Boyar Value Group's 1st-Quarter Letter: A Look Back

The Momentum Continues

Although a strong start to the year is generally a bullish signal, investors should curb their enthusiasm for spectacular gains for the rest of 2024: in 10 of those 15 years, the 1Q gains eclipsed those of the remaining 3 quarters combined.

AI Mania and Signs of Froth

Investors continued their love affair with all things AI, sending Nvidia (NVDA, Financial) up 80% during 1Q 2024 (adding more than $1 trillion in market value to a market capitalization that now eclipses both Amazon's (AMZN, Financial) and Alphabet's (GOOG, Financial))—and this after 2023's standout performance, when shares more than tripled in value. Nvidia is now the biggest holding in individual investors' portfolios, at ~9% (surpassing Tesla (TSLA, Financial), previously the most popular stock), according to data from VandaTrack. Other stocks that investors believe will benefit from AI are drawing similar attention: Super Micro Computer Inc (SMCI, Financial), and MicroStrategy (MSTR, Financial), for example, advanced by 255% and 170%, respectively.

Signs of speculation in the financial markets abound (and make us somewhat nervous), with Bitcoin having advanced ~61% for the quarter after various Bitcoin ETFs were made available to the public. Similarly, the Donald Trump-controlled Truth Social (DJT, Financial) sported a market cap of ~$8 billion at the end of the quarter (despite having posted tens of millions of dollars in losses since 2021 and having generated a paltry ~$4 million—not a typo—in sales in 2023) before falling ~44% thus far in April. Similarly, social media company Reddit, which has never posted a full-year profit since its founding in 2005, advanced 48% on its first day of trading as a public company and is valued at ~$7 billion.

Interest Rates

These spectacular gains occurred even after two hotter-than-expected inflation reports (and continued economic momentum) reduced investor expectations to just two or three rate cuts in 2024 (down from ~6 interest rate cuts that were expected before the year began)—a stark contrast to the equity rally of Q4 2023, which was fueled in part by expectations that the Federal Reserve would soon pivot and begin to decrease rates. Although it is worth noting that a stronger than anticipated inflation report released on April 10^th sent the major indices down sharply (due in part to worries that Fed rate cuts may be delayed longer than anticipated).

In response to elevated—and not-so-transient—inflation, the Federal Reserve started hiking rates aggressively in March 2022, with 11 hikes ranging from 25 bps to 75 bps each, bringing the Fed funds rate from near zero to 5.25%-5.5% in less than 1½ years—the fastest rate hiking cycle since the 1980s. During this time, the 10-year yield surged from under 2.5% to, briefly, more than 5.0% last October. Since then, however, it has undergone a sudden retracement as the Fed has paused hiking interest rates, with interest rate cuts now expected sometime in 2024 (although the talking heads on Wall Street hotly debate both their amount and their timing). While CPI inflation has cooled from a peak of 9.1% in June 2022, it has remained stuck in a 3.0%-4.0% range over the last 12 months (with hotter-than-expected rates throughout Q1 2024), stubbornly higher than the Fed's 2.0% target.

Impact on Stock Market Investing

What does the current interest rate environment mean for equity investors? According to JP Morgan, since 1979 there have been 71 months when 10-year Treasuries were 4%-5% (currently ~4.5%). During those times, value stocks' annualized total return was 11.2%, versus 9.4% for growth shares. During the 60 months when the U.S. 10-year was in the 3%-4% range, value stocks' annualized total return was 5.7%, versus 6.3% for growth stocks.

Mild-to-moderate levels of inflation are normal and, in fact, can be a symptom of economic prosperity. Inflation can even be beneficial to companies in commodity-related industries (i.e. food, energy, miners, steelmakers, chemical producers), which are more commonly associated with value than growth, and who are likely able to assert pricing power. Despite an uneven effect across economic sectors, the impact on broader stock market valuations is clear: elevated levels of inflation (exacerbated by accompanying rising interest rates during such periods) generally correlate with lower P/E multiples.

Interest rates' effect on value versus growth stocks makes sense: investors' willingness to pay higher valuations for growth stocks partly depends on the present value of future cash flows, which are more significantly discounted against higher-interest-rate backdrops. Furthermore, financial companies (such as banks and insurers), which make up a meaningful percentage of the “value” indices, have historically performed better in times of higher inflation, which are usually also times of higher interest rates.

