Market Commentary | December 9th, 2024

by | Dec 9, 2024 | Market Commentary

Market Commentary | December 9th, 2024

Week in Review…

The market extended its gains, with the S&P 500 and Nasdaq reaching new all-time highs after a solid week of economic data that boosted confidence that the economy remains on strong footing, and is not running too hot to deter the Federal Reserve (Fed) from lowering its rate in December.

  • The S&P 500 rose +0.71%
  • The Dow Jones Industrial Average was down -0.03%
  • The tech-heavy Nasdaq finished up +2.35%
  • The 10-Year Treasury yield ended the week at 4.149%

This week, key economic data revealed mixed signals about the U.S. economy. The Manufacturing Purchasing Managers’ Index (PMI) for November increased to 48.4 from October’s 46.5, exceeding expectations of 47.7. While still below the critical 50-point threshold, which separates contraction from expansion, the uptick suggests a slower pace of decline in manufacturing activity. Conversely, the ISM Services PMI fell to 52.1 from 56.0 in October, indicating the services sector continues to grow but at a reduced rate.

Labor market indicators were a focal point, with the Job Openings and Labor Turnover Survey (JOLTS) report surprising markets. October’s job openings rose to 7.7 million, up from 7.4 million in September, signaling persistent demand for labor despite higher interest rates. Initial jobless claims also pointed to labor market resilience, coming in at 224,000 for the week, which is in line with normal market level. In addition, the nonfarm payrolls report also surprised the market with it adding back 227,000 jobs in November, compared to 36,000 the month prior. The increase is largely due to workers sidelined by storms getting back on the job, and thousands of striking Boeing employees returned to work.

Federal Reserve Chair Jerome Powell’s comments this week emphasized the Fed’s data-driven approach to monetary policy. He highlighted that the current state of the economy is stronger than the Fed has projected, and it is too soon to say how policy changes from the new administration might reshape the outlook for economic activity and interest rates. The Fed’s next meeting is December 17-18. Investors in interest-rate futures markets are currently pricing in a roughly 80% chance of a 25 bps rate cut and 20% chance of no cut, according to the CME Group.

Spotlight

The Trump Effect on Factors

Since the election, equities have continued to rally higher as investors analyze the impact of a second Trump term. However, underneath the surface, there has been a shift in the types of companies that investors are betting on. This week, we take a look at how the market has adjusted their equity position within factors in both the Russell 1000 and Russell 2000.

The Russell 1000 shows a strong year-to-date (YTD) return of 28.08%. The Momentum factor outperforms with a YTD return of 33.64%, indicating that high-momentum stocks lead the gains, while the Volatility factor underperforms with a YTD return of 21.22%. For the quarter-to-date (QTD) period, the Momentum factor again outperforms with a 6.58% return, while the Volatility factor lags with a 3.20% return.

In November, the Size factor saw the highest gain at 9.38%, significantly outperforming the broad index’s 6.44% gain. This recent surge in the Size factor may be attributed to the impact of tariffs, which have made smaller large-cap stocks more attractive due to their lower exposure to international trade and supply chain disruptions. Meanwhile, the Yield factor has the lowest November return at 4.56%, highlighting the impact of higher rates on dividend stocks. The notable change in November, with the Size factor outperforming, contrasts with the broader trends observed over the past four years indicating a potential broad investor shift away from the larger names in the index.

The Russell 2000 shows a solid YTD return of 21.58%. The Momentum factor outperforms with a YTD return of 27.79%, indicating that high-momentum stocks lead the gains, while the Size factor underperforms with a YTD return of 17.51%. For the QTD period, the Quality factor outperforms with a 9.82% return, while the Value factor lags with an 8.27% return.

In November, the Quality factor saw the highest gain at 11.17%, slightly outperforming the broad index’s 10.97% gain. Meanwhile, the Yield factor has the lowest November return at 9.22%, a similar trend seen in large caps. The strong performance of the Momentum factor could be attributed to investors flocking into the asset class broadly post-election. The recent outperformance of the Quality factor may be due to investors rotating into small-cap stocks broadly post-election, driven by expectations of lower taxes, increased domestic production, and potential benefits from a U.S.-first policy.

Overall, we have seen a broad shift away from mega-cap stocks to small-to-medium size quality companies that are isolated from international trade and have the capacity to handle both higher rates and will benefit from lower taxes. If Trump’s proposed tariffs and economic policies come to reality in 2025, we could potentially continue to see small, quality companies outperform larger multi-nationals.

