Market Commentary | November 4th, 2024

by lportee53 | Nov 4, 2024 | Market Commentary

Market Commentary | November 4th, 2024

Week in Review…

With this past week being the last full week before investors go to the election polls, labor market numbers and inflation were the focus as markets struggled to overcome a surprise in payroll numbers.

The S&P 500 fell 1.37%, continuing a two-week negative streak
The Dow Jones Industrial Average was slightly negative at 0.15%
The Nasdaq finished the week down 1.50%, snapping a seven-week positive streak
The 10-Year Treasury yield ended the week at 4.38%

This last week was an important week as market participants updated their forecasts and debated the direction of the economy and interest rates alike. Looking back, the data released last week can loosely be grouped into three buckets: labor, economic/inflation, and earnings data.

The reports pertaining to the labor market last week seemed to indicate a solid labor market. The biggest headline from last week was the Bureau of Labor Statistics’ Nonfarm Payroll report that fell significantly short of expectations. However, this report was quickly written off as noise due to hurricane disruptions and union strikes. This consensus has been validated by a host of supplemental and surrounding data. For example, ADP Nonfarm Payroll showed a significant number of jobs had been added during October. Also, surrounding data like initial jobless claims, continuing jobless claims, and average hourly earnings all exceed expectations. Furthermore, the unemployment rate remained unchanged at 4.1% as well. The only miss was the Job Openings and Labor Turnover Survey (JOLTS) report on Tuesday. In aggregate, the labor market appears to be on solid footing.

Last week also provided a chance for markets to evaluate the directional trends in the economy and inflation. On Thursday the Bureau of Economic Analysis preliminary Q3 gross domestic product (GDP) showed the economy may be cooling, as GDP was 2.8% quarter-over-quarter compared to an estimated 3%. On the other hand, demand within the economy appears to be robust with pending home sales and crude oil beating estimates by a wide margin. Thursday’s Core Personal Consumption Expenditures (PCE) report showed inflation remains stubbornly above the Fed’s 2% target at 2.7%. Both economic activity and inflation are important inputs for nominal yields and as a result of last week, the market will have to navigate pricing treasuries with somewhat mixed signals.

Finally, earnings were strong for most of the mega cap stocks last week. Microsoft, Google, Amazon, and Meta reported earnings beating estimates. Trading for the week was mixed as markets priced in management’s forward guidance. Apple was the lone mega cap that was unable to beat estimated earnings. All in all, earnings continue to be strong.

Spotlight

A Look at Q3 Fund Flows

As we move into the last quarter of the year, we take a look at fund flows and see how investors are allocating given equity valuations and potential future rate cuts on the horizon. Year to date (YTD), we continue to see investors move from U.S. equities into fixed income broadly in both taxable and municipal bonds.

Overall, the total net flow across all categories for the year was $749,428 million, indicating robust activity in the investment landscape. Taxable Bonds has had a YTD net flow of $351,210 million, leading all categories. Over the past year, the net flow reached $388,710 million, reflecting strong investor interest given valuations in equities as well as potential rate cuts in the future. Compared to September 2023, the market share slightly decreased from 16.49% to 15.61%. Despite this small decline, Taxable Bonds remain a significant category in the market and rank third behind equities and money markets.

Equities have had a more U.S.-dominated year so far. In September 2024, U.S. Equity had a market share of 42.69% with a YTD net flow of $52,487 million, while International Equity had a market share of 11.98% with a YTD net flow of $10,947 million. Compared to September 2023, U.S. Equities’ market share increased from 39.63% to 42.69%, and International Equities’ market share slightly decreased from 12.06% to 11.98%.

Regarding cash, Money Market funds had a YTD net flow of $325,177 million, reflecting their continued popularity among investors. With a market share of 17.37%, they remain a significant portion of the investment landscape. Despite their substantial inflows, Money Market funds still represent cash on the sideline, indicating that many investors prefer to keep their assets in liquid, low-risk investments given market valuations and concerns around the election.

In September 2024, Actively Managed funds had a YTD net flow of $214,611 million and a market share of 57.09%, maintaining their top rank. However, this is a decrease from a quarter ago when actively managed strategies experienced significant outflows, reversing the revitalization seen in 2022 and 2023. Passively managed funds, with a YTD net flow of $534,818 million and a market share of 42.91%, have continued to attract more investor interest, reflecting a growing preference for passive management strategies we have seen over the last decade.

