A ‘Magnificent’ Leap in February

In Short

• February saw the S&P 500 and Nasdaq hit fresh highs while longer-dated bonds pulled back
• In light of January inflation data, the impact of “higher-for-longer” rates is a potential concern, especially their effect on the middle-class consumer
• While the “Magnificent 7” stocks posted their best monthly return in nine months, excluding these seven names, blended earnings actually declined 2% year-over-year
• Mega-cap technology companies may not maintain the same level of earnings growth into the second half of 2024, which in our view makes a broadening of performance across companies important to maintain market momentum
• We continue to believe that quality companies and active management should be well-suited to navigate future uncertainty

Picture Perfect?

Courtesy of the leap year, February closed out with an extra business day and a continued trend of strong equity returns, as the S&P 500 Index and the Nasdaq Composite hit fresh highs. However, longer-dated bonds and commodities (excluding oil) pulled back as yields rose, with the 10-year U.S. Treasury yield peaking at 4.32% after starting the month at 3.85%. Posting its best February return since 2015 at +5.3%, the S&P 500 Index far exceeded its election-year average for February of -0.31% (and -0.14% in all years). Notably for domestic stocks, small caps outperformed large caps during the month. (Our Asset Allocation Committee recently upgraded our view on small caps due to lagging 2023 performance and a more constructive economic outlook.) Interestingly, relative outperformance by the S&P 500 Index over the Russell 2000 Index was at its widest level in decades. The Russell 2000 Index’s last record close was in November 2021, and it now sits 14% below that point. During the same period, the S&P 500 Index has risen nearly 9%.

As discussed in our year-end recap, Bulls Run, Doves Fly, we believe that areas of the market with a greater degree of pessimism priced in—such as small caps—are likely to perform better this year than those “priced for perfection.” The macro environment has provided a “Goldilocks” scenario of declining inflation, low unemployment and resilient growth, which should all bode well for asset classes that previously priced in a hard landing.

However, while the current scenario paints a rosy picture, including expected rate cuts later this year, we continue to monitor the economy for signs of stress. Expectations for cuts have declined since the end of last year, when the market anticipated six rate cuts in 2024 with a 73% chance of a reduction in March. As of the end of February, the market is now expecting three rate cuts (for a total of 75 basis points) with a 4% chance of a rate cut at the March FOMC meeting. While we believe that inflation and interest rates are trending downward, January CPI data came in hotter-than-expected, reminding investors of the continued risk of rising prices and other potential catalysts that could help maintain high interest rates.

Cutting The Cuts: Implied Fed Funds Rate

Source: Bloomberg as of February 29, 2024.

As discussed in our Solving for 2024 outlook, higher-for-longer interest rates could have a trickle-down effect on the consumer. We have already seen signs of stress in rising credit card delinquencies and weak retail sales for staples among lower-income consumers. It is possible that we could begin to see similar pressures for middle-income earners, who could then cut back on spending amid still-elevated interest rates. As a result, companies may struggle to sustain profit margins in the face of lower demand and rising labor and borrowing costs. These are potential risks that could affect the economy this year and could have knock-on effects on equity markets, which have continued to move higher largely on the strength of U.S. mega-cap companies. That said, anticipated stress on the consumer due to higher prices, elevated rates and diminishing savings has not yet resulted in a meaningful deterioration in spending; and based on current employment data, the near-term risk appears limited.

Buzz continues to surround the Magnificent 7 stocks, which posted their best monthly return in nine months in February and drove 62% of the S&P 500’s return in 2023. So far this year, this basket of stocks has accounted for less than half of S&P 500 Index returns, a welcome change from last year and a potential sign that the market rally could be broadening. These highly concentrated stocks have also propped up earnings data for the broader index, although many analysts believe that this trend could shift in the second half of 2024.

Eyes on Earnings

Earnings season for 2023 has almost wrapped up, with 98% of S&P 500 Index companies having reported 4Q results through the end of February. As things stand, the blended earnings growth rate for the S&P 500 Index during the fourth quarter is 4.0% compared to the initial expectation of 1.5%. From a bottom-up perspective, however, the Magnificent 7 contributed much of this, with the rest of the market actually declining 2% year-over-year—a stark difference.

Two highlights in 4Q were Nvidia and Amazon, which were among the top contributors to growth for the broader index. Nvidia reported almost 500% year-over-year earnings growth, with sales up 265%, and provided positive guidance for the current quarter. Much of the company’s success has been due to demand for processors used in artificial intelligence, which CEO Jensen Huang claims will continue.

As for Amazon, CEO Andy Jassy’s efforts to rein in costs appear to be paying off, and revenues were strong amid a record-breaking holiday shopping season and October’s Prime Day sales event. The company went through layoffs from late 2022 to mid-2023 and announced additional cuts in January in areas such as Prime Video, Twitch and MGM Studios. A big area of focus for increased investment is within generative AI services. Clearly, some of the major players in the S&P 500 are focused on artificial intelligence as a tailwind.

