June 2024
US Economy: Signs of slowdown.
The U.S. economy grew just 1.3% in 1st quarter 2024 (down from the 1.6% initial estimate), a big drop from the 3.4% growth rate at the end of 2023. Spending by consumers, the key driver of U.S. GDP growth, seems to be waning: Retail sales were flat in May and delinquency rates on credit card and auto loans are higher. Meanwhile, the U.S. unemployment rate ticked up to 3.9% and U.S. manufacturing activity is once again contracting after rebounding for a couple of months.
US Stocks: AI offense and defense.
Despite the lack of upbeat economic data, U.S. equities rebounded strongly in May. A surge in the AI-driven earnings of chipmaker Nvidia (+26.9) helped make the technology sector (+10.1%) the front runner. Still, utilities (+8.7%) were the second-strongest sector as investors sought out relative bargains, utilities as an AI energy play, and utilities’ relatively reliable earnings and dividends providing a hedge against a slowing U.S. economy.
Foreign Stocks: Europe close second.
International equities trailed the U.S. but with pockets of strength in Europe (+4.8%) given that the unemployment rate there is down to 6.4%, an all-time low, and the European Central Bank is considering interest rate cuts despite a slight uptick in May inflation (+2.6%), the first rise in five months. Emerging markets struggled given a stronger dollar and higher inflation expectations, both notable headwinds for the oil-dependent Middle East (-5.7%).
Fixed Income: Rates down slightly.
U.S. inflation eased a bit in May (3.4% CPI and 3.6% core CPI) but remains well above the Fed’s 2% target. Meanwhile, the Fed’s preferred gauge of inflation — the Core Personal Consumption Expenditures (PCE) Index — came in at 2.8%, trending down. U.S. yields fell slightly (to around 4.5% on 10-year Treasuries) but remain near 2024 highs. However, the yields on municipal bonds rose in May amid the biggest wave of new issuance in two years.
Real Assets: Renewable energy in play.
Renewable energy related infrastructure stocks were up 10.6% in May, the best-performing real asset category in the public markets, for reasons similar to utilities: attractive valuations, defensive characteristics, and long-term demand for energy including the energy required to power the ongoing development of AI. Traditional infrastructure (+6.3%) has also performed well, leading the real assets category with a 13.6% return over the last 12 months.
Alternatives: Distressed credit opps.
Higher U.S. interest rates have driven up the cost of financing private equity and real estate deals, creating a headwind for each of these segments to a varying degree. That said, while higher interest rates continue to buffet private market equities, they should provide a fertile backdrop for investing in private credit. In particular, securitized credit, including Collateralized Loan Obligations (CLOs) that bundle together bank loans, can offer both elevated yields and limited downside.
Source of data: Bloomberg
Equities Total Return
| MAY | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 5.0% | 11.3% | 28.2% |
| U.S. Small Cap | 5.0% | 2.7% | 20.1% |
| U.S. Growth | 6.0% | 12.7% | 32.8% |
| U.S. Value | 3.3% | 7.2% | 21.7% |
| Int’l Developed | 3.9% | 7.1% | 18.5% |
| Emerging Markets | 0.6% | 3.4% | 12.4% |
Fixed Income Total Return
| MAY | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 1.7% | (1.6%) | 1.3% |
| TIPS | 1.7% | (0.1%) | 1.6% |
| U.S. High Yield | 1.1% | 1.6% | 11.2% |
| Int’l Developed | (0.5%) | (2.8%) | (0.8%) |
| Emerging Markets | 0.9% | 1.9% | 5.7% |
| Tax-Exempt | |||
| Intermediate Munis | (0.5%) | (1.6%) | 2.0% |
| Munis Broad Mkt | (0.2%) | (1.6%) | 2.8% |
Non-Traditional Assets Total Return
| MAY | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 1.8% | 6.8% | 10.9% |
| REITs | 5.3% | (4.3%) | 9.0% |
| Infrastructure | 6.3% | 7.2% | 13.6% |
| Hedge Funds | |||
| Absolute Return | 0.3% | 2.0% | 4.7% |
| Overall HF Market | 0.5% | 2.5% | 4.8% |
| Managed Futures | (1.5%) | 10.2% | 7.0% |
Economic Indicators
| MAY-24 | NOV-23 | MAY-23 | |
|---|---|---|---|
| Equity Volatility | 12.9 | 12.9 | 17.9 |
| Implied Inflation | 2.4% | 2.3% | 2.2% |
| Gold Spot $/OZ | $2327.3 | $2036.4 | $1962.7 |
