Quarterly Insights: October 2024
The U.S. economy and capital markets performed well in the third quarter of 2024. It’s hard to predict whether this strength will continue as we face a mixed bag of signals. No matter the environment, our focus on high-quality investments both provides protection during turmoil and participation in the market’s growth.
The domestic economy is still growing (supported by strong consumer spending), inflation has been tamed for now, and central bank policy has reached an important turning point. With inflation approaching the Federal Reserve’s 2% target, the Fed cut rates by 50 basis points at its September meeting. Now that inflation has moderated, the Fed’s attention has shifted heavily to the labor market. September’s jobs report was strong, with employers adding 254,000 jobs. This was much more robust job growth than the 150,000 jobs economists expected, and the largest monthly increase since March. Any softening jobs data in the coming months could be reflective of normalization – which is perfectly healthy as every strong economy must eventually reallocate its resources – rather than imminent recession.
While GDP growth and jobs data look good, economic signals for consumers – whose spending drives the bulk of economic activity – are weakening. Both the rich and the poor are scaling back spending; the high-end art market is collapsing, and families are dining out less. Further, the personal savings rate declined in July, while credit balances and loan delinquencies are up. The University of Michigan’s survey of consumers indicates consumer sentiment is low, especially compared to the strength of the economy. This is unsurprising as the cost of living remains high for many Americans.
Looking abroad, China poses an elevated risk to the global economy. China’s economic expansion has been a story of state-fueled spending. However, China’s population has peaked, and a housing glut is coinciding with a fast-aging population. How long can that persist? As a key consumer as well as a key supplier to the world, it will be a twofold blow if China stops importing foreign goods as they continue selling exports at or below cost. Given these significant risks, combined with suppressed manufacturing activity in Europe, we question whether slow global growth will be the new normal. If yes, portfolio returns may be constrained.
The U.S. stock market rally continued in the third quarter. However, we are cautious of turbulence ahead. The five big tech companies are budgeting $500 billion this year for capital expenditures, mostly tied to artificial intelligence (AI). These companies are investing indiscriminately in AI, with some business leaders acknowledging their decision-making is based more on FOMO (fear of missing out) than on solid capital allocation plans. The social and business impacts of this powerful technology are just beginning to unfold, and the market is starting to question whether these outsized investments will pay off. If the AI narrative loses steam, the market will punish these technology stocks. We prefer portfolio exposure to AI in less obvious ways that are generally not as expensive.
While interest rates have declined with the Fed’s September rate cut, short-term bonds still earn more than 4.0%. These rates are attractive, and we continue to buy U.S. Treasuries and government agencies with a focus on quality and liquidity. We believe there is no need to get greedy and reach too far for income given that credit spreads are tight. That is, savers are not being adequately compensated for lending to riskier areas of fixed income like high-yield corporate bonds.
Finally, with November’s Presidential election fast approaching, we should remind ourselves that elections don’t matter nearly as much to market performance as one would expect. While markets can be volatile around elections, data going back to 1926 shows a long-term trend of growth in the stock market, no matter who sits in the Oval Office. However, the election introduces uncertainty around tax policy. With key provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 set to expire at the end of 2025, now may be a good time to take profits from the stock portion of your portfolio (while taxes are relatively low) and allocate those proceeds to fixed income. This move has three key benefits: taking advantage of current tax law, locking in relatively high fixed income rates, and having more liquid funds ready to deploy for investment opportunities in the case of a market dip or economic recession.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.