Compared to a quarter ago, where passive strategies saw $605 billion in inflows over the past year, the trend has persisted with substantial inflows in 2024. Despite actively managed funds holding a larger share of total net assets at $19.4 trillion compared to $13.8 trillion for passive funds, their market share has fallen below 60% year to date. This shift is likely due to investors favoring lower cost indexing versus higher cost active management within traditional asset classe

Week Ahead…

Next week’s economic and market review centers around the anticipated rate cut and its implications on market sentiment, against the backdrop of the upcoming election. With the election approaching, markets have been cautiously optimistic, as investors are gauging potential policy changes while closely tracking economic indicators. While political uncertainties often create short-term volatility, the market appears relatively stable as of now.

The Federal Reserve is widely expected to implement a 25 basis points (bps) rate cut next week, following a 50 bps cut during their September meeting. This expectation reflects a trend of slowing inflation and slightly softer-than-expected GDP growth over the past couple months, which has signaled to the Fed that a moderate easing could help sustain economic momentum. However, expectations for a more aggressive 50 bps cut remain low, as recent data, such as the ADP jobs report, show no signs of a significant economic downturn. Job market resilience and improving consumer sentiment over the past quarter underscore the Fed’s current strategy of gradual adjustments rather than abrupt rate cuts.

As we approach the year end, market expectations align closely with the Fed’s own projections released during September, where a cautious yet steady path was indicated. The market is pricing in a high likelihood of another 25 bps rate cut during the December meeting, barring any sudden economic changes. Investors are already factoring in this anticipated rate trajectory, which could bring further stability to equities and bonds. As a result, markets may see modest gains if the Fed’s actions next week align with these projections, providing a smoother close to the year as rate adjustments become more predictable.

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.

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Weekly Market Commentary | October 28th, 2024

by lportee53 | Oct 28, 2024 | Market Commentary

Weekly Market Commentary | October 28th, 2024

Week in Review…

The major indices exhibited mixed performance for the week ending October 25, 2024.

The S&P 500 declined by 0.96%, ending its six-week winning streak
The Dow Jones Industrial Average fell by 2.68%, also recording its first weekly loss after six consecutive weeks of gains
The tech-heavy Nasdaq Composite continued its upward trajectory, finishing the week 0.14% higher and extending its winning streak to seven weeks
The 10-Year Treasury yield concluded the week at 3.90%

The Federal Reserve’s latest Beige Book, which reports on current economic conditions across the 12 Federal Reserve Districts, indicated stagnant growth in most regions over the past month. Manufacturing continues to show weakness, and consumer data revealed that shoppers across all income levels, including higher-income brackets, are increasingly seeking lower-priced alternatives for goods and services.

U.S. initial jobless claims decreased by 15,000 to 227,000, while continuing claims rose to 1.897 million for the week ending October 12. Additionally, U.S. Purchasing Managers’ Indices (PMIs) suggested strong economic growth at the start of the fourth quarter, with both Services PMI and Manufacturing PMI advancing in October.

The University of Michigan’s consumer sentiment index increased to 70.5 for October, up from 68.9 in the previous month. With inflation expectations easing, consumers are expressing optimism about the future of the economy. Economists will be closely monitoring this trend to see if it continues.

Existing home sales in September declined 1% from the previous month to a seasonally adjusted annual rate of 3.84 million, marking the lowest level since October 2010. In contrast, new home sales rose to their highest levels since May 2023, increasing 4.1% to 738,000 units on a seasonally adjusted annual basis. The average price of new homes has decreased by approximately 3% over the past year, while new home completion has increased by 40% compared to pre-pandemic levels.

Spotlight

Growth of Defined Outcome ETFs

Defined Outcome ETFs, also known as buffer ETFs, offer investors predetermined range of outcomes over specific periods, blending downside protection with upside potential. These funds have gained popularity among risk-conscious investors navigating volatile markets.

Growth of Assets and Funds

The popularity of Defined Outcome ETFs has surged in recent years, driven by market volatility and investors’ desire for more predictable returns. Per Morningstar, “Assets in defined outcome ETFs have grown to $22 billion as of January 2023 from approximately $183 million as of December 2018. The number of products jumped to 169 ETFs (in 2023) available from fewer than 10.” This rapid growth was attributed to several factors:

Striking a balance between equity volatility and fixed income returns
Offering some downside protection while allowing for some upside participation
Providing the liquidity, transparency, and tax efficiency inherent in the ETF structure

Types of Defined Outcome ETFs

While a detailed examination of their structural design is beyond the scope of this discussion, Defined Outcome ETFs generally fall into three primary categories:

Funds With Upside Cap: These funds buffer a range of losses while capping returns beyond a certain point. This is the most common approach.
Funds With Partial Upside Exposure: These ETFs provide downside protection by capturing only a portion of positive index returns instead of implementing a cap.
Downside Floor: This strategy may offer maximum loss protection in an extreme down market with a lower cap on gains which may provide returns higher than CDs or Treasury bills. However, in a market with “average” volatility, it may offer no protection at all.