Looking further into 2024, analysts anticipate earnings growth of nearly 11% for the year. However, one risk is the sustainability of the Magnificent 7’s robust earnings growth. Although these companies see artificial intelligence as path to expand in the future, the broader market will need to catch up if mega-caps show signs of slowing. Many analysts do not expect mega-cap technology companies to maintain the same level of earnings growth into the second half of this year, which in our view, makes a broadening of performance important to maintain market momentum.

Overall, the first-quarter outlook has been lackluster. For companies that have issued 1Q earnings guidance adjustments, 70% have guided negatively. However, the decline in bottom-up EPS estimates have been generally in line or below the long-term average for this time of year. Analysts also generally reduce annual earnings estimates during January and February.

Earnings Set to Reaccelerate for S&P 500 ex-Magnificent 7 Stocks

Source: Factset as of February 29, 2024. Magnificent 7 estimated growth is the median earnings growth of that universe. Rest of S&P 500 estimated growth is the median earnings growth of that universe.

Looking ahead, we will continue to monitor the impact of past rate hikes that have the potential to restrict capital expenditures and growth given the higher burden of borrowing costs. We believe that quality companies may be well-suited for an uncertain environment thanks to their moderate leverage (and lower exposure to higher rates) and higher profitability (a welcome cushion in a potential downturn). Simply said, quality continues to matter, in our view.

Portfolio Implications

Equities saw strong performance during the month, led by small caps and growth stocks. We maintain an overall neutral view across equities, with an overweight to small caps, a laggard that has priced in a hard-landing scenario. Given ongoing economic uncertainty, we believe that clients may want to consider adhering to long-term strategic asset allocations. Within equities, we still favor lower-beta, higher-quality names, with a neutral view on value versus growth. In this more challenging environment, we also favor employing active management to select companies with high earnings visibility.

Fixed income was mixed, with longer-dated bonds moving lower as yields rose. We continue to favor credit markets, maintaining an overweight view on investment grade securities. With short-term rates set to decline, we believe that clients may want to consider moving away from overweight cash positions and locking in incrementally longer-term bond yields. We maintain a neutral view on high yield debt to balance risk in portfolios as well as in light of recent spread-tightening that has reduced the risk-adjusted return potential of the asset class. We are neutral on emerging markets debt due to overall global growth fears, particularly in China.

Within private markets in a challenged fundraising, exit and financing environment, significant opportunities exist for firms and strategies that can act as liquidity and solutions providers to help close the capital supply/demand gap and support value-added transactions. This backdrop, along with Neuberger Berman’s deep relationships and unique position within the private equity ecosystem, has translated into record levels of deal flow across our platform. We continue to see potentially compelling opportunities across secondaries, co-investments, private credit and capital solutions.

Index Returns

Source: Bloomberg, total returns as of February 29, 2024. S&P 500 Index is represented by S&P 500 Total Return Index. Nasdaq Composite NASDAQ-Composite Total Return Index. Dow Jones is represented by Dow Jones Industrial Average TR. Large Cap is represented by Russell 1000 Total Return Index. Mid Cap is represented by Russell Midcap Index Total Return. Small Cap is represented by Russell 2000 Total Return Index. All Cap is represented by Russell 3000 Total Return Index. Large Cap Growth is represented by Russell 1000 Growth Total Return. Large Cap Value is represented by Russell 1000 Value Index Total Return. Small Cap Growth is represented by Russell 2000 Growth Total Return. Small Cap Value is represented by Russell 2000 Value Total Return. ACWI is represented by MSCI ACWI Net Total Return USD Index. ACWI ex US is represented by MSCI ACWI ex USA Net Total Return USD Index. DM Non-U.S. Equities is represented by MSCI Daily TR Gross EAFE USD. EM Equities is represented by MSCI Daily TR Gross EM USD. Cash is represented by ICE BofA US 3-Month Treasury Bill Index. U.S. Aggregate is represented by Bloomberg US Agg Total Return Value Unhedged USD. Munis is represented by Bloomberg Municipal Bond Index Total Return Index Value Unhedged USD. Munis Short Duration is represented by Bloomberg Municipal Bond: Muni Short (1-5) Total Return Unhedged USD. Munis Intermediate Duration is represented by Bloomberg Municipal Bond: Muni Intermediate (5-10) TR Unhedged USD. Investment Grade is represented by Bloomberg US Corporate Total Return Value Unhedged USD. High Yield is represented by Bloomberg US High Yield BB/B 2% Issuer Cap Total Return Index Value Unhedged USD. Short Duration is represented by Bloomberg US Agg 1-3 Year Total Return Value Unhedged USD. Long Duration is represented by Bloomberg US Agg 10+ Year Total Return Value Unhedged USD. Global Aggregate is represented by Bloomberg Global-Aggregate Total Return Index Value Unhedged USD. EMD Corporates is represented by J.P. Morgan Corporate EMBI Diversified Composite Index Level. EMD Sovereigns – USD is represented by J.P. Morgan EMBI Global Diversified Composite. Commodities is represented by Bloomberg Commodity Index Total Return. Commodities ex Energy is represented by Bloomberg ExEnergy Subindex Total Return. U.S. 10-Year Yield is represented by US Generic Govt 10 Yr.