2024 is off to a fast-moving start. Many investors are confused about today’s market conditions, unsure of whether to focus on positive or negative indicators or both.1 For even the most experienced among us, there is a lot to unpack right now. This month, we’re taking a look at the strong momentum of the 2024 M&A market, the power and impact of Nvidia and AI overall, as well as America’s ongoing battle with inflation.
2024 M&A market revival
The Mergers and Acquisition (“M&A”) market has had a strong start in 2024. According to Bloomberg, year to date, as of February 20th, the total value of announced deals reached $425 billion, a 55% jump from 2023 at this point of the year. The breadth of the market is also quite healthy – deals are not only happening in the popular areas like technology and health care sectors but also across a wide variety of sectors and industries. The largest deal announced so far this year is a $35 billion merger between Capital One and Discover in the financial sector, a highly regulated industry that has historically not seen many large deals.2
Despite the strong performance of the stock market, 2023 was a slow year for M&A activity, with total deal value below $3 trillion for the first time in a decade. One reason was due to the concentration of stock market gains. For the most-watched S&P 500 Index, most of the index gains in 2023 was driven by the Magnificent Seven stocks. The other reason was that most of the gains took place in 4Q/2023. For example, the equal-weighted S&P 500 Index returned 11.9% in 4Q/2023 and 13.8% in 2023, respectively. As a result, for most companies, the stock market bull market has suddenly arrived and they are beginning to look into the M&A market for further opportunities. This strong momentum of the 2024 M&A market is likely to continue. In addition to the pent-up demand mentioned above, companies have plenty of “dry powder” to do deals. According to Morgan Stanley, public companies currently have around $5.6 trillion in cash and private equities have another $2.5 trillion. Moreover, despite some delay, the Fed is still on its path to start cutting its policy interest rates later in the year.3
By: Frank Wei, CFA, CAIA Senior Investment Analyst - Alternatives Research
Meteoric rise for Nvidia and its impact on active management
The stock price of AI-chipmaker, Nvidia (NVDA), has experienced a meteoric rise over the past 18 months, which has created an uphill battle for active large cap growth managers. Nvidia was one of the key drivers behind the stock market’s sizeable gains of the past year. In 2023, NVDA gained 239% helping to push the Magnificent Seven to a gain of 107%, and the Russell 1000 Growth Index to a 42.7% return. The company’s Wall Street success has carried into 2024, behind a blowout quarterly earnings report in February, making it the one of the most enviable stock holdings.
Financial results from Nvidia continue to impress and the stock has grown into its valuation. In the most recent quarter, Nvidia reported revenue of $22.1 billion, easily surpassing the average analyst estimate of $20.62 billion, and a 265% increase from revenue one year prior. Driving the strong sales was the continued surge of specialized chips, which are key components that help power artificial intelligence within AI chatbots, such as ChatGPT and Google’s Gemini. Nvidia responded by surging 16% on the day, or a gain of $277 billion in market capitalization, a record one-day increase. In the days following earnings, the company eclipsed the $2 trillion market cap level, up from $280 billion back in October 2022, and is now ranked as the third largest company in the world. For the Nvidia skeptics, concerns are geared towards the company’s ability to sustain this high earnings growth in the future. While Nvidia continues to enjoy a dominant market share in the higher computing power GPU market, higher earnings growth may get arbitraged away if competition increases.456
The speed and size of the company’s historic growth has created challenges for active managers. The decision to hold the stock, or whether to enter now if they have missed the run, is a hefty decision to make and one that can’t be ignored as Nvidia now comprises such a large share of their benchmark. Nvidia, Apple, and Microsoft now comprise roughly 30% of the Russell 1000 Growth Index, and the full roster of the Magnificent Seven is now roughly 50% of the index. Active managers often have limits on exposure to individual stocks and seek to position their active approach as being distinct from the benchmark. However, the lack of exposure has been challenging and has weighed down significantly on relative performance. In 2023, roughly 70% of active large-cap growth managers trailed the performance of the Russell 1000 Growth Index. Thus far in 2024, Nvidia is off to the races again, with the stock up over 80% YTD through early March, and active managers are battling to keep up.
By: Tim Murphy, Vice President, Senior Portfolio Manager
Ongoing battle with inflation
Most recent data report an inflation rate of 3.1% for January, down from 3.4% from the previous month. While the reduction is encouraging, it was not as large as expected and suggests that the war on inflation may not be over. This matters as current restrictive monetary policy by the Federal Reserve Bank was largely expected to ease this year. However, should inflation prove sticky, market participants may see prolonged monetary tightness.
While inflation has come down over the past month, it remains above the Fed’s 2% target and is not falling as quickly as expected, with January’s inflation forecasted to be 2.9%. When digging into the January data, prices for gasoline, clothing, and used vehicles all experienced notable price drops, while prices for services are seeing steady increases. The economics of service pricing is closely linked to local conditions such as wage rates and spending, both of which are constantly above pre-pandemic levels.7
Restaurant and grocery costs have also been increasing, with prices at eateries up 5.1% in January when compared with 2023, and grocery bills also increasing 1.2% over the same period. When looking at food expenditures as a percent of disposable income, Americans spent 11.3% in 2023, the highest level since 1991. This is unlikely to change any time soon, as restaurants and grocery stores deal with a tight labor market, and shortages of food goods.8
While the recent inflation number represents just one month of data, many are concerned that further reduction of inflation may be more difficult than expected. In fact, market participants have already adjusted expectations, and are now forecasting rate cuts to begin in June, as opposed to May.9 Recent comments by Chair Jerome Powell convey the Fed’s belief that interest rate cuts later this year are still appropriate, provided evidence of further slowing inflation.10
While there is much uncertainty about future levels of inflation, what’s certain is that the Fed’s war on inflation is not yet over. With the effects of high inflation still fresh in the memory of Americans, the inflation rate and the Fed’s response will be a closely watched as any further drift from the expected outcome is likely to have large ramifications for the markets and economy.
By: Scott Keller, Portfolio Manager
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