| Oil ($/BBL) | $81.6 | $82.8 | $72.7 |
| U.S. Dollar Index | 122.0 | 120.5 | 121.2 |
Our Take
Bringing U.S. inflation down from a blistering 9% in 2022 to below 4% has been a lot easier than getting it down a couple more percentage points to the Fed’s 2% target. Yes, the supply chain problems created by Covid and the Ukraine war are largely behind us, as is the glut in excess U.S. household savings, which finally evaporated this spring. However, as is typical in the late stages of economic cycles, above-trend growth in the last few quarters has boosted corporate earnings and stock market returns. That environment creates a bit of a self-fulfilling phenomenon in that it allows consumption to stay elevated a bit longer, thereby making inflation stickier.
Working through the stickier phase of inflation will likely continue to be a challenge as we enter the second half of 2024. Consumer spending and the labor market remain mostly healthy while the economy continues to get annual infusions of $100 billion to $200 billion from recent government programs: the Jobs and Infrastructure Act, the Inflation Reduction Act, and the CHIPS Act.
At this point, it is the blunt tool of prior interest rate increases that is expected to tame inflation. By now, most of the Fed’s 11 interest rate increases since 2022 have worked their way through the U.S. economy (16 months is typical lag time), but the last three increases have yet to bear their full force. Will the impact be stronger than what we have been already? It’s possible as we are beginning to see evidence of a slowing economy: A slowdown in the growth of consumers’ disposable income (the main driver of consumer spending), consumers opting for lower-cost alternatives, consumer credit delinquencies, contraction in manufacturing, a less robust job market, and the real estate market continuing to look anemic.
With that said, the U.S. economy has shown itself to be quite resilient and has provided some head fakes over the past few years. The Fed is unlikely to feel the need to cut interest rates dramatically in the coming months unless they see the whites of inflation’s eyes, i.e. multiple data points indicating inflation has been subdued. In any case, the U.S. economy is likely to have to stand on its own without the Fed saving the day.
What Now
Even though some valuations appear stretched, we are seeing a market dynamic that is typically positive: investors rewarding companies with strong fundamentals (beyond the mostly momentum AI story) and punishing those that disappoint. That said, we are focused on establishing strategic positions and not getting caught up in market noise. Those who abide by the maxim “sell in May and go away”, for example, just missed out on a nice rebound in most asset classes. This again underscores the pitfalls of market timing, including what are considered market truisms. Still, we don’t mean to imply that investors can fall asleep at the switch.
So what are we paying attention to and what could knock the U.S. economy and markets off course? We continue to think geopolitical risk is being underappreciated and undervalued. In the U.S. especially, as we progress through the summer and the presidential election looms in our collective consciousness, we anticipate greater market volatility. There is the potential for new fiscal, trade and immigration policies as well as a contested election that risks eroding confidence in the U.S. as the world’s beacon of democracy and capitalism. Moreover, with U.S. political tensions simmering, the Fed may hesitate to cut interest rates ahead of November to avoid the perception of political bias.
With volatility likely to be a more regular visitor, we continue to believe the most attractive positions now on a risk-adjusted basis are those that help diversify equity exposure in portfolios. U.S. large-cap stocks generally look expensive but rebalancing into international and small-cap equities can offer more attractive valuation entry points. Additionally, topping up bond exposures within core fixed income, arguably our most effective diversification lever, as well as adding to or establishing exposure to hedge funds and private credit, which we categorize as diversifiers.
