Market & Performance Summary

Despite the Federal Reserve’s restrictive interest rate policy, the U.S. economy continues to be resilient. Recent data, including a robust January jobs report showing the economy added 517,000 positions, has been surprisingly strong, prompting the Federal Reserve to raise its expectations for growth in 2024 to 2.1%, up from a previous estimate of 1.4%.  This economic strength is fueling optimism in the markets, with many investors expecting a "soft landing" where growth slows but a recession is avoided.

However, a strong economy also means inflation remains a concern. While core inflation[1], which excludes volatile food and energy prices, is showing signs of moderation, it's still running above the Fed's 2% target at 3.8% year-over-year. This has led the Fed to push back the timing for interest rate cuts, although central bank projections still call for three cuts in the back half of the year, which would bring short-term rates down to 4.75%.

Market participants seem to be fully on board with the Fed's “Goldilocks” scenario, with recession probabilities for the next year declining significantly from 65% to 35% compared to this time last year[2]. Additionally, unlike the Fed’s own projections, the Fed fund futures markets indicate less certainty for the need to cut interest rates in 2024, which implies the market is increasingly confident in the resilience of the economy in the face of higher rates. While the data supports expectations for a soft landing, predicting recessions is challenging, as they are often triggered by unexpected events in the financial markets.

Predicting the future, especially when it comes to interest rates, is a fool's errand. At the start of 2022, the market was predicting two 0.25% rate hikes for the year instead of the equivalent of seventeen that ensued. To start this year, the market was predicting more than six cuts. So far, we’ve witnessed zero with no immediate plans to start.

The good news is that successful outcomes for our fixed income investors don’t rely on predictions of recession timing or the next rate cut or hike. Our fixed income strategies are built to deliver durable returns regardless of the direction of interest rates.

Gyrations in bond market betting engines for predicting recessions and interest rates led to continued volatility to start the year. The Aggregate Bond Index, which broadly measures the US bond market, reported a 1% decline for the quarter despite robust levels of interest income[3]. The average Kovitz-managed bond portfolio performed in line with expectations, generating positive returns to start the year, suffering less price volatility while still collecting meaningful income[4].

Intermediate Credit: A Shelter from Financial Storms

Let's face it, the market is feeling pretty good right now. Premiums afforded for taking on additional risk have compressed across the investment landscape. The S&P 500 witnessed a robust 10% increase in the first quarter, marking its best start since 2019. Unlike previous years, where gains were concentrated in select sectors, this year's performance is characterized by widespread growth across various segments of the market. The appetite for risk has also increased in the bond markets. For example, the additional yield investors demand to hold high-yield bonds, relative to the yield on Treasury bonds, is currently at its narrowest in almost two years.

History tells us corrections are inevitable. Over the past century, the stock market has seen pullbacks of over 10% roughly once a year.  While nobody can predict when the next one will hit, it’s not a question of ‘if’, but ‘when’.

This is where intermediate credit steps in. High-quality, shorter-duration bonds offer a valuable shield against market downturns.  Think of them as a life raft – they provide stability and income when stocks get choppy. While past performance isn't a guarantee of future results, intermediate-maturity high-quality bonds have, on average, delivered positive returns during equity market drawdowns of over 10% during the last three decades – even including the severe bond bear market of 2022.
Figure 1: Intermediate Credit Index Performance During Recent 10%+ Drawdowns in the S&P 500

Source: Kovitz using data from Bloomberg Finance, L.P. Indices used are the S&P 500 and the Bloomberg US Intermediate Credit Index.

An allocation to intermediate credit strategies provides a source of stability and income that helps offset those stock market losses. Moreover, maintaining a balanced portfolio enables investors to adopt an offensive stance during market pullbacks by providing a liquid source of funds to rebalance, rather than succumbing to fear and panic selling. Strategic rebalancing not only safeguards against downside risks but also enhances the potential for long-term wealth accumulation – forcing investors to sell high and buy low – the opposite of what fear says to do.

CONCLUSION

The economic and market outlook remains uncertain. With interest rates likely to fluctuate, stocks near record highs, and a general sense of complacency, we believe a focus on lower-volatility fixed income strategies is prudent.

Our core fixed income strategies offer a powerful hedge against potential market downturns. Absolute yield levels are attractive on several levels, and, if the Fed's dovish bets pan out and inflation truly moderates, these bonds could see additional price appreciation tailwinds.

In short, we're committed to steering our clients’ fixed income portfolios through all market environments so that you can stay focused on your long-term financial goals.

[1] US Consumer Price Index – Urban Consumers Less Food & Energy.

[2] US Recession Probability Forecast – monthly & quarterly surveys conducted by Bloomberg and from forecasts submitted by various banks.

[3] Measured using the Bloomberg US Aggregate Bond Index.

[4] Measured using the internal rate of return on all fixed income securities by account.

DISCLOSURES

Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. The information and opinions expressed in this publication are not intended to constitute a recommendation to buy or sell any security or to offer advisory services by Kovitz. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to participate in any trading strategy, and should not be relied on for accounting, tax, or legal advice. This report should only be considered as a tool in any investment decision matrix and should not be used by itself to make investment decisions.

Kovitz Investment Group Partners, LLC (“Kovitz”) claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Kovitz has been independently verified by The Spaulding Group for the periods January 1, 1997 through December 31, 2022. The verification report(s) is/are available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report. GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete, and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicate of future results, which may vary.