September 2024 Capital Markets Perspective

It seems a distant memory at this point, but during the first few days of August, the Nikkei fell by 12.4% on a rate hike announced by the Bank of Japan, and the S&P followed, losing about 6% over a couple of days. But the apparent overreaction was quickly corrected for, with the Nikkei gaining over 10% the following day, and both it and the S&P 500® ended the month with gains, advancing by 2.2% (in yen) and 2.4%, respectively. But that set the tone for the month, as jittery investors weighed slowing economic data and attempted to ascertain the probability and size of rate cuts between now and year-end, all while gauging the impact of what is certain to be a volatile presidential election. Easy, right?

But while numerous economic indicators are slowing, the data in total suggests that the Fed is on that soft-landing path. To begin, second-quarter Gross Domestic Product (GDP) growth was revised upward, with stronger consumer spending offsetting downward revisions in other components (and July’s retail sales were healthy as well). Productivity gains surprised to the upside, coming in at 2.3% quarter-over-quarter, against expectations of 1.8%. The consensus estimate for 2024 GDP, which stands at around 2.5%, has continued to rise, in part on expectations for stronger business investment. Further, according to Goldman Sachs, the share of management teams discussing labor shortages and labor costs as concerns on earnings calls has subsided to pre-COVID levels. Add to that the U.S. Census Bureau’s release on business formation statistics, which shows that the number of new business applications remains remarkably high, well above the levels seen over most of the past two decades, if not longer. And job openings keep coming down but remain elevated compared to the years prior to 2020, and initial and continuing jobless claims have come down of late and layoff indicators remain subdued.

On the inflation front, July’s Consumer Price Index (CPI) came in as expected and year-over-year registered its first sub-3% reading since 2021. The University of Michigan’s consumer survey showed that for the first time in years, consumers’ longer term inflation expectations are now higher than for the next twelve months, which could have a beneficial calming effect on spending behaviors.

Not all the news has been positive of course. Post month-end, the jobs report from the Bureau of Labor Statistics showed that the economy only added 142,000 jobs last month versus expectations for 160,000. And July’s job’s number was revised down from 114k to 89k. Excess savings from COVID-era stimulus have continued to shrink (and have probably been exhausted) and the savings rate as a percentage of disposable income is flirting with its lowest level since the Global Financial Crisis; a sign that consumer resilience may be tested. Remember though, it was the Fed’s explicit intention to slow things down, so not surprising.

A concluding thought. Uncertainty spikes leading up to elections, and historically that has meant that we are entering a period where markets struggle on average. But after the results are known and that uncertainty lifts, more often than not, markets experience a relief rally and/or resume their upward trends. So, keep that in mind as you brace yourself for what’s to come between now and November 5th.

What happened in the markets in August?

EQUITIES: DIFFICULT START, NICE ENDING

Throughout the month, market breadth – the percentage of S&P 500 members trading above their 50-day moving average – improved, and the equal weighted S&P 500 nudged out its market cap weighted sibling by a tenth of a percent, returning 2.5%. Certain members of the Mag 7 were pressured during the month, and in total the group reduced the S&P 500’s total return by about 75 basis points (bps), according to S&P Global. And the CBOE put/call ratio fell to levels not seen since 2020, suggesting that sentiment was quite bullish by month end.

While high beta stocks in general, and small caps specifically, sank, low volatility, high dividend, momentum and quality factors all did well, as did large caps. The S&P 600 returned -1.4% and the S&P 500 moved higher by 2.4%. Overseas, large caps also outperformed, gaining 3.3% in dollar terms versus 2% for small caps. U.S. based investors benefitted from the falling dollar to the tune of about 280 basis points (MSCI EAFE was up 0.5% in local currency terms). And emerging market shares advanced by 1.6%.

Earnings season essentially ended with only a half dozen laggards failing to report before month end. And with that, S&P reports that 79% of companies beat on earnings and 62% beat on sales. Earnings in total were up 7% over the first quarter and almost as much over the trailing year, with operating margins coming in just shy of 12%. For the full calendar year, S&P is expecting earnings growth of 11.4%, with an even better 16.6% gain to look forward to in 2025.

BONDS: THE YIELD CURVE SHIFTS LOWER AND DISINVERTS

The yield on the 10-year Treasury fell by 18 bps, setting the stage for another good month for all things fixed income. And the entire yield curve, from 1-month to 30-years, shifted lower, with the 2-year to 10-year portion of the curve reaching parity for the first time in over two years (the 10-year minus 3-month remains inverted). With the drop in yields, long-term Treasuries again led, advancing by just over 2%, followed by high yield bonds, which gained 1.6% with spreads narrowing by 12 bps, and the bond market as a whole returning 1.4%. TIPS (+0.8%) and floating rate loans (+0.6%) trailed most major fixed income sectors, but produced solid returns, nonetheless.

COMMODITIES: THAT LOW ENERGY FEELING

Commodities as a group were flat for the month, but the energy complex struggled, as heating oil (-6.7%), petroleum (-4.4%), Brent crude (-3.7%), WTI crude (-3.6%) and natural gas futures (-2.9%) all declined. Natural gas has been by far the worst performer year-to-date, down 38%, as a glut of inventory has depressed prices, which has led to a reduction in drilling activities.

Outside of energy, gains were fairly broad, with industrial metals gaining 3.4%, precious metals rising by 1.9%, and agricultural futures advancing by 1.3%. Even so, the continued softening of Chinese demand has put pressure on steel and iron ore futures, and has led some Wall Street firms to cut their 2025 estimates for economic bellwethers like copper.

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. Because of the continuing decline in return expectations for cash/short term bonds, at the beginning of September, our asset allocation models experienced reductions in managed futures, floating rate notes, and cash, with corresponding increases in TIPS and high-quality bonds.

Return expectations for emerging market equities and international small caps remain near the tops of their respective 20-year ranges but have declined year-over-year. As mentioned above, expectations for floating rate loans have come down meaningfully as well but remain above those for other fixed income sectors. Expectations for U.S. large caps continued to fall, as was the case for REITs, but those for commodities inched higher.

PERFORMANCE ATTRIBUTION

After soundly beating their large cap peers in July, global small caps reversed course, underperforming in August. U.S. small caps ended in the red, while overseas, small caps still performed reasonably well but trailed large caps. That, plus Frontier’s underweights to REITS and exposure to managed futures strategies were the primary headwinds to performance for the month. On the positive side, avoiding commodities was beneficial, as was healthy exposure to all things international, chiefly because the U.S. dollar took a hit and that added a few hundred basis points of return to international assets held by U.S. investors. The overweights in certain strategies to long-term Treasuries was also additive, as duration exposure paid off to a greater degree than credit for the month.