Investment Commentary – October 7, 2024

Market Summary

Last week, stocks were mixed, and bonds were down (price down/yield up). The MSCI Emerging Markets index outperformed the S&P 500 and the MSCI EAFE non-US developed index. As for fixed income, the 10 year treasury yield rose 23 bps on the week to 3.98%, and the 2yr – 10yr treasury yield spread flattened to +5 bps. High yield bond spreads were down on the week to 284 bps, still well below their 20-year average of roughly 500 bps. To the extent, the Fed accelerates the economy, raising inflation expectations, that would be a headwind for the “risk on” market narrative. In other words, a prolonged environment of higher borrowing costs may push more borrowers, including small cap companies, into weaker financial situations. The Fed began cutting borrowing costs to keep the job market from weakening too drastically. The idea was to prevent a hard landing of the economy and to get on a glide path toward stability. And after so many quarters of worrying about inflation, the central bank believed the risks had shifted more firmly toward the job market.

What caught our attention

• Higher in Chinese stocks.
• Geopolitical risk pushes up oil prices.
• The U.S. economy continues to power ahead.
• Fundamental insights and guidance from the S&P500 Q3 Earnings Season.

Last week, the MSCI China Index gained 11.5%. China makes up nearly 28% of the MSCI emerging market index, and with the China rally, emerging markets have gone from the laggard of global equities to nearly the leader (only behind the S&P 500). The Investment Office will be monitoring property sales as some early indicator of the policy effectiveness or the wealth effect from the equity rally. In addition, the announced measures are largely supply-side monetary measures. The Investment Office will be waiting for more substantive fiscal demand-side measures to jump start consumption. In the past week, the macro environment was not typically very favorable for emerging markets with higher treasury yields, stronger U.S. dollar, and weaker global manufacturing activity. To put this in perspective, the emerging markets index was up nearly 2.5% last week, while the emerging markets ex-China was down 1.5%. Geopolitical risk rose the week based on further developments in the Middle East conflict. Oil prices were up 7%, as was the S&P 500 energy sector. U.S. high yield spreads ended the week at even lower levels and stocks rallied back near alltime highs. There is potential for further geopolitical risk, which could cause more upside for energy and oil. Value stocks tend to have more energy exposure. After the energy sector has been the worst performer over the last year, it may become a positive contributor to value stocks going forward. The U.S. jobs data reported last week was strong. The JOLTS report comes in above expectations, with more normalization of the labor market (lower quit rate). The ADP report came in above expectations and then the NFP jobs report massively beat expectations. The unemployment rate fell to 4.1%. The bond market has removed all probability of a 0.50% rate cut at the November meeting and is now placing a 97% probability of one 0.25% cut, and then placing an 80% probability of another 0.25% cut in December. The bond market and the Fed are now in synch. With that said, we have another big inflation report (CPI) coming out this week, and we will see what the bond market prices-in based on incoming data. Finally, earnings season is set to kick-off this week, with Friday’s financials (tickers: JPM, WFC, BLK) potentially setting the tone for what to expect with the Q3 reports. The Investment Office will be monitoring company guidance to determine if the Fed is right in its assessment that the economy is losing momentum. However, the full picture won’t come into focus until later in October.