Some providers also offer fund-of-funds structures aimed at providing more flexibility, albeit with higher fees and fluctuating upside cap.

Cost of Protection

While Defined Outcome ETFs offer attractive benefits, they come with certain trade-offs:

Higher fees (typically 70-80 basis points above traditional S&P 500 ETFs)
Most do not pass through dividends from underlying stocks
Capped upside potential may result in missed gains during strong market rallies

The effectiveness of Defined Outcome ETFs depends on several factors:

Market Performance: The actual performance of the underlying index or asset during the outcome period
Buffer Level: The amount of downside protection offered by the ETF
Cap Level: The maximum return potential of the ETF. It is occasionally referred to as the Cap Rate, though this term has a distinct meaning in the context of real estate investments.
Timing: When an investor enters and exits the investment relative to its outcome period
Fees: The expense ratio of the ETF

General Investment Structure and Investor Outcomes

Defined outcome ETFs use options strategies, making them complex before option expiration. Options have two values:

Intrinsic value: The difference between strike price and underlying security price
Extrinsic value: Additional value based on time until expiration and market volatility

At expiration, options are valued only on intrinsic value. Before expiration, most options in these ETFs have both intrinsic and extrinsic value.

The ETF’s price change relative to the S&P 500 depends on the cumulative “delta” of its options. Delta measures how much an option’s price changes when the underlying security’s price changes.

Moreover, these funds reset annually, offering a new upside cap and refreshed protection for the next 12-month period.

Defined Outcome ETFs represent a notable innovation in the ETF landscape, offering investors a tool to potentially manage risk while maintaining exposure to equity markets. Matt Kaufman, Head of Calamos Investments, notes that Buffer ETFs may present a potential solution for a large demographic of retirees by addressing longevity risks and combating inflation for this group. However, investors should carefully evaluate their personal risk tolerance, market expectations, protection costs, associated risks, and investment horizon before incorporating these products into their portfolios.

Financial professionals should be aware that Cambridge classifies Defined Outcome ETFs as liquid alternatives. As such, these investment products are subject to specific concentration guidelines that apply to Non-Conventional Funds and Traded Securities.

Week Ahead…

The upcoming week is packed with several significant economic reports that will provide crucial insights into the U.S. economy’s state. These reports will cover consumer confidence, job openings, payroll data, inflation, and manufacturing activity.

The timing of these data releases is particularly significant given the Federal Open Market Committee’s (FOMC) November meeting scheduled for the following week (November 6-7). Market participants will closely analyze this information to assess the probability of potential rate movements.

The labor market will be in the spotlight with the releases of Job Openings and Labor Turnover Survey (JOLTS) job openings, ADP Non-farm Payroll, and Nonfarm Payrolls reports.

Consumer and economic growth indicators will also be closely watched, including the Consumer Confidence (October) and preliminary Q3 gross domestic product (GDP) releases.

The Core Personal Consumption Expenditures (PCE) Price Index release will be scrutinized as the Federal Reserve continues to balance its dual mandate of price stability and maximum employment. This data may be crucial in shaping the Fed’s policy decisions.

Five of the “Magnificent 7” tech companies – Apple, Microsoft, Google, Amazon, and Meta – are scheduled to report their Q3 2024 earnings next week. These reports will provide valuable insights into the health of the tech sector and its impact on the broader economy.

Given the abundance of critical economic data and high-profile earnings reports, next week promises to be a pivotal period for financial markets and economic forecasting.

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 | October 21st, 2024

by lportee53 | Oct 21, 2024 | Market Commentary

Weekly Market Commentary | October 21st, 2024

Week in Review…

As quarterly earnings come to an end, all major indices ended the week in positive territory, as small caps led with the Russell 2000 ending the week up 1.87%, leading to signs that small cap stocks are continuing their third quarter turnaround this year. Weekly performance for the week ending October 18, 2024:

The S&P 500 rose last week 0.85%
The Dow Jones Industrial Average climbed 0.96%
The Nasdaq finished the week up 0.26%
The 10-Year Treasury yield ended the week at 4.08%

Last week the market wrapped up quarterly earnings for many of the large U.S. banks and most were able to exceed profit expectations. Drivers of these profits and future economic conditions were key takeaways from the earnings reports. Year-over-year, banks are having to spend more to retain deposits to fund their loan programs and as a result, saw a decrease in net interest margin. The Federal Reserve’s September rate cut should help reduce this cost; however, banks like JPMorgan are still expecting margin compression to continue into the next quarter. On the other hand, a major driver in bank profitability was the Investment Banking and Wealth Management divisions. Looking forward, banks like JPMorgan, Citibank, and Goldman Sachs significantly increased the amount of cash set aside for potential credit losses.

