Equity Market Commentary Q1

U.S. and non-U.S. markets had a bullish start to the year, up 10.56% and 4.69%, respectively, as represented by the S&P 500 Index and MSCI All Country World Index (ACWI) ex USA. For the S&P 500 Index, it was the best start to a year since 2019.

A strong start to 2024 comes in the aftermath of a similarly strong end to 2023 with the S&P 500 Index up 11.69% and the MSCI ACWI ex USA Index up 9.75% in the final quarter of last year (and up 26.29% and 15.62%, respectively, on the year).

Gains in the S&P 500 Index were widespread in the first quarter of 2024, with all sectors up except for real estate, which was down 55 basis points. Energy, industrials, financials, information technology and communication services led with returns in the double digits. In the MSCI ACWI ex USA, the majority of sectors were up, led by information technology at 11.37%. The few laggers were consumer staples, utilities, materials and real estate.

This continued ascendance has carried the S&P 500 Index to more than 20 new all-time highs thus far in 2024, largely owing to enthusiasm around artificial intelligence and recessionary fears subsiding. Above all, investors appeared optimistic about a potential soft landing from the U.S. Federal Reserve as inflation inched closer to target, as well as the hint from the Fed that three rate cuts could take place in 2024 and begin to get priced into investments.

For seemingly the third year in a row, the actions of global central banks are at the center of market movements. Since inflation peaked in 2022 the U.S. Federal Reserve, as well as global central bank counterparts, have been raising interest rates in an effort to tame inflation. Domestically, that has been done without triggering a recession, bringing the term “soft landing” into the conversation.

That battle against inflation, much of which can be attributed to supply shocks during the COVID-19 pandemic, now seems in the final stretch. The downward trajectory of inflation from peaks of 9% in the U.S., and even higher internationally, to the target of 2% has gotten “bumpy” in the words of U.S. Federal Reserve Chair Jerome Powell. While U.S. inflation, as measured by the Consumer Price Index, has been floating within 2% of the target, there has been less clear trajectory over the past few months. A major outlier is Japan, which has finally seen an end to negative rates after many years and was up 11.01% in the first quarter as represented by the MSCI Japan Index.

The bull market that has rolled over seamlessly from 2023 to 2024 has come with several notable characteristics: among them are the dominance of U.S. markets over international markets (represented by the S&P 500 Index and MSCI ACWI ex USA Index), and developed international markets over emerging markets (as represented by the MSCI ACWI Index and MSCI EM Index). The longstanding superiority of growth to value in the U.S. (represented by the Russell 1000 Growth and Value Indexes) remained, while not being as clear-cut internationally (as represented by the MSCI ACWI ex USA Growth and Value Indexes). Dividend payers have continued to experience pain, with the highest yielding tercile in the S&P 500 Index meaningfully behind the lowest yielding tercile on the quarter. However, that dividend payer phenomenon is much less pronounced within the MSCI ACWI ex USA, as increasing market breadth takes hold outside the U.S.

The much bandied-about Magnificent 7 have shown signs of divergence. NVIDIA, Meta, Microsoft and Amazon have picked up in 2024 where they left off. However, Tesla, Apple and, to a lesser extent, Alphabet have stumbled out of the gate. Some of this can be attributed to the anticipated winners and losers of the emerging AI landscape but there are also important idiosyncratic trends such as Tesla seeing a drop in deliveries and sales, a sign that fundamentals still matter.

As the year unfolds, expect earnings to be a key driver, as it was the fuel that powered the meteoric rise of NVIDIA. Consensus analyst estimates for corporate earnings growth percentage in the S&P 500 Index are in the double-digit range after being less than a full percent last year. A bullish outlook is widespread, with emerging markets estimates of almost 18% growth in corporate earnings this year compared with a decline of almost 14% for last year.