Week Ahead…

The headline event next week will be the release of the November Consumer Price Index (CPI) data. Core CPI, which excludes volatile food and energy prices, is closely watched by the Federal Reserve as a key indicator of underlying inflation. By focusing on this metric, policymakers can better gauge price pressures and make informed decisions about monetary policy.

Markets expect November’s Core CPI to align with October’s 0.3% increase. Any significant deviation from this forecast could cause market volatility as investors adjust their expectations for potential policy actions and economic outcomes.

Tuesday will bring two reports that will provide further insights into the labor market and its relationship with inflation.

  • Nonfarm Productivity measures the annualized change in labor efficiency. Higher productivity can lead to higher wages without fueling inflation. Given the recent strong job growth, increased efficiency could help alleviate inflationary pressures.
  • Unit Labor Costs measure the annualized change in labor costs for businesses. This is a leading indicator of consumer inflation. As such, the market will closely watch this report to gauge how recent job market strength will translate into price pressures.

Additionally, the 10-year Treasury note auction on Wednesday will be significant. The 10-year note plays a crucial role in pricing 30-year mortgages and long-term inflation expectations. Auction results will give markets an opportunity to see how recent economic data, particularly the strong job market, is being priced into the long end of the curve.

This content was developed by Cambridge from sources believed to be reliable. This content is provided for informational purposes only and should not be construed or acted upon as individualized investment advice. It should not be considered a recommendation or solicitation. Information is subject to change. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice. The information in this material is not intended as tax or legal advice.

Investing involves risk. Depending on the different types of investments there may be varying degrees of risk. Socially responsible investing does not guarantee any amount of success. Clients and prospective clients should be prepared to bear investment loss including loss of original principal. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.

Market Commentary | December 2nd, 2024

by | Dec 2, 2024 | Market Commentary

Market Commentary | December 2nd, 2024

Week in Review…

With markets closed on Thursday for the holiday and an early closure on Friday, the market still demonstrated positive momentum across the major indices:

  • The S&P 500 rose +1.06%
  • The Dow Jones Industrial Average was up +1.39%
  • The tech-heavy Nasdaq finished up +0.74%
  • The 10-Year Treasury yield ended the week at 4.178%

Housing Market Update: A Mixed Bag

Last week’s headlines were dominated by disappointing new home sales figures. Sales came in significantly below expectations, particularly in the South, likely impacted by hurricanes. However, building permits showed some strength, suggesting builders may be optimistic about future demand.

Interest Rate Dynamics

The U.S. Treasury auctioned 2-, 5-, and 7-year notes last week. Short-term yields rose, particularly the 2-year note, potentially signaling expectations of higher Fed Funds rates. In contrast, long-term rates declined, leading to a drop in 30-year mortgage rates. Markets are navigating a challenging environment with elevated short-term (gross domestic product) GDP and inflation. While the market anticipates the Fed will eventually achieve its 2% inflation target, the path to getting there may be less straightforward.

Inflation and GDP

Both core (personal consumption expenditures) PCE inflation and Q3 GDP were in line with expectations. While GDP remains strong, inflation persists at around 3%. This mixed picture highlights the challenge of balancing economic growth with price stability. Both GDP and inflation are key inputs for bond yield and market return forecasts. Strong GDP and persistent inflation at around 3% will challenge these forecasts.

Spotlight

Implications of the Upcoming Trade War in 2025

As we approach 2025, the prospect of a new trade war looms large, with significant implications for global markets and economies. Drawing insights from recent analyses by Charles Schwab and the International Monetary Fund (IMF), we can better understand the potential impacts and prepare for the challenges ahead.

Historically, trade wars have introduced volatility into the stock market. According to Charles Schwab, while the initial announcements of tariffs and trade restrictions often lead to sharp selloffs, markets tend to stabilize as the specifics of the trade policies become clearer. For instance, during the U.S.-China trade war, the S&P 500 experienced significant fluctuations, but eventually recovered as investors adjusted to the new trade environment.

The IMF’s World Economic Outlook highlights that the global growth outlook remains stable yet underwhelming, with growth projections for 2024 and 2025 at around 3.2%. However, the balance of risks is tilted to the downside, with rising protectionism and trade tensions posing significant threats.

