Investment Commentary – October 21, 2024

Overview

Everyone's talking about the Fed, the election, and geopolitics. However, we believe fundamentals matter. The US Federal Open Market Committee cut the policy interest rate in September amid slowing inflation and a cooling labor market. We believe that lowering rates will help sustain the economy, corporate earnings, and the stock market. The yield on the 10-year US Treasury note is hovering around 4.15%, the highest since late July 2024. We believe this is in part due to two primary reasons. First, the economy continues to defy expectations- -nominal GDP grew 5% in 1H24 and is on track for a similar level for Q3-- and solid productivity gains and ample investment should benefit future growth. Second, we believe investors are increasingly worried about the path of the US deficit and pending supply of Treasury debt regardless of which candidate wins the race for the White House. For a sustained risk rally and rotation into cyclical assets, investors need to believe the Fed is ahead of the curve and proactively exercising its “put”, thereby extending the economic expansion. The Fed did its part with the cut, and Chair Powell said "we don’t think we’re behind the curve ... and you can take this as a sign of our commitment not to get behind.” We are in the early stages of Q3 earnings season, and S&P 500 companies have thus far surprised to the upside in aggregate. While valuations remain elevated, the continued move higher in earnings presents a tailwind for equity markets. We remain overweight US vs. Non US, large/mid cap vs. small cap; underweight China vs. the MSCI EM benchmark and underweight the fixed income benchmark duration.

S&P 500 Q3 earnings season expectations

Overall, strong results. Results should confirm strong profit growth against a resilient macro backdrop. Broadening profit growth. While growth rates for the Mag 7 should remain healthy at around 20% year-over year, we also expect earnings growth to continue improving beyond that sector. Encouraging management guidance. We expect executives to strike a fairly positive tone—especially given easing bank lending standards, which tend to be a good leading indicator for profit growth. Banks issued almost unanimously strong guidance on their outlooks.

Equities

The S&P 500 returned 0.9% for the week and ended the week at a new all-time high on the back of a strong earnings season. Rate sensitive utilities (+3.4%), real estate (+3.0%) and financials (+2.4%) sectors were the best performing in the S&P 500; energy (-2.6%) and healthcare (-0.5%) were the laggards. EAFE markets returned -0.4%, with Japan (-1.0%) and Europe (-0.2%) dragging on returns. EM markets returned -0.4% as China, after some record-setting weeks, fell -2.8% amid continuing concerns that stimulus measures announced so far may not be enough to boost the economy. 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 +1.4. For the next 12 months, EPS growth for S&P 500 is expected to be 9.0% (vs. 7.2% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 14.5% (vs. 12.7% 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 were mildly positive as rates moved slightly lower across the curve. Municipals returned +0.2%, while US AGG returned +0.1% and US IG returned +0.1%. HY bonds returned +0.3% as the spread compressed 8bps, while bank loans returned 0.2%. EM debt returned 0.4% even as the US dollar rose 0.6%.

Rates

Rates fell slightly across the curve. The recession-watch 3M-10Y spread compressed 12ps and closed the week at -54. The 2Y-10Y spread compressed 10bps and is now +14. Rates fell in other developed economies as well. The BTP-Bund spread is at 1.18%. 5-year and 10-year breakeven inflation expectations fell and now sit at 2.24% and 2.31%, respectively; the 10Y real yield rose 1bp to 1.78%. The market now expects the Fed to cut between one and two times vs the Fed’s guidance of two cuts. At year-end 2024, the market expects the Fed Funds rate to be 4.4%.

Currencies/Commodities

The dollar rose 0.6%. The commodities complex fell 4.9% as energy prices fell 7.9% for the week. Brent prices fell to $73/bbl amid rumors that Israel does not intend to strike Iran’s oil production facilities. US natural gas prices fell 14.8% on warmer-than-expected weather and ramped-up production, while European gas fell 2.5%.

Market monitors

Volatility fell for equities but rose for bonds (VIX = 18, MOVE = 123); the 10-year average for each is VIX=18, MOVE = 78. Market sentiment (at midweek) fell from 28 to 20 but remains bullish.