Beyond the mega-cap tech stocks, valuations are not universally stretched; that, paired with moderating inflation and potential declining interest rates, could create a favorable backdrop. Some volatility may emerge from earnings, elections globally and other unpredictable occurrences, but that could pale in comparison to the larger structural tailwinds.

Capital Group equity-focused mutual funds and ETFs update

American Funds mutual funds results based on F-2 share class, ETFs based on market price

During the first quarter, all 28 of our equity-focused funds¹ delivered positive returns for shareholders. The range of these returns spanned from 3.0% for American Funds Developing World Growth and Income Fund — which seeks growth and income within emerging markets — to 13.3% for Capital Group Growth ETF (ticker: CGGR), which seeks capital appreciation from primarily U.S. companies.

When measuring results against benchmarks,² our funds that seek capital appreciation fared well, with 8 of 13 outpacing during the quarter. Conversely, most of our growth-and-income income funds (6 of 10) trailed benchmarks. This was mostly true for our U.S. growth-and-income funds, where the highest cohort of dividend payers in the U.S. trailed by nearly 10%.³ Similarly, most of our equity-income and balanced funds⁴ (4 of 6) lagged benchmarks during the quarter.

Looking beyond the recent quarter is always a useful exercise, and the trailing results of all our funds are shown in a table at the end of this piece spanning the past decade.

With the post-pandemic down markets of 2020 and 2022 now firmly planted in the market’s history, it’s tough to tell how much has changed in the world by examining just the five-year annualized total returns of our equity-focused mutual funds. Ten of them,⁵ for example, have annualized returns in excess of 10% over this timeframe, and seven of them have done so over the past decade. With the post-pandemic rollercoaster we’ve been on, it’s a good reminder that, “time, not timing, is what matters” in the market.

We’ve also been pleased with the contour of our equity-focused mutual funds’ downside resilience over varying timeframes. This is less obvious over the past three years, where 38%⁶ of our funds produced better downside resilience than their indexes due to most of our growth funds declining more than the market in 2022. However, over the past five years, 56%⁶ of our funds have held up better than benchmarks on the downside, and over the past decade 81%⁶ of them have done so. Moreover, the five that produced the greatest downside resilience were — in order — American Mutual Fund®, American Funds International Vantage Fund, Washington Mutual Investors Fund, American Funds Developing World Growth and Income Fund and American Funds Global Insight Fund. All these funds either seek either growth-and-income or, in the case of American Funds International Vantage Fund and American Funds Global Insight Fund, include conservation of principal as an objective.

Outlook

The dominance of mega-cap tech stocks has sparked discussions about how much higher equity markets can climb, particularly in the U.S. However, even considering recent stock gains, overall valuations do not appear stretched and innovation remains alive and well across many businesses and industries.

Global corporate earnings have rebounded from a near trough and are expected to improve further. Additionally, moderating inflation and declining interest rates could create a favorable backdrop.

Earnings growth remains a key driver for stocks, and companies like NVIDIA and Meta have demonstrated impressive results of late.

While “Magnificent 7” has become something of a pejorative for investors wary of how much of the benchmark those stocks now comprise, innovation goes some of the way to explaining their success.

Still, the fact that some of them are innovative doesn’t mean the Magnificent 7 are all equally magnificent, or that the grouping contains every company that is.

And we agree that when a group of stocks gets a name like that, it’s usually a sign to proceed with caution and not buy them as a market cap–weighted basket. Outside of these investments, for example, our investors are finding opportunities for above-market growth at below-market valuations in industries such as commercial aerospace; hotels, resorts and cruises; industrials companies and payment processors.

What’s also fascinating is that if we examine the seven stocks that contributed to 2023’s calendar-year returns for the MSCI EAFE (Europe, Australasia, Far East) Index, this group of non-U.S. companies in the collective has done better than the Magnificent 7 stocks, as shown below. This helps confirm that the myopic obsession with growth among just the U.S. mega-cap technology-oriented companies is highly misguided.