Recent Inflation Developments

The proposed tariffs could have varied impacts across various sectors and regions, while different sectors will likely experience various impacts from the trade war. Industries heavily reliant on international supply chains, such as technology and manufacturing, may face increased costs and disruptions. Conversely, sectors less exposed to international trade, like utilities and consumer staples, might be more resilient. The IMF notes that sectors with high foreign sales exposure could see more pronounced effects, necessitating strategic adjustments by companies. Tariffs can lead to higher costs for imported goods, which may be passed on to consumers, potentially driving inflation. This inflationary pressure can squeeze corporate profit margins, particularly for companies that cannot easily pass on these costs. The IMF’s analysis suggests that while the overall impact on inflation might be contained, certain industries could see significant cost increases, affecting their earnings.

In the long term, markets often adapt to new trade realities. Companies may shift their supply chains, seek new markets, or innovate to mitigate the impact of tariffs. Historical data shows that despite initial disruptions, stock markets have shown resilience and the ability to recover over time. For example, during past trade tensions, firms with high international sales performed similarly to those with minimal foreign sales, indicating a capacity for adaptation.

MSCI World Constituents Performed Similar Despite Foreign Sales Exposure

To navigate the uncertainties of a trade war, investors should consider diversifying their portfolios and focusing on sectors less affected by international trade. On the other hand, the IMF emphasizes the need for a policy pivot to address the rising threats posed by trade tensions, which includes shifting gears on fiscal policy to ensure sustainable debt dynamics and rebuilding fiscal buffers to mitigate the adverse effects of trade tensions.

While the upcoming trade war in 2025 presents significant risks, understanding these potential impacts and preparing strategic responses can help investors and policymakers navigate and adapt to the challenges ahead.

Week Ahead…

The market will be active over the next week, with labor reports and economic sentiment indexes taking center stage. Investors will closely watch these key indicators for clues about the economy’s trajectory and potential year-end market volatility.

Labor Market Focus

The week provides an opportunity to assess the overall health of the job market. Jobs data has become increasingly important as the Federal Reserve resumes its dual mandate.

  • Tuesday’s Job Openings and Labor Turnover Survey (JOLTS) report will provide insights into labor demand and, by extension, economic demand
  • On Friday, the nonfarm payrolls report will be crucial, especially after October’s figures were skewed by hurricanes. Markets will closely watch this report.
  • Also on Friday, the unemployment rate will be released. It has remained at 4.1% for the past two reports, and a significant increase would be unwelcome.
  • Weekly jobless claims will continue to provide additional information about the job market

Markets will watch these reports closely as a strong job market could discourage the Fed from cutting interest rates.

Economic Sentiment Indexes

A couple of important market sentiment indexes will be released this week:

  • Monday’s ISM Manufacturing Purchasing Managers’ Index (PMI) will gauge whether the manufacturing sector will continue to drag on economic activity or start to participate in the upside
  • Wednesday’s ISM Non-Manufacturing PMI will be more important as economic activity is driven more by consumption and non-manufacturing sectors. The last three reports have beaten expectations, and markets hope this trend continues.

This content was developed by Cambridge from sources believed to be reliable. This content is provided for informational purposes only and should not be construed or acted upon as individualized investment advice. It should not be considered a recommendation or solicitation. Information is subject to change. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice. The information in this material is not intended as tax or legal advice.

Investing involves risk. Depending on the different types of investments there may be varying degrees of risk. Socially responsible investing does not guarantee any amount of success. Clients and prospective clients should be prepared to bear investment loss including loss of original principal. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.

Weekly Market Commentary | November 25th, 2024

by | Nov 25, 2024 | Market Commentary

Weekly Market Commentary | November 25th, 2024

Week in Review…

Markets rallied last week as investors digested positive economic data and election results. The major indices all reached new record highs:

  • The S&P 500 rose +1.68%
  • The Dow Jones Industrial Average was up +1.96%
  • The tech-heavy Nasdaq finished up +1.73%
  • The 10-Year Treasury yield ended the week at 4.412%

A Quiet Week Ahead of the Holidays

Last week was relatively quiet as the market geared up for the holiday season. Despite the slower pace, several key reports provided important insights into the economy.

