iShares April Road Report: top advisor questions of the month

The U.S. economy might be skipping the April showers. With robust underlying macro data, fits of inflation that seem contained, and a confident Fed, markets continue to push higher. What gives?

Our team spent the month working out our Q2 investment views, now published in our Spring Investment Directions. We address a few of the nagging questions below (as well as give an idea of where to consider investing). Feel free to reach out to the team for a deep dive and more charts than you’d like. In the meantime, here are the top 3 questions we’ve received:

Since October 2023, the top 10 largest companies in the S&P 500 returned, on average, 43% versus about half that for the remaining 490 firms.¹ These companies account for 33% of market capitalization and over a quarter of this past quarter’s earnings.² Although we’ve seen recent divergence in top names, the same names, sectors, styles, and sizes seem to have often come out on top.

Despite this, today’s top 10 stocks trade at lower valuations, and boast higher profit margins and ROE’s, when compared to past “bubbles”.³ This is reinforced by data showing that since the start of the year, performance has been driven by earnings growth, rather than valuation expansion.⁴

We believe the concentration has more to do with tight monetary policy weighing on the rest of the market – with the few stand out performers already the biggest and the best the S&P has to offer and delivering the earnings growth to earn their place. In other words, quality remains the name of the game.

We believe inflation should continue to decline, but as Chair Powell has noted, the rate of decline will be ‘bumpy’ rather than a smooth glide back to the 2% target. While core inflation continues to trend lower over the longer term, the Fed has expressed caution given the near-term upswing in 3-month annualized core CPI to over 4%.⁵ Similarly, growth has remained persistently above the longer-run ‘neutral’ pace expected by FOMC members.⁶ Strong growth is of course a good thing, but growing at a pace above the neutral pace eliminates slack in the economy. That in turn makes it that much more difficult for the Fed to bring down the pace of inflation.

While there is a small risk that inflation reaccelerates, that seems to be an outside scenario. Instead, the risk appears to that inflation’s zigs and zags delay the start of the Fed’s campaign to normalize policy rates. The median FOMC member currently believes that the Fed will cut rates 3 times this year, but inflation is not expected to reach its 2% target until 2026.⁷

As the Japanese economy emerges from its three-decade battle against deflation and economic stagnation, many investors have been prompted to look again at the country’s weight within their portfolio. But after a 30% runup since January 2023, investors are wondering if they’ve missed out on the trade.⁸

We see three reasons Japanese equities may continue to outperform their developed market peers:

• Central bank officials will be reluctant to declare victory on embedding inflation. Despite exiting their ultra-accommodative monetary policy, policy normalization (relative to its peers) for the island state is still far from reality. In other words, accommodative monetary policy will likely remain in place.
• Japanese equity multiples are not necessarily expensive relative to their own history or even relative to U.S. equities.⁹ Structural and company-level reforms are encouraging businesses to focus on capex and earnings growth – music to the ears of investors.
• Foreign investment flows to Japan have been robust, but there still may be more money to come. Domestic investment has historically been light – whether that be from households or corporates. If the country can tap into that wealth to fund further investment, it may create a generous cycle that we’re just at beginning of.