August 2024 Capital Markets Perspective

July rewarded investors with globally diversified, multi-asset class portfolios, as all major asset classes except commodities outperformed the invincible S&P 500®. In fact, the S&P barely escaped ending in the red thanks to a rally on the last day of the month. Helping the broader market was the 2Q Gross Domestic Product (GDP) report showing that growth came in at 2.8%, well above expectations for 2% growth, and the 1.4% rate in the first quarter. Businesses invested more in equipment and software, and consumers spent more on goods and services alike.

Also adding to positive sentiment was inflation data showing that the Consumer Price Index (CPI) continued to cool in June, surprising to the downside. It’s the first time it’s dropped in four years. The year-over-year number was 3.3%, just below expectations, with the housing component dipping to levels similar to those seen pre-COVID. Further, consumers’ inflation expectations continue to fall, which is good because that affects purchasing decisions, and thus actual inflation. The University of Michigan’s consumer survey showed 1-year expectations of 2.9%, down from well over 3% in the prior month.

And while we learned after month end that the job market has softened and job openings keep coming down, they remain above levels seen prior to 2020. Voluntary resignations have also fallen significantly as a sign of a loosening labor market; a positive on the inflation front. The Fed certainly would have liked to have seen that jobs report before they met and held rates steady, but now market participants not only see a cut in September, but a total of three before year end, and many strategists are calling for larger cuts than were previously priced in. The case can certainly be made, but remember, “the market” has been wrong at every step of the way on rates, so perhaps we shouldn’t put much stock in that.

What happened in the markets in July?

EQUITIES: A WELCOME REVERSAL

So, that game of chicken that we mentioned last month regarding semis and big tech? Well, it seems that for at least a moment that crowded trade has given risk seekers pause. If not for the ninth inning rally, the S&P would have ended in the red, on declines in some of the biggest names, including Amazon (-3.2%), Meta (-5.8%), NVIDIA (-5.3%), and Microsoft (-6.4%). But the pain was thankfully confined to the big names, as small caps in the U.S. were up almost 11% and small stocks across the pond advanced by just under 6%. International large caps also fared well, gaining about 3% thanks in large part to the fall in the U.S. dollar, which added about 213 basis points (bps) to U.S. investor returns.

Small cap breadth greatly improved during the month, in part on market expectations that credit conditions for leveraged companies will ease. And more and more stocks on the NYSE have been participating in the rally, as the year has progressed, while the opposite has been true of NASDAQ stocks. In fact, the NASDAQ advance-decline line has been falling since early 2021.

Earnings season is coming to a close, and with 82% of companies reporting thus far, operating earnings are almost 8% higher than in the first quarter of this year and about 7.3% higher than in the same quarter last year. In addition, margin estimates are high and keep moving upwards. With producer price pressures lessening, interest costs likely to fall, slower wage gains, and perhaps the beginning of AI related productivity gains, that makes sense, but there is a lot of optimism baked in here.

BONDS: COOLING INFLATION PROVIDES BOOST

For the second straight month, the yield curve shifted lower. The rate on the 10-year Treasury fell by 27 bps to end at 4.09%, again providing the backdrop for widespread gains in fixed income. Contributing to the decline in the 10-year yield were growth and inflation expectations, Fed policy, and a shrinking of the term premium. The fact that the CPI surprised to the downside, dropping for the first time in four years was helpful. Duration was sought after, with long-term Treasuries advancing by 3.6%. The broad market advanced by 2.3%, with investment grade corporates gaining 2.4% and high yield bonds moving higher by almost 2%. Leveraged loans brought up the rear for the second straight month, but still managed a respectable return of 0.7%.

COMMODITIES: CHINA’S GROWTH PROBLEMS HAUNT MARKETS

Commodities can’t catch a break. Another month and more red. As a group they were off by about 4%, buoyed only by precious metals (+2.7%), which benefited from geopolitical concerns and softening U.S. economic growth that has increased the likelihood and size of rate cuts. Industrial metals (-6.8%) and energy (-7.7%) struggled mightily on Chinese economic data and the failure of the Third Plenary Session of the 20th Central Committee of the CCP to result in meaningful stimulus or reforms. The energy complex was primarily impacted by a 21% plunge in natural gas due to rising production and subdued demand. Agriculture (-4.8%) was also hurt by slowing Chinese demand and favorable weather conditions that have boosted production. Corn has now fallen by more than 50% from its most recent peak.

How are Frontier strategies positioned?

ALLOCATION CHANGES

Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, ETF, Multi-Asset Income, and Faith-Based Strategies, and the additional difficulties of properly conveying how those asset allocation changes flow through to trade level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.

Focusing on our Core Strategies, relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. small caps, emerging market equities, managed futures, floating rate loans, and cash/short term bonds. We are generally underweight U.S. and international large cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will occur. At the beginning of August, our asset allocation models registered modest decreases to U.S. and international small caps, as well as floating rate notes, in favor of short-term bonds. However, those asset allocation model changes were insufficiently beneficial, according to our metrics, to warrant trading in most cases.

Return expectations for emerging market equities and international small caps remain near the tops of their respective 20-year ranges. Expectations for TIPS, managed futures, and T-bills are likewise high relative to history, and leveraged loans continue to offer the highest expected returns within the fixed income space. Expectations for high yield bonds continue to fall, given where spreads are, and expectations for U.S. large caps remain near their 20-year lows, as is the case for REITs and commodities.

PERFORMANCE ATTRIBUTION

After a disappointing June, small caps in both the U.S. and overseas markets outperformed their large cap peers and were the biggest positive contributors to absolute and relative performance. In addition, avoiding commodities continued to pay off, as they were the worst performing asset class among those utilized in Frontier strategies. Our fixed income exposures garnered mixed results. On the plus side, we still have overweights to long-term Treasuries in certain strategies, which outperformed all other sectors, but our underweights to quality fixed income more generally was somewhat detrimental, particularly where we were overweight to floating rate notes or managed futures as a diversifier. Being underweight REITs also negatively contributed to performance, as they joined the rally in all things small and value oriented.