Mixed Signals in the Housing Market

The housing market presented a mixed picture. While existing home sales exceeded expectations, rising month-over-month (MoM) by 3.4%, new home construction showed signs of weakness. Building permits and housing starts underperformed, with the latter declining by 3.1% MoM. This suggests that while buyers are willing to purchase available homes, builders may be hesitant to start new projects due to rising long-term interest rates.

Consumer Sentiment Remains Cautious

The University of Michigan’s consumer sentiment index and inflation expectations surveys offered further insights into consumer attitudes. While consumers’ inflation expectations align with consensus forecasts, their overall sentiment remains cautious. Both consumer sentiment and inflation expectations came in lower than expected, indicating continued uncertainty about the economy’s trajectory.

Spotlight

Tax Strategies Unveiled: Understanding 1031 Exchanges Versus Qualified Opportunity Zones

For decades, investors have utilized Internal Revenue Code (IRC) Section 1031 to defer capital gains on investment property sales through like-kind exchanges. The Qualified Opportunity Zone (QOZ) program, established by the Tax Cuts and Jobs Act of 2017, offers an alternative method to postpone and potentially eliminate certain taxable gains. This spotlight examines key characteristics and investment considerations for these two programs without delving into their mechanics.

1031 Exchanges

The 1031 exchange, named after its section in the Internal Revenue Code, involves selling and buying similar types of investment properties of equal or greater value. If the exchanged property involves leverage, the replacement property must have equal or greater leverage to avoid triggering taxable events. Key aspects of 1031 exchanges include:

  • A 45-day identification period for the new asset after the original asset’s sale
  • A 180-day acquisition period for the replacement property
  • Potential combination with other tax benefits, such as depreciation. When exchanging properties, the cost basis of the new property is reduced by previously claimed depreciation on the original property, allowing continued depreciation claims on the new property.
  • Indefinite tax deferral through repeated exchanges, unless a 721-tax deferral option is used to UPREIT the DST interests into a REIT

IRC Section 1031 does not permit exchanges for primary residences. Instead, IRC Section 121 addresses the homebuyer exclusion limits.

Qualified Opportunity Zone Funds

Qualified Opportunity Zone (QOZ) Funds offer tax benefits for investors with capital gains, including:

  • Capital gains tax deferral
  • Potential reduction of the original deferred gain (if the investment is held for at least five years)
  • Tax-free appreciation on the QOZ Fund investment if held for at least 10 years

Unlike 1031 exchanges, only the gain needs to be invested in a QOZ Fund within 180 days of sale to defer taxes, and the investment can be from any appreciated asset. QOZ Funds must adhere to specific guidelines, including:

  • Investing only in QOZ-specific census tracts designated by the U.S. Treasury
  • Holding at least 90% of assets in QOZ property
  • Deriving at least 50% of gross income from active conduct of business in the QOZ
  • Using a substantial portion of intangible property in active business conduct in the QOZ
  • Having less than 5% of assets in nonqualified financial property

Deferred gains invested in QOZ Funds become taxable on December 31, 2026, or when the investment is sold, whichever comes first. Investors who hold their QOZ Fund investment for at least five years can permanently reduce their tax liability on the original deferred gain by 10%.

Comparing the Two

The key difference between 1031 exchange and QOZ programs lies in their tax deferral structures. Non-721 (pure) 1031 exchanges offer unlimited tax deferral, while QOZs have a limited deferral period but provide tax-free profits after a 10-year hold.

For those aiming to defer taxes indefinitely without accessing investment capital, non-721 1031 exchanges are preferable. They can be valuable estate planning tools, as heirs receive a stepped-up basis to the property’s fair market value at death, erasing previous appreciation.

QOZs are better for investors planning to realize profits within their lifetime. However, taxes on the original investment are due on December 31, 2026, regardless of circumstances.

Risks

Both 1031 exchanges and Qualified Opportunity Zones (QOZs) carry significant risks.

For 1031 exchanges, these include strict timelines, adherence to the ‘seven deadly sins,’ potential overpayment for replacement properties, and market volatility. QOZs face risks such as regulatory changes, economic uncertainties in designated zones, and the requirement to pay deferred taxes by December 31, 2026.

Both strategies involve illiquidity and the potential for investment losses that are inherent in any private real estate transaction, and sponsor/manager risk for syndicated private placement programs.

Optimal Choice

The optimal choice between these strategies hinges on each investor’s specific financial objectives and tax planning considerations. Depending on a client’s unique circumstances, both approaches can be effectively utilized, either independently or in combination, to maximize overall financial benefits.

