Review & Outlook
April 10, 2024
In our firm’s experience over the past 38 years, Quality Growth stocks have been rewarded for their steady cash flows, predictable returns and serviceable debt loads across a variety of sectors and themes. While our investment results have never exactly correlated perfectly with markets in the short term, we are encouraged to know that our longer-term results have not left clients behind. The S&P 500 Index gained just over 10% during the first quarter while Carderock stocks were not far behind at 8%. For sure, a much stronger start of the year than anticipated.
Continuing the theme from 2023, momentum in Artificial Intelligence (AI) companies have been the dominant beneficiaries within the S&P 500 Index. In looking back over the past 15 months, investors have been hyper fixated on AI’s potential to reshape the US economy – projecting changes in consumption, goods, services and labor. We do agree with the consensus that AI is in its beginning stage and the prospects look promising, but as for investing, it is too unproven and narrow in scope.
The current environment reminds us of the late 1990s when the Technology sector received all the attention with the anticipation of future profits and growth of the Internet. But as we all found out, it took years for winners and losers to be evident. Today, we find ourselves in a similar cycle, but our view is that the associated risks in AI stocks are too high relative to the expected returns. In time, these companies will start to differentiate themselves as the cycle matures producing sustainable sales AND profitability that will clear the path for making investment decisions based on sound fundamentals rather than on just “hype.”
For the remainder of the year, we see the following factors driving our investment process:
- Inflation remains stubborn, limiting the Federal Reserve’s ability to cut rates.
- Manufacturing activity continues its upward trend, increasing the attractiveness of Industrial and Cyclical sectors.
- Valuations in Stocks remain lofty but will not deter us from investing in Quality Growth stocks with excellent long-term growth prospects.
- Speculative activity and IPO issuance has been muted by high interest rates, freeing up Capital toward more productive investments.
- Labor markets, GDP and earnings growth remain strong, making a recession increasingly unlikely.
Furthermore, our recent and expected activity can be summarized as follows:
- Cash reserve targets currently stand at 10%, a multi-year low that reflects our improved outlook on Stocks.
- Buying activity has marginally exceeded selling over the past year as we rotate into new issues with better growth prospects, which we expect to continue.
- We will continue to buy Treasury bills for equity cash reserves, as short-term rates remain attractive.
- Interest rate spreads on high quality bonds between short and long-term maturities should continue to narrow, and we expect to lengthen our maturity schedule over the coming months as short-term rates slowly come down.
While it’s been a great start to the year, we think the current underlying trends are closer to their beginning rather than in its final stages. Of course, there will be “bumps” along the way, but we expect these to be short in duration and shallow in magnitude. As always, feel free to call us or review your investment progress with any questions you may have.
Warmest Regards,
Daniel A. Kane, CFA
President
Stephen F. Knapp, CFA
Portfolio Manager and Director of Research
