Investment Commentary – November 18, 2024

Market Observations

Economic data continues to show signs of resilience, and inflation remains on a moderating path, providing room for further easing over time. U.S. data is holding up, confirming soft landing as inflation, while “sticky” appears to be in the range of the Fed target. European growth remains modest where manufacturing lags, especially in Germany, which is at the risk of a recession. Chinese stimulus is expected to continue to help support growth in the face of increased tariff wars. However, the stimulus so far has been modest. The path of Fed cutting largely depends on incoming data where the pace and magnitude of cuts are more uncertain. The European Central Bank looks to advance easing as inflation data provides support. Key risks to global markets include elevated geopolitical tensions, central bank policy missteps, the path of Chinese growth, and US policy decisions, which may aggravate the deficit, inflation expectations, and interest rates. The Investment Office continues to watch market-related inflation indicators, such as oil prices, to monitor if the macro backdrop is suggesting a greater re-flationary force. Over the last week, oil prices fell again and are now sitting at the lowest level in nearly 8 months; any lower, and we start reaching 2021 levels (not an inflationary signal). On the economic data front, it is hard to complain about the strength of the U.S. economy. Initial jobless claims fell to a six-month low, suggesting not a lot of weakness in the labor market. We continue to use initial jobless claims as an indicator of “real-time” recession indicator, and it continues to indicate a resilient labor market that provides support for consumer spending. Recent retail sales beat overall expectations, but much of it was driven by autos and building materials in a bounce back from the hurricanes. Then, the empire manufacturing index surged to a three-year high. According to the Atlanta Fed GDPNow, the Q4 GDP estimate is for 2.5% growth. The next couple months will be critical for the U.S. economy going into the all-important holiday shopping season.

Equities

The S&P 500 returned -2.0% for the week as the breakneck rally in stocks ran out of steam amid a rise in treasury yields and the dollar hitting its highest level in two years. After sizable post-election gains, small-cap stocks lost ground as well. Financials (+1.4%), energy (+0.9%), and utilities (+0.2%) were the only sectors in the S&P 500 to eke out gains; healthcare (-5.5%) and technology (-3.2%) were the key laggards. EAFE markets returned -2.6%, with Japan (-2.8%) and Europe (-2.6%) both dragging on returns. EM markets returned -4.4% with both Korea (-6.5%) and China (-6.1%) hit hard. From a valuation perspective, most markets are within ±1 standard deviation based on historical forward P/E ratios, though the S&P 500 is at +2.2 and the NASDAQ is at +1.3. For the next 12 months, EPS growth for the S&P 500 is expected to be 7.4% (vs. 6.8% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 12.4% (vs. 12.2% annualized over the last 20 years). All major world indices, including the S&P 500 (US Large Cap), NASDAQ, Russell Midcap (US Midcap), Russell 2000 (US Small Cap), MSCI EAFE (Non-US Developed Market Equities), and MSCI EM (EM Equities) trade at or above their 20-year averages based on forward P/E ratios.

Fixed Income

Investment grade fixed income sectors posted mixed returns as rates across the curve. Municipals returned 0.2%, US AGG returned -0.8% and US IG returned -1.1%. HY bonds returned -0.4%, while bank loans returned 0.2%. EM debt returned -0.5% as the US dollar rose 1.6%.

Rates

Rates rose across the curve as Chair Powell suggested that the Fed can be “patient” with further rate cuts, remarks that were interpreted to be hawkish by the markets. The recession-watch 3M-10Y spread compressed 17bps and closed the week at -17. The 2Y-10Y spread widened 8bps to +13. Rates were mixed in other developed markets, falling slightly in Europe while rising slightly in the U.K. and Japan. The BTP-Bund spread is at 1.20%. 5-year breakeven inflation expectations fell 2bps and now sit at 2.40% (peak on Nov 6 of 2.44% vs. low of 1.88% on Sept 10); 10-year breakeven inflation expectations fell 2bps and now sit at 2.34% (peak on Nov 6 of 2.40% vs. recent low of 2.03% on Sept 10); and 2.36% respectively; the 10Y real yield rose 16bps to 2.11%. The market now expects the Fed to cut once more in 2024 and two times in 2025 vs the Fed’s guidance of four cuts in 2025. At year-end 2025, the market expects the Fed Funds rate to be 3.8% vs. the Fed’s guidance of 3.25%-3.5%.

Currencies/Commodities

The dollar rose 1.4% to its highest level in two years. The commodities complex fell 2.3% as energy prices fell 3.0% for the week. Brent prices fell to $71/bbl. US natural gas prices rose 5.8% while European gas rose 7.5%, both on expectations of cooler weather.

Market monitors

Volatility rose for equities and bonds (VIX = 16, MOVE = 102); the 10-year average for each is VIX=18, MOVE = 78. Market sentiment (at midweek) rose slightly to 22 from 14 and remains optimistic post elections.