IMPORTANT DISCLOSURE

This content is presented for informational purposes and is not an exhaustive list of all considerations related to 1031 exchange and qualified opportunity zone investments.  The information presented was not prepared in connection with any specific offering or based on the individual needs of any one investor but rather for general educational purposes. This communication shall not constitute an offer to sell or the solicitation of an offer to buy securities. 1031 Exchange and Qualified Opportunity Zone investments are intended only for persons who are accredited investors. We make no representation or warranty of any kind with respect to the acceptance by the IRS or any state taxing authority of your treatment of any item on your tax return or the tax consequences.

There is no guarantee that any real estate strategy, including those described herein, will be successful. An investment in a real estate investment offering is speculative and involves significant risks including but not limited to: no secondary market for the securities; limited liquidity for the securities, limitations on the transfer and redemption of shares; distributions made may not come from income, could be subject to Board discretion, not guaranteed and can be deemed a return of capital – there can be no limits on the amounts paid from these other sources;  the investment may lack property diversification;  the Sponsor and Trustee are generally dependent upon the advisor to select investments and conduct operations; and the advisor will face conflicts of interest. Investments are not bank guaranteed, not FDIC insured and may lose value.

Week Ahead…

A Busy Week for Economic Data

Despite the Thanksgiving holiday shortening the week, several important economic reports are scheduled to be released. These reports will provide valuable insights into the current state of the U.S. economy and could influence market sentiment.

Treasury Auctions and Yield Curve

On Monday and Tuesday, the Treasury Department will auction off 2-year and 5-year Treasury notes. The 2-year note is particularly significant as it’s highly sensitive to interest rate policy decisions and reflects market expectations for short-term rates. The yield curve, often measured by the difference between the 10-year and 2-year yields, is a key indicator of economic health. An inverted yield curve, where the 2-year yield exceeds the 10-year yield, can signal an impending recession.

Consumer Strength and Housing Market

Tuesday will also bring data on new home sales and consumer confidence. New home sales will reveal how consumers have navigated rising mortgage rates in October, which started the month at 6.12% and ended at 6.72%. Consumer confidence is a crucial indicator as consumer spending accounts for approximately 68% of U.S. GDP in Q2 2024.

GDP and Inflation

On Wednesday, the Bureau of Economic Analysis will release the annualized quarter-over-quarter change in real gross domestic product (GDP), a measure of economic growth. Additionally, the Core Personal Consumption Expenditures (PCE) Price Index, a key inflation indicator, will be released. Current projections point to a 0.3% month-over-month increase and a 2.7% year-over-year increase.

This content was developed by Cambridge from sources believed to be reliable. This content is provided for informational purposes only and should not be construed or acted upon as individualized investment advice. It should not be considered a recommendation or solicitation. Information is subject to change. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice. The information in this material is not intended as tax or legal advice.

Investing involves risk. Depending on the different types of investments there may be varying degrees of risk. Socially responsible investing does not guarantee any amount of success. Clients and prospective clients should be prepared to bear investment loss including loss of original principal. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.

Market Commentary | November 18th, 2024

by | Nov 18, 2024 | Market Commentary

Market Commentary | November 18th, 2024

Week in Review…

Markets retreated last week as investors reassessed potential tariff implications as well as concerns around inflation reaccelerating.

  • The S&P 500 fell 2.08%, ending a multi-week positive streak
  • The Dow Jones Industrial Average was down 1.24%
  • The Nasdaq finished the weakest, down 3.15%
  • The 10-Year Treasury yield ended the week at 4.45%

This past week’s economic data centered around inflation with Consumer Price Index (CPI) data for October having been released. Core CPI remained unchanged at 0.3% month-over-month (MoM), in line with expectations. Headline CPI also held steady at 0.2% MoM and rose to 2.6% year-over-year (YoY). Investors paid close attention to these rates as concerns of possible reinflation have started to worry some market participants, which could limit the Fed’s rate cut regime. However, steady core CPI suggests underlying inflation pressures remain stable, providing some mild reassurance to investors.

Thursday, we received Producer Price Index (PPI) data which increased by 0.2% MoM, matching expectations. Crude oil inventories rose by 2.1 million barrels, reflecting ongoing market adjustments following geopolitical tensions. Additionally, Fed Chairman Powell spoke on Thursday, emphasizing that the economy is not signaling a need to rush interest rate cuts. Powell’s cautious stance on rate cuts indicates the Fed’s focus on sustaining economic stability amid mixed signals from inflation data.

