Market Commentary - September 2024

Monthly Update

In September, the S&P 500 rallied for the 8th time in 9 months in 2024, with performance finally being driven by stocks outside of big-cap tech. Through most of the year, big cap tech, names you all know, dominated the earnings, stock and sentiment performance relative to most everything else. Beginning in mid-July, when the biggest tech stocks reported earnings, the market started to ask tough questions about whether all the spending on AI would deliver a respectable return on investment. Even with the main receiver of that spend, Nvidia and its high-end semiconductor chips, investors noted the slowdown in its growth rate, however still robust. On a positive note, for markets, investors expanded their investing imagination, and we saw a nice broadening in market breadth.

To highlight, the Russell 2000 index of small cap stocks rallied by 10% in July and has mostly held those gains by September month end where the tech heavy NASDAQ lagged that performance. Also catalyzing the shift in market attention was the bigger than expected interest rate cut on September 18^th by the Federal Reserve. Going into the meeting, I would have characterized the odds as a coin toss as to whether it would be a 25 or 50 basis point reduction in the fed funds rate. The decision to go 50 bps was the Fed’s way of front loading the beginning of the rate cutting process, but Jay Powell told us not to expect that cadence of cuts going forward and likely 25 basis point of cuts will come at each of the remaining two meetings this year with more to come priced in through next year[1].

As many small and medium-sized companies have floating rate debt, the drop in short term rates for those that have debt priced off SOFR (secured overnight financing rate) could provide some interest expense relief. Also, the chasm between growth and value had gotten so wide that some mean reversion was due and Q2 tech earnings was the beginning of it.

The rate cutting cycle is now global outside of Japan but measured and not uniform. The European Central Bank in September cut its deposit rate for a 2^nd time, but the Bank of England decided not to after doing so in the meeting before. The Bank of Canada cut rates for a 3^rd time in early September, but the Reserve Bank of Australia decided not to. The Bank of Japan, because they waited so long to respond to rising inflation in Japan, is looking as to when to next raise rates. At their September meeting they did nothing and likely won’t in October, but December is the time when they might raise again off the current level of just .25%. That said, the Bank of Japan is in the process of slowing the pace of Japanese Government Bonds asset purchases and that combined with quantitative tightening elsewhere, particularly in the US and Europe, global liquidity is slowing getting drained.

Notably, although the Federal Reserve cut the overnight fed funds rate, long-term interest rates have risen in response. As a result, the anticipated relief for homebuyers relying on mortgages tied to the U.S. 10-year yield may have already seen the benefits. As of this writing in early October, the US 10 yr yield is at 3.79% vs the 3.65% it stood at the day before the September FOMC meeting[2]. Mortgage rates have fallen to around 6.15% according to Freddie Mac from the 2023 peak of 7.90%. That is still double the 3% it was at in 2021 and with most having existing mortgage rates below 6%. For perspective, the 10-year yield is roughly where it was in the summer of 2023 before rising to 5% in October 2023 and then falling back down again[3].

I believe there is further upside risk to long-term rates if the Fed becomes too complacent in its fight against inflation. It's one thing for the inflation rate to drop, but another to keep it down. Also, the big news in September was out of China as they took a multitude of both fiscal and monetary steps in order to put a floor in their troubled residential real estate market and the down and out but cheap stock market.

The policy steps in China will take time to play out with respect to the housing market where over the past few years Chinese officials decided to pop the epic bubble. The aftermath of that popping though has been difficult with a slew of developer bankruptcies (which is needed in order to cleanse the system of its excessive overbuilding and debt) and a sharp fall in home prices where a large majority of Chinese households have savings tied up in them and are seeing a drop in their wealth as a result. Hopefully the moves put a floor under the drop in home prices. The steps to lift stock prices has had an immediate and substantial impact.

As of this writing and ahead of the Golden Week holiday which has closed their market, the Shanghai composite has rallied by 21% since the news began to roll out. I say ‘roll out’ because the steps announced came out over four days in a row[4]. The Hang Seng index has rallied by 23% and we continue to remain positive on some stocks there, as well as in the broad Asian region[5]. We’ll of course soon see if there is any sustainability to the rally there, but stocks got egregiously cheap prior to these policy moves with the Hang Seng only trading at around 8 times earnings and still inexpensive at 10 times after the spike in stock prices.

Tying this all together with still a robust pace of US government spending and a reminder that war is historically inflationary, and we are on watch to see if the inflation war can be won. The battle has been in that we’ve seen a decline in the pace of gains but sustainably keeping inflation low would be the true victory.

With respect to US government spending, for 40 years we all wondered when ever rising debts and deficits would finally matter and if so, how it would be reflected in the economy and markets. Well, with a budget deficit as a percent of GDP at around 6% in a non-recessionary, low unemployment economic backdrop, along with debt as a percent of GDP above 100%, maybe now it matters. I say ‘maybe’ because the record high price of gold is sending a signal about the world’s attitude towards the value of the reserve currency of the world, the US dollar. We remain positive of gold and its sister metal, silver.

Conclusion

Nothing is ever boring when it comes to world events and the market, and in September it was no different. As I’ve stated over the past few months in these letters, investing and market/economic forecasting is a humbling business and why we are always diligent when it comes to investing client money in terms of constantly gauging the risk and reward and taking a long-term time horizon perspective. That allows us to ignore much of the short-term noise and focus most on the bigger picture. I say this all because it now seems like we’re in an even more uncertain time with so many cross currents to juggle. The US election and the heightening geopolitical tensions further illustrate this.

We also acknowledge that we live in a different macro world than enjoyed in the 15 years pre-Covid and the resumption of easy money that took place to help economically get us out of the self-imposed shutdowns. While the Fed, and some other central banks, have embarked on a rate cutting process, we view this right now as more of a tweak in policy rather than a trip back to zero interest rate policy.

Whatever comes our way though in this very dynamic investing landscape, it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from the ups and downs of the market. Time horizon is always crucial and is always the best friend of any investor. We are not just in the asset management business but also in the risk management business and always believe that by watching our back and focusing on the risks, the upside should take care of itself.

Disclaimer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The market and economic data is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information in this report has been prepared from data believed to be reliable, but no representation is being made as to its accuracy and completeness.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Stoxx Europe 600 index also called the STOXX 600 is an indicator of the performance of the European stock market. It measures the performance of large mid and small-cap companies across 17 countries in Europe. The number of constituents is fixed at 600.

The Hang Seng Index is a freefloat-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong. These 82 constituent companies represent about 58% of the capitalization of the Hong Kong Stock Exchange.

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The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.

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[1] Bloomberg

[2] Bloomberg

[3] Bloomberg

[4] Bloomberg

[5] Bloomberg