Second Quarter 2024 Investment Commentary

By Published On: July 1st, 2024

Executive Summary

  • Financial Markets Overcome Tough April as Inflation Picture Improves  The Fed May Not Wait for Exactly 2.0% Inflation
  • Economic Deceleration, Long Resisted, May be Closer at Hand
  • Presidential Debate Brings New Intrigue and Clouds Policy Outlooks
  • Thayer Portfolio Moves: Trim Small Capitalization and Dividend Stock Exposure in Favor of S&P 500 Exposure, Cutting Stock Fund Count by Two; Trim Short Term Bond Exposure while Reducing Bond Fund Count by One, Modestly Lengthening Duration

What happened in the financial markets in 2024’s second quarter?

Both stocks and bonds recovered from April losses, a month that featured an inflation reality check, and posted positive returns for the second quarter as the inflation data and investor attitudes improved.

Stock index returns again were driven by Nvidia and other large “Fab” names, the latter accounting for essentially all of the S&P 500’s 4.4% return. Tellingly, the Dow Jones index, more skewed to longer-established, dividend-paying stocks, lost 1.1%. The globally inclusive ACWI gained 2.9% in the quarter. Thayer client portfolios advanced, notwithstanding some headwinds from dividend payers.

Bonds also followed the inflation news, with the AGG index dropping 2.5% in April but then recovering to scratch out a quarterly gain of just above zero. Following early- year disappointments, more benign April and May inflation reports, along with a somewhat friendly June Fed meeting, again raised hopes for a cut or two later this year (September and/or December), with more to follow in 2025.

Has the inflation narrative shifted toward slightly greater tolerance?

The upturn in financial markets may reflect not only inflation data but also nuances in how the numbers are viewed. The European Central Bank also has a 2% goal, and also is stuck around the 2.6% level, but still cut its policy rate from 4.00% to 3.75% in early June, with inflation considered manageable.

The Fed may follow suit in accepting something over 2%. By several measures, both PCE and CPI numbers are above 2% due mainly if not entirely to real estate pricing, with the inflation fight already won more broadly. Ironically, real estate is propped up in part by Fed policy. The dynamics of higher interest and mortgage rates have capped supply (fixed-rate holders reluctant to sell/move) and enabled higher rents (landlords less concerned about renters leaving to buy homes with high mortgages).

Further, the 2% target might be out of step with longer history. According to well- established market tabulators Roger Ibbotson and Rex Sinquefeld, inflation maintained a 3% annual rate from 1926 through 2010, a period of 84 years. Only after 2010, following the Financial Crisis and the beginning of a long and weak economic recovery, did inflation shift down to the 2% level, where it stayed until the post- COVID up-spike. In other words, mid to upper 2%s might be a more natural equilibrium rate.

Has the long-resisted deceleration in GDP actually started to happen?

The economy has withstood the Fed’s rate hike campaign to date, contrary to economists’ consensus expectations since 2022. A robust run in job gains since the pandemic has been a key factor, as have reasonably strong wage gains. Also, consumer spending has been robust and resilient, thanks to healthy employment but also to excess savings from COVID.

That said, we may be starting to see indications of fatigue in these engines. Workforce growth now shows signs of tapering, and indeed may be bumping up against some post-boom retrenchment as well as demographics and limits on labor force participation. And, by most measures, COVID savings are essentially depleted. Finally, a threat may be posed by the Fed itself, if policy paralysis keeps them on their restrictive policy setting for too long.

All told, GDP forecasts generally call for ebbing growth rates in the 1-2% range in the next year or two. Recession may be avoided, but by a smaller margin.

Now that the presidential campaign has begun, will fiscal and geopolitical questions gain importance versus monetary ones?

With the June 27th debate, we now have new points of conversation, and fodder to gauge implications for the fiscal side of the economic equation. But we also have a higher level of uncertainty about the race itself given President Biden’s debate performance. The “bad night” defense may be outweighed by notions that the display was actually revelatory of an age issue that not only is real but worse than thought, and also unfixable.

Staying in the race, as it appears Biden and his team are planning, would seem to offer high odds of a loss. Usually, resolutions of uncertainty, including elections, are market- friendly, enabling traction on the newly firm terrain. Biden stepping aside could elevate uncertainty as a Trump win could become less of a given, and also because a new candidate (and selection process) would bring uncertainty.

We will of course need to game out in this year’s second half what either party would do in the White House as two major wars continue, protective trade policy remains in place, deficit spending and debt service become ever more burdensome, and immigration reform seems continually unreachable. Heading the list will be whether to renew and/or alter the 2017 Trump tax cuts with an eye on possible fiscal restraint and debt vigilance. But for now, the Biden issue needs to be clarified.

Are there any changes in Thayer portfolio positioning, and if so, why?

Heading into 2024’s second half, we have made a few changes in client portfolio positioning. We also are slimming down the fund count on both the Thayer stock and bond sides.

In the stock book we are muting small and mid-capitalization exposure, and also trimming exposure to the dividend payers, in favor of the S&P 500. While we have been outlier GDP optimists for two years, we see deceleration as closer at hand. The moves should moderately reduce economic sensitivity.

The bond book consolidates two short term funds into one and plays up the attractive two-year Treasury yield (currently 4.7%), enhancing portfolio yield in so doing. Duration also moves up a bit, which is aligned with possible easing of both inflation and GDP growth, which could put downward pressure on rates.

We wish you all the best and, as always, thank you for your confidence in the Thayer team.

Sincerely,
David Beckwith
Chief Investment Officer
Thayer Partners, LLC

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