What’s New

A lot can happen in a month. From an attempted assassination of former US President and the current frontrunner in the upcoming election, to the announcement that President Biden would not be seeking a second term, to a significant move in bond yields, to a large rotation in the equity market, investors had no shortage of information to digest in July.

On the political front, rather than making predictions, we focus on potential upside and downside risks in various scenarios. To that end, Donald Trump was the frontrunner coming into the month and he remains the frontrunner now, even after President Biden announced that he won’t be seeking re-election. A lot can happen between now and November, and we expect to see a tick-up in volatility as campaigns ramp up.

Returning to financial markets and the real economy, the most significant economic release in early July was the CPI print for the previous month. The print continued the recent trend that we’ve seen of moderate inflationary pressures following some upside surprises to start the year. July’s numbers solidified the market’s view that we will likely get our first rate cut in September 2024. This catalyzed a sharp move lower in Treasury yields, with the yield curve steepening fairly aggressively. It’s also noteworthy that the second quarter GDP surprised to the upside.

Treasuries were not the only asset class that moved sharply on the CPI release. The inflation print – coupled with the move lower in yields – sparked an aggressive rotation in equity markets. While headline indices moved only modestly on the month (the S&P 500 was up 1.13% and the Nasdaq Composite fell by .75%), these numbers hide a sharp rotation that we saw under the surface. The Russell 2000, an index more heavily geared toward small-cap US names, massively outperformed the Nasdaq and the Magnificent 7 from July 11th through the end of the month, rising by roughly 10% over that period versus a nearly 10% decline in the Magnificent 7. There are a few reasons why this could be the case: falling yields easing pressure on smaller businesses, the move in megacaps was simply overextended, and valuation differentials had gotten extreme. It will be important to monitor the durability of the rotation given the potential scope for catch-up between most of the market and a small number of names that have driven returns. It will be critical for economic growth to remain resilient if the rotation we saw has legs given the leverage of smaller companies to the real economy.

Against this backdrop, the broad market continues to look very expensive in the US. We’ve been talking about several industries being priced to perfection, and we continue to believe that this is the case even after some of the weaknesses we have seen. Such an environment continues to necessitate balancing risk and reward in portfolios. We believe that our active approach to investment management will continue to allow us to uncover investment opportunities, while largely avoiding parts of the market where we see elevated risks moving forward.

Our Perspective

We have been concerned about the downside risks to the US economy for some time now. While growth is slowing from elevated levels, the economy has remained incredibly resilient due, in large part, to the massive fiscal transfers undertaken in the months and years following the pandemic. We believe we are nearing a critical juncture; fiscal stimulus has mostly moved through the system and unemployment is rising. With the Federal Reserve on the precipice of its first rate cut in years, we are closely monitoring for signs that the much-needed normalization in the economy does not turn into something worse. Given the varied risks we see in the market today, we are emphasizing risk management and have adopted a modestly defensive position in our core portfolios.

Shifting Narratives: What the Highs and Lows Mean for Expectations

With the first half of 2024 behind us, what does the rest of the year look like given the degree of market concentration we’ve seen? From all-time highs to a slowing economy, we share our thoughts on how we’re preparing for the rest of the year. Read the article for our full thoughts.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, we did see pain in industries including transport and manufacturing. The US consumer has remained strong. The lagged effect of monetary policy may start to be felt in other parts of the economy in the coming quarters, and we are keeping a close eye on the labor market.
Stock Market		The US stock market continues to trade near all-time highs. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansion. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		While growth has remained resilient and inflation remains above target, interest rates have come in off of their peak as the market has started pricing rate cuts from the Fed. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
Important Issues on the Radar		Inflation: After surprising to the upside to start the year, inflation has resumed its downward trajectory. However, we would caution that we are still well above target and upside risks remain.
		China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the policy response in the coming months.

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Source: Bloomberg

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