Finally, we finished the week with retail sales numbers for October, which showed a 0.74% MoM increase and a 4.13% YoY rise. Core retail sales also saw a modest gain of 0.3% MoM. The robust retail sales figures suggest consumer spending remains resilient as we head into the holiday season, potentially boosting economic growth.

Spotlight

A Relook at the 60/40 Portfolio

The 60/40 was once the gold standard of portfolio allocation. Over the past few years, we have seen this standard challenged by rising inflation and dominance in U.S. equities. Why has this changed and what can be learned?

The Rise

The 60/40 portfolio is a portfolio that consists of a 60% equity allocation and a 40% bond allocation and has its roots stretching back to Harry Markowitz and modern portfolio theory. The crux of the theory rests on the idea that diversification is a desirable feature in constructing a portfolio. In the same way, the 60/40 rests on the idea of diversification of asset classes.

The 60/40 portfolio has become more than a theory, and over the past 70 to 80 years, essentially became the gold standard of investment allocation. Below is a chart for return, risk, and efficiency ratios from January 1, 1981 to October 31, 2024, for a hypothetical 60/40 portfolio (all numbers have been annualized):

Despite portfolio returns that lagged stock returns, the beauty of the portfolio was the efficient use of risk. The 60/40 portfolio was able to capture more excess return per unit of risk taken. This was made possible in part because the correlation between stocks and bonds remained negative throughout that period. Meaning, the combined risk of the portfolio was less than the sum of its parts.

What made the strategy even more impressive was its simplicity and how it was tailored to investor’s biases. The 60/40 neither requires active management nor access to exclusive funds. The strategy was simple, liquid, and built to suffer shallower drawdown (periods of loss) to prevent panic selling. The market had found a simple but powerful tool to help harness the benefits of diversification. However, no tool is suitable for every situation.

The Fall from Grace

2022 was more than simply a bad year; for the 60/40 portfolio, it was a bit of an identity crisis. Both U.S. equities and U.S. Treasuries suffered significant drawdowns. Bonds did not serve as a ballast for equity losses that year. As a result, the 60/40 portfolio suffered its worst performance since 1937, declining 17.5%, the fourth worst performance in the last 200 years.1 The portfolio was built on the principles of diversification and risk efficiency. Perhaps the 60/40 portfolio had outlived its utility?

As it turns out, 2022 was a “perfect storm” of economic factors like highest inflation levels in 40 years and a Central Bank that raised interest rates 11 times to combat this inflation.2 In essence, the confluence of strong economic headwinds showed investors that the 60/40 is not bulletproof. The portfolio relies heavily on the correlation between stocks and bonds and correlations change over time. The graph below illustrates these changing correlations:

The academic term for the chart above is regime change, but this is basically a fancy term for “things don’t stay the same.” This statement is true for correlations as well. Correlations are not static. This can become problematic when portfolio allocations are built around a negative correlation between stocks and bonds that is no longer true. That is what happened in 2022. Investors are not terribly concerned about assets appreciating in unison, but they become concerned when assets begin falling together in unison. Both bonds and stocks lost money at the same time. Not surprisingly, investors began to question how viable the 60/40 portfolio would be going forward.

The Prodigal Son Returns?

The strategy will remain relevant because it is built on a fundamental tenet of finance: diversification. In short, the 60/40 portfolio is not dead because diversification is not dead. The below graph provides a reference for how diversification is helpful in smoothing out the volatility of asset class returns. 

Recent history shows that the 60/40 portfolio can be very sensitive to the change in correlation between stocks and bonds. For example, the chart below shows how changes in the stock/bond correlation are influenced by different inflation regimes. Meaning, historical correlations may not be as stable as they appeared. Consequently, a 60/40 portfolio might not be your entire portfolio, but rather, a core position with supplemental assets to help reap further diversification benefits. In that sense, perhaps the 60/40 portfolio didn’t die, but expanded upon its core tenant of diversification. 

The 60/40 portfolio provides a wonderful example of how constructing a portfolio is less about how well assets perform individually, but rather, how assets and asset classes interact with each other. The next time you look to add or subtract a position to your portfolio consider how the current and proposed positions move in relation to the other assets. 