We don't know when the Fed will start cutting interest rates, but we don't expect a return of the ultra-low rates we saw after the Great Financial Crisis and during the COVID-19 pandemic. Most Fed officials believe that short-term rates will likely close out 2024 in the 4.5%-5.0% range, and only one of them sees the Fed funds rate going below 2.5% over the longer run. Meanwhile, the normalization of 10-year yields above 3% (currently ~4.5% as of April 11th), in combination with elevated growth stock valuations, seems to suggest that—unlike the long period when growth outperformed value between the Great Financial Crisis and the COVID-19 pandemic, while rates were historically low—value shares may be primed for a durable resurgence.

Whether the Fed reduces interest rates three times this year or only once (or not at all, as some are starting to suggest), investors should view current interest rates in their proper historical perspective. At 4.2% and 0.44% (as of March 31^st2024), respectively, nominal and real yields are still low, historically speaking. The economy can function—and has repeatedly functioned—with rates at these (and even higher) levels. If they seem high, they are only high relative to recent history.

Reasons for Caution

As contrarians, we are given pause by the results of the latest Bank of America (BAC, Financial) fund manager survey, with two-thirds of respondents not expecting a recession during the next 12 months. At the start of 2023, right before the S&P 500 began a 39% bull run (through 1Q 2024), that figure was a little over 10%. What's more, that same survey, for the first time in over 2 years, showed that the majority of investors expect corporate profits to increase over the medium term according to The Financial Times, despite the currently elevated corporate profit margins by historical standards.

1Q 2024 brought a smooth advance with no meaningful pullbacks, but investors should remember that markets generally do not advance in a straight line. According to JP Morgan, since 1980 the S&P 500 has seen an average intra-year drop of 14.2%. With the biggest decline this year a trifling 2%, it would not be unusual for the market to suffer a fairly significant pullback at some point during the year—and in fact it would be perfectly normal.

The U.S. economy is in much better shape than most would have expected after such a rapid jump in interest rates, but we're keeping a lookout for any early signs of trouble. The household debt service ratio (the percentage of after-tax income used to make payments on mortgages and other consumer debt) is starting to creep up, and early delinquencies on auto and credit card loans are also increasing despite very favorable levels of employment. The numbers we're seeing so far aren't anything to be overly concerned about, but we're watching these indicators closely even so.

The State of the Market

Market Concentration and Sector Returns

As of March 31, 2024, the 10 largest stocks in the S&P 500, as measured by market capitalization, were selling for 28.4x earnings (fwd.), compared to an average of 20.3x since 1996. What's more, they currently sell at a multiple 35% higher than the overall market (and 40% more than the top 10 market capitalization names have historically sold for), and their weightings (at 33.5% of the S&P 500) are at multidecade highs. The stocks outside the top 10 aren't cheap, either, at 18.3x earnings (fwd.) against an average of 15.7x since 1996, but they currently sell at a 13% discount to the overall market.

It is not just the S&P 500 that is heavily concentrated. According to The Financial Times the 10 largest stocks in the MSCI World Index account for 21.7% of its total market capitalization (a multi-decade high) and US stocks comprise 71% of the index.

The market rally has started to broaden, however, giving some hope of a sustained advance. During the quarter, over half the stocks in the S&P 500 have notched 52-week highs, according to data from the Wall Street Journal. Even so, the Magnificent Seven still dramatically affected the overall index results (though admittedly not as much as in 2023). According to Howard Silverblatt, senior analyst at S&P Global Indices, these seven stocks were responsible for 37% of the S&P 500's 10.2% 1Q gain, compared with ~66% of the market's gain in 2023. We do note, however, that performance within the Magnificent Seven has started to diverge materially, with Nvidia, Meta (META, Financial) and Microsoft (MSFT, Financial) advancing 82.5%, 37.3%, and 12.1% during the quarter, respectively, with Apple (AAPL, Financial) and Tesla declining by 10.8% and 29.3%. (In fact, Silverblatt notes that Amazon, Meta, Microsoft, and Nvidia alone contributed 47% of the gains for the entire index).

Notably, 10 of the 11 S&P 500 sectors were positive for the quarter (with the sole decliner, real estate, losing 1.1%). Communication services was the best performer for 1Q 2023 (up 15.8%), followed by energy, which declined in 2023 but advanced by 13.7% to start the year; the third-best performer was technology, which advanced by 12.7%.

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