Market and Portfolio Commentary (08/16/2024)
#Market Volatility
INFLATION & FED ACTION:
The Consumer Price Index (CPI) reported Wednesday, and it was in line with expectation. The July CPI marks a third consecutive month of broad cooling in consumer prices. 90% of the increase in the headline index was due to shelter prices, and for the first time in two months energy prices did not negatively contribute to the index.
Three months of encouraging inflation data should be enough for Fed officials to tee up a 25bp September rate cut. Chicago Fed President Austan Goolsbee was the first FOMC participant to comment publicly after the CPI this week. He reiterated recent statements emphasizing the need to ease policy before the labor market overly weakened but, considering the views of some more cautious Fed Governors - like Michelle Bowman, it seems incredibly unlikely the FOMC will reach enough consensus to deliver on anything bigger than 25bp next month. In addition, this is election season, and the last thing Powell wants to do is to appear as if he’s playing political favorites.
MARKETS PERFORMANCE & TRENDS:
The STOCK MARKET: US Equities continue to recover from August 5th sell-off. They recorded the best week since 2023 – The S&P500 is up ~16% for this year and the NASDAQ surged 12% from the last Monday’s lows - as this week there was positive news in both inflation and growth front. This week Growth Stocks outpaced Value shares.
THE VIX - the index that measure the equity volatility - is back to ~23 - after the last month crisis that brought it to spiked over 200 - signaling confidence from Investors that the economy will have a “soft landing”.
YEN CARRY TRADE is back again: the carry trade that blew up markets two weeks ago is attracting Hedge Funds again. The Japanese Yen has weakened more than 5% vs USD since August 5th.
USD & GOLD: The USD plunged to 5-months lows and Gold soared to a record high, topping $2,500 for the first time.
TREASURY CURVE: the 10-year Treasury yield decreased through most of the week on the benign inflation data but jumped on Thursday following the strong retail sales data. The yield curve continues to be inverted but steepened from last year, as the Fed was talking about more hikes that did not happen. If Fed eases, we will see the slope from the 2yr to 10yr normalizing.
CREDIT MARKET: rallied hard this week, adjusting from “hard landing” to “soft landing” scenarios.
FED RATE-CUTTING CYCLES tend to lead to above average returns: Data since the early 1980s suggest that the S&P 500 averages +14.2% within the first 12 months following an initial rate cut, absent a recession. In fact, rate cut cycles tend to lead to above average returns. Here’s a chart from Julius Baer that illustrates this point:
Julius Baer
OUR PORTFOLIO CONSTRUCTION:
In Equity we continue to focus on our 3 criteria:
Names that fit into one or more of the 5Ds: Defense, Digitalization, Distribution, Dislocation, or Diffusion.
Names that make “must have” products and services versus just “nice to have”. The former are keepers. The latter, a risk we don’t want.
Names that have defensible margins and customers are rushing to it.
In Fixed Income we favor Convertible Bonds – for their unique feature of behaving more like Equity when the market is up but have limited downsize – like Fixed Income – when the market goes down.
In terms of Portfolio Construction:
We continue to overweight Equity Tech/Growth: AI is the next big revolution, and we need to be in it to win - although Tech/Growth names could go through moments of volatility, as we saw.
On the contrary, dividend stocks tend to fall less, stabilize faster, and come back more quickly than their non-dividend paying counterparts. Our recommendation is to have some of those to mitigate volatility and to get some cash.
Oil demand will continue to accelerate, as big part of oil production capacity goes offline because of antiquated equipment, war, and civil unrest. A way to express this view is to stay long the Energy sector.
Every sell-off tends to be short term in nature, and it is a good thing: it will give us the opportunity to pick up more of our favorite names at cheaper prices. If you want to play win you need to think beyond that. During selloffs, defense or pharma are good sectors to keep flow grow and receive dividends.
BOTTOM LINE:
We encourage to keep portfolios in accumulation mode: even if there will be volatility, staying invested is the most important thing you can do with your money: missing opportunity is always more expensive than trying to avoid risks you can’t control.
There is a huge amount of cash sitting on the sideline ready to enter the market. Liquidity will continue to drive up prices of good names – even thought, not necessarily in a straight line. A portfolio is like a garden: flowers will grow with lots of water.
AI will contribute trillions to the global economies in the next decades and there are very few manufacturers capable of provide the goods needed to power it all, therefore staying in good names is very important.
Volatility will be our traveling companion into US Presidential Elections - as many people expect volatility to rise as we head into what are widely anticipated to be extraordinarily contentious US presidential elections. Sell-offs will give us the opportunity to continue investing in our favorite names.
Best wishes for Health and Wealth, Rosanna
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