Week Ahead…

Next week is expected to be relatively quiet in terms of economic data releases. On Tuesday, the market will see new data on housing starts and building permits. Housing starts have shown some improvement, reaching a five-month high in the previous month, while building permits posted a slight increase. However, economists caution that residential investment will likely continue to weigh on gross domestic product (GDP) growth.

On Thursday, the weekly jobless claims report will be released, continuing to serve as a leading indicator for the labor market’s health. Recent disruptions from hurricanes and ongoing labor disputes led to a temporary rise in jobless claims last month, and these impacts will likely linger into next week’s report, potentially inflating the jobless numbers. While the figures may appear elevated due to these external factors, they’re unlikely to signal underlying weakness in the labor market. The temporary rise in unemployment claims from the recent disruptions isn’t expected to prompt faster rate cuts, as the broader labor market remains relatively resilient. Unless there are signs of sustained weakness, the Fed is likely to stay cautious in its approach, keeping a close eye on economic data over the coming months before making significant policy adjustments.

Additionally, next week will bring the latest consumer sentiment data from the University of Michigan. This sentiment index has shown steady improvement over the past four months, with last month’s reading sitting 50% above its level in June 2022. However, despite this upward trend, sentiment remains below pre-pandemic levels. Next week’s release will also be the first to capture sentiment following the recent election, providing insight into how the results may influence consumer confidence. It will be interesting to see whether the election outcomes further boost sentiment or if concerns over economic and policy uncertainties temper consumer outlooks.

1 Kandhari, Jitania. “Big Picture: Return of the 60/40. https://www.morganstanley.com/im/publication/insights/articles/article_bigpicturereturnofthe6040_ltr.pdf.

2 Thornburg Investment Management®. “Revisiting the 60-40 Portfolio.” Thornburg Investment Management, November 28, 2023. Accessed November 14, 2024. https://www.thornburg.com/article/revisiting-the-60-40-portfolio/.

3 Albrecht, Bella. “‘Diversification Is Back’—Why 60/40 Portfolios Are Working.” Morningstar, Inc., November 8, 2024. Accessed November 14, 2024. https://www.morningstar.com/markets/diversification-is-backwhy-6040-portfolios-are-working.

4 Vanguard. “The Global 60/40 Portfolio: Steady as It Goes,” October 22, 2024. Accessed November 14, 2024. https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/global-60-40-portfolio-steady-as-it-goes.html#:~:text=Fast%20forward%20to%20September%202024,return%20since%20year%2Dend%202022.&text
=Even%20accounting%20for%202022%2C%20the,above%20its%20long%2Dterm%20average.

5 Godbersen, Soren. “The 60/40 Portfolio: Why the Classic Model Faces Challenges, and How to Go Beyond.” EquityMultiple, November 10, 2024. Accessed November 15, 2024. https://equitymultiple.com/blog/60-40-portfolio.

This content was developed by Cambridge from sources believed to be reliable. This content is provided for informational purposes only and should not be construed or acted upon as individualized investment advice. It should not be considered a recommendation or solicitation. Information is subject to change. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice. The information in this material is not intended as tax or legal advice.

Investing involves risk. Depending on the different types of investments there may be varying degrees of risk. Socially responsible investing does not guarantee any amount of success. Clients and prospective clients should be prepared to bear investment loss including loss of original principal. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.

Market Commentary | November 11th, 2024

by | Nov 11, 2024 | Market Commentary

Market Commentary | November 11th, 2024

Week in Review…

Following the highly anticipated U.S. election and rate cut decision by the Fed, last week saw equity market’s rally after the election of Donald Trump as the 47th president of the United States.

  • The S&P 500 rose 4.66%, snapping a two-week negative streak
  • The Dow Jones Industrial Average was up 4.61%
  • The Nasdaq finished the strongest, up 5.74%
  • The 10-Year Treasury yield ended the week at 4.34%

Last week saw U.S. elections take center stage as Donald Trump was reelected, winning both the electoral vote and popular vote. Additionally, Republicans won a majority in the Senate while the House is still up in the air as 19 races are still too close to call. Markets rallied in futures on early Wednesday morning, leading to a strong rally that persisted through the end of the week. In this week’s spotlight, we analyze some of the market’s reaction to Trump’s victory.

