MAP Views Fourth Quarter 2024
Oct 01, 2024During the third quarter, the biggest question on investors' minds was whether the Federal Reserve (the Fed) would cut 25 or 50 basis points at their September meeting. With one dissenting vote, the Fed surprisingly cut rates by 50 basis points, marking the first split vote since 2005. Fed Governor Bowman advocated for a 25 basis point cut, indicating that despite progress on inflation, it still remained a concern. The fact that the Fed cut rates so close to a Presidential election was historic. Never before has the Fed changed the direction of interest rates after Memorial Day in the year of a Presidential election. Prior to cutting by 50 basis points about a month and a half before November 5, 2024, as seen below, the Fed held rates at their peak for the longest cycle in history.
We view this cut as too much, too soon, given what we believe to be a more balanced job market than economists have stated and an inflation battle that has not been won.
The Fed's decision to reduce interest rates by 50 basis points serves to solidify our belief that inflation will remain "sticky" for longer. Inflation rates declined sharply from the June 2022 peak of 9% to June 2023 of 3.05%. At this time, many investors and economists were forecasting a continued descent to the Fed’s target rate of 2%. Instead, inflation levels picked up in the back half of 2023 before trending lower over the past few months. In short, from June 2023 to July 2024 (13 months), inflation fell a minuscule 0.07 percent, while the drop in the August CPI was almost entirely due to a 4 percent decline in energy.1 In our opinion, this reflects the difficulties of driving down inflation to that 2% target.
Everyone knows that commodity prices go up and down, but wages do not. Despite a slightly softer job market, wages have grown 3.8% since August 2023.2 Corporate America experienced a lot of labor unrest last year, pushing wages higher – a trend that has continued in 2024. Currently, machinists at Boeing are on strike after asking for a 40% pay increase, and Boeing countered with a proposed 30% increase over the four-year life of the contract. Port workers on the East and Gulf coasts also appear to be headed to the picket lines, as contract negotiations have not progressed much. It is hard to envision a scenario where wages climb at nearly 4% annually and inflation falls to 2%.
With that said, we do believe, over time, Artificial Intelligence will help companies reduce their headcount and therefore, increase efficiency. There are signs that this has already impacted certain sectors, such as software development, information design, and documentation. Based on job postings by Indeed.com, job listings in these sectors have been halved since the rollout of ChatGPT in Q4 of 2022. Overall, the job market and broader economy remain reasonably strong. Economic activity has softened slightly from last year but remember that last year's growth was unexpected and unusually strong. As of quarter end, the Atlanta Fed GDPNow forecast calls for Q3 GDP growth of 3.1%, up from a revised 3% in the second quarter. A recent survey of Americans indicated that one out of five plans to travel abroad over the next twelve months. You would not expect to see this trend if we were on the edge of an economic collapse.
At some juncture, inflation will return to 2% or lower, likely the result of a recession. However, aided by strong government spending, the economy has been chugging along. While we acknowledge the lower income cohort (those not considered middle class or above) is under pressure; we note that the top 20% of U.S. consumers spend the same amount as the bottom 60%.3 With the net worth of the top quartile at historic highs, we believe a recession is not imminent. For more economic insights, please see our August 15, 2024, thought piece: "A Murder Mystery: What Kills the Economy?“
Next month marks the long-awaited U.S. elections. The polls indicate that there will be another remarkably close Presidential election. Will we have a decision on election night, or will this election end up in the courts? Historically, financial markets tend to perform the best when there is a division of power between the executive and legislative branches of government. Markets prefer gridlock in Washington, and a division of power increases the likelihood of gridlock.4 Therefore, keep a close eye on the Congressional races, not just on who becomes President, as we believe that will dictate the response from the broader markets. We caution against making dramatic portfolio changes based on the political winds. Sometimes, things are not as clear-cut as they would appear. Energy stocks are a prime example. The sector performed better under President Biden than under President Trump, which was contrary to the conventional thinking at the time of the election. One last thought on the election…historically, markets have moved higher regardless of the party in power. As we have noted recently, markets are neither red nor blue, but green (not as in energy, but dollars).
From a valuation perspective, we do not view the broader markets as “cheap,” especially considering that they are higher today than when the Fed first began raising interest rates in March 2022. This means the equity risk premium (the extra return that investors demand over and above the risk-free rate to compensate for the risks equities have over risk-free assets), is elevated. In fact, as evidenced by the chart below, more than half of the S&P 500’s returns to date have been driven by higher valuations. With the Fed having just begun a rate-cutting cycle, this is likely to provide a bit of a tailwind for stocks in the shorter term as rate cuts during non-recessionary environments have historically led to strong S&P 500 returns over the next two years. Geopolitical risks remain a significant concern, as the geopolitical environment is more hostile than ever in recent memory. We have structured our portfolios to take advantage of opportunities while attempting to mitigate some of the risks we see. While this may hold back performance when markets are off to the races, we believe this positioning will provide smoother sailing during turbulent times. Our goal is to deliver superior risk-adjusted returns over a complete market cycle.
We work diligently every day to earn the trust you place in us. Please get in touch with your MAP representative with any questions or concerns. It is hard to believe the year's final quarter is already upon us! Stay well!
Managed Asset Portfolios Investment Team
Michael Dzialo, Karen Culver, Peter Swan, Zachary Fellows, John Dalton, and Nicolas Vilotti
October 2024
1Bloomberg: CPI All Items Less Energy
2https://fred.stlouisfed.org/series/CES0500000003
3https://think.ing.com/articles/getting-some-answers-from-the-us-consumer-puzzle/#:~:text=The%20top%2020%25%20of%20households,a%20low%20fixed%2Drate%20mortgage. 4https://www.fidelity.com/learning-center/trading-investing/election-market-impact
Certain statements made by us may be forward-looking statements and projections which describe our strategies, goals, outlook, expectations, or projections. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. The information contained herein represents our views as of the aforementioned date and does not represent are commendation by us to buy or sell this security or any other financial instrument associated with it. Managed Asset Portfolios, our clients and our employees may buy, sell or hold any or all of the securities mentioned. We are not obligated to provide an update if any of the figures or views presented change.
