit from AI tailwinds and optimism about lower interest rates. “Old economy” sectors like energy and basic materials lagged early in the quarter, but they bounced back to have the strongest performance during the final month of Q1. This breadth offers a positive sign for the economy and markets, with gains and growth broadening beyond the seven tech stocks that accounted for the majority of market growth last year.

Speaking of the “Magnificent 7,” these seven mega-cap names have continued to grow, though we are beginning to see some divergence in their returns. Nvidia continued to benefit from the focus on AI, with the company reporting better-than-anticipated quarterly results despite already lofty expectations for revenue and net income. The AI chipmaker was up by +82% in the first quarter and has gained +225% over the past 12 months.[1] On the other hand, Tesla was the weakest member of the Magnificent 7, with shares down by -29% during the quarter, and down more than -50% from their 2021 highs. Apple shares were also down approximately -7% in the first quarter. Our client portfolios have exposure to each of these companies, though we remain well-diversified to reduce risks to the overall portfolio from any one company or sector. 

International stocks in developed economies, as measured by the MSCI EAFE Index, grew by +5.8% during the quarter. While this price growth is impressive in a single quarter, it lagged behind US equity growth and reflects an uneven economic landscape in varying countries. Recessions arrived in the UK, Finland, and Ireland, and negative GDP rates for Q4 2023 were also reported in Germany and Canada. On the other hand, the Japanese economy was a bright spot. Growth has accelerated there to such a degree that the Bank of Japan (the Japanese equivalent of the US Fed) hiked interest rates for the first time in 17 years. While we continue to see international stocks as a core part of our diversified portfolios, we reduced our exposure slightly over the past year as we see better opportunities in the US. 

The Bloomberg US Aggregate Bond Index, which broadly measures US bond performance, declined by -0.8% during the first quarter. After rising in Q4, stickier-than-anticipated inflation in January and February led investors to dial back expectations for rate cuts, and bond prices drifted downward. Higher income from bonds is helping support portfolios, but bond prices will remain sensitive to any changes in interest rates. 

Real estate was the worst-performing sector due to the Fed’s “higher for longer” interest rate policy. The FTSE NAREIT Index declined by -1.3% during the quarter. While not a precipitous decline, it reflected the ongoing impact of interest rates on mortgages and the US real estate market. Similar to bonds, real estate is particularly sensitive to interest rates, and growth will depend on the Fed’s timeline for lowering rates.

Complex systems like shipping infrastructure or financial markets aren’t perfect; rather they are designed with a balance of efficiency and resiliency. In Baltimore, efforts are already underway to dig a temporary channel to get “commercially essential” seaborne traffic moving, and longer-term clean-up and reconstruction plans are already being discussed. Just as our economic system is flexible enough to create alternative routes that ensure the flow of commerce continues, even when key bridges collapse, a diversified portfolio spreads risk across a wide array of assets. This ensures the impact of a downturn in any single investment is mitigated. At North Berkeley, this insulation is a core part of our investment strategy. 

For our clients, we aim to build portfolios that prioritize resiliency over perfection. We understand that financial shocks will happen along the way, and prices can be volatile in the short-term, even as the historical trend has been one of growth for long-term investors. Patience, close observation, and careful planning underpin our conviction that our client portfolios will be resilient through difficult times and thrive when market conditions are supportive.

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[1]  As we mentioned in our recent article, there’s little doubt the quality of the Magnificent 7 companies is vastly better than the Pets.com or Webvan from the 1990s, but any asset can get overpriced. Nvidia is now larger than the value of Diageo, UPS, Philip Morris International, Nike, Shell, McDonald’s, L’Oreal, Nestle, Costco Wholesale, and LVMH, combined.