Additionally, the Federal Reserve cut its benchmark interest rate by 0.25 percentage points, bringing it to a target range of 4.50%-4.75%. This marks the second consecutive rate cut, aimed at supporting employment and addressing cooling inflation. The decision reflects the Fed’s ongoing efforts to recalibrate monetary policy to better align with current economic conditions.

Finally, the U.S. Department of Labor reported that initial unemployment claims rose slightly to 221,000 for the week ending November 2, 2024, up by 3,000 from the previous week’s revised level. This increase in claims suggests a modest uptick in layoffs, though overall levels remain historically low. The four-week moving average, which smooths out weekly volatility, decreased by 9,750 to 227,250, indicating a generally stable labor market.

Spotlight

How The Market Reacted Following the Election Results

The 2024 election was one of the closest elections in recent history, with no clear frontrunner emerging polls prior to Election Day. Uncertainty about the outcome led the market to not price in a decisive scenario for either candidate. Following the election outcome, markets reacted swiftly and positively, particularly in sectors expected to benefit from the new administration’s policies.

Equity Markets

U.S. Equity Markets’ capitalization rose by $1.62 trillion the following day, the fifth-best one-day return ever. The S&P 500 rose by 2.5%, reaching an all-time high. Small cap stocks saw the largest growth, with the Russell 2000 also hitting an all-time high and rising by 5.8%. This small-cap surge is largely attributed to the perception that tariffs will protect smaller companies with primarily domestic operations.

Enthusiasm was especially pronounced in the financial services and energy sectors, which returned 6.3% and 4.3%, respectively. Investors anticipate eased regulatory pressure on banks and increased dealmaking among smaller and midsize financial institutions under a Trump administration. Bank stocks were also said to be expected to benefit from a steeper yield curve and higher long-term interest rates. The energy sector gained from expectations of fewer environmental regulations, while clean energy stocks plummeted.

 

Fixed Income Markets

U.S. government bond yields increased due to anticipated fiscal expansion, larger deficits, and inflationary pressures. Trump’s victory had minimal impact on market expectations regarding the Federal Reserve’s cutting cycle, with projected rate cuts for 2024 and 2025 remaining unchanged. Credit spreads tightened, indicating a risk-on sentiment in the markets following the election.

Credit Spreads Tightened and Yield Rose for U.S. Corporate Bond

U.S. Dollar and Cryptocurrency

The U.S. dollar initially strengthened against other currencies but later relinquished some gains. The cryptocurrency market soared, with Bitcoin surpassing $76,000, an all-time high. This surge was generally attributed to the Republican party’s embrace of crypto and investors pricing in a less restrictive regulatory environment for the industry.

It is important to note that while elections often spark short-term volatility, markets typically return to fundamentals once the immediate effects settle. It is prudent to note that no one can predict market performance with certainty, and most strategies do not anticipate outsized moves to persist in the long term.

Week Ahead…

This week’s economic and market review centers around inflation with Consumer Price Index (CPI) data for October set to be released. Core CPI is expected to be unchanged at 0.3% month-over-month. Headline CPI is expected to be unchanged as well at 0.2% and 2.4%, for both month-over-month and year-over-year, respectively. Investors will pay close attention to these rates as concerns of possible reinflation have started to worry some market participants, which could limit the Fed’s rate cut regime.

Thursday we will get Producer Price Index (PPI) data which is expected to rise to 0.2% month-over-month from last month’s 0.0%. Crude oil inventories will also be closely watched following Trump’s election and unrest in the Middle East. Additionally, Fed Chairman Powell is expected to speak again on Thursday. Market participants will be curious what Powell has to say following CPI numbers as well as expand on last week’s comments regarding the election and working with President Trump.

Finally, we finish the week with retail sales numbers for October, which will be watched as we enter into the holiday months of the year. Core retail sales are expected to be lower, with a month-over-month change of 0.2% versus 0.5%. Headline retail sales are expected to be 0.3% versus last month’s 0.4% month-over-month.

This content was developed by Cambridge from sources believed to be reliable. This content is provided for informational purposes only and should not be construed or acted upon as individualized investment advice. It should not be considered a recommendation or solicitation. Information is subject to change. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice. The information in this material is not intended as tax or legal advice.

Investing involves risk. Depending on the different types of investments there may be varying degrees of risk. Socially responsible investing does not guarantee any amount of success. Clients and prospective clients should be prepared to bear investment loss including loss of original principal. Indices mentioned are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.