On Thursday, the market received important updates on the overall strength of the economy. Thursday provided two indicators that consumer demand and economic activity remain strong. For starters, the Census Bureau released September month-over-month headline and Core Retail Sales. Core Retail Sales significantly exceeded expectations, coming in at 0.5%, compared to a forecasted 0.1%. The report showed that consumer demand is strong, and by extension, so is the U.S. economy. Because consumer spending accounts for a large percentage of U.S. gross domestic product (GDP), this report is viewed as a bullish indicator for future GDP forecasts.

Thursday also provided an update on crude oil inventories, which is a key indicator of economic activity/demand. Once again, economic activity and demand proved to be robust as oil inventories decreased by 3.991 million barrels.

Friday was headlined by Netflix’s blowout earnings and September housing data. Netflix reported increases in both revenues and net income. The company also reported an increase in total subscribers of 14%. On the housing front, the Census Bureau reported fewer-than-expected new building permits, and the U.S. Department of Commerce reported fewer-than expected housing starts. Both reports indicate the adverse effect higher interest rates are having on builders.

In summary, the economy appears to be doing well, and this strength is being reflected in corporate earnings. However, sluggish housing growth and potential credit losses will need to be monitored going forward.

Spotlight

How Homeownership is Being Redefined by Enviornmental Uncertainty

The numerous environmental and financial challenges resulting from recent natural disasters in the U.S. have left many Americans financially struggling, wondering what might happen next, and if there are any preventative measures that should be taken. According to an analysis published by Nature Climate Change, over 14 million U.S. properties are at risk of flooding, with annual damages exceeding $32 billion. By 2050, these numbers will rise by at least 11%, adding substantial pressure to insurers, mortgage lenders, and property owners.

Millions of Americans have been watching with an alarm as their homeowners insurance premiums have risen and their coverage has shrunk in recent years. According to LendingTree, premiums have risen 37.8% nationwide since 2019, and continued to rise 5.8% merely in the first quarter of 2024. As stated by Insurify, if a claim is made, the insurance rates will go even higher, as much as 25%, if you claim a total loss of your home. Because of this, most properties are simply covered with HO-3 (standard), while riders such as flood and earthquake insurance are being passed due to cost.

Average Annual Cost of Home Insurance

As a result of the increasing premiums from claims and natural disasters, climate risks have become a crucial factor in the home-buying decision. Zillow has stated that more than 80% of potential home buyers now consider climate risks when choosing a home. However, it’s not just about knowing the risks; understanding how they impact long-term affordability, particularly through rising insurance costs, is just as important.

During the house-hunting process, there are five key climate risks that home buyers are considering:

Flood
Wildfire
Wind
Heat
Air quality

Climate risks are a major concern for younger home shoppers, who are currently driving the housing market. The median age of today’s home buyer is 39, and first-time buyers make up 50% of all buyers. According to Zillow, Millennial and Gen Z shoppers, who comprise 54% of all home buyers, are most likely to consider climate risk when determining where to shop for a home.

Percentage of Climate Risk Considerations Per Generational Class

As of the beginning of October, all three major house hunting sites (Zillow, Realtor.com, and Redfin) provide ratings for each climate criteria pertaining to the area of every individual listing. Understanding a home’s vulnerability to risks like flooding and wildfires also plays an important role in other aspects of a homeowner’s financial health, such as financial planning, since the cost of insuring a property against climate-related risks can dramatically influence monthly payments and the affordability of a home. For sellers, having a clear understanding of a property’s climate risk can be equally valuable. Sellers can take proactive measures to mitigate hazards, such as flood-proofing or adding fire-resistant landscaping, which can enhance the home’s appeal and market value, and minimize unexpected issues at closing.

With these five published climate-risk criteria, a new concerning trend has emerged — many homes in climate-risk areas are overvalued. For example, a study shows that properties within the 100-year flood zone are priced at about 8.5% higher than they should be, as flood risks are often not fully accounted for in market values. This has sparked fears of a potential real estate bubble in these risky areas, as home prices may eventually deflate, leaving homeowners vulnerable to financial losses. With flood risks not properly factored into home values, many Americans could face significant losses in home equity, causing ripple effects on local governments heavily relying on property taxes.

Municipalities all over the U.S. will need to make their communities more resilient despite climate change. According to Redfin, paying for mitigation and adaptation measures will likely need to be funded through an increase in property taxes and fees. Additionally, as people leave coastal communities due to flooding, or tropical areas due to hurricanes, the tax base in those areas will shrink, further driving up taxes for those that remain.

With increased property taxes and a decrease in the resale value of homes with high climate risk, the local GDP of that area will start to deteriorate due to less economic activity and residential occupancy. Consequently, these areas will start to become underdeveloped, and eventually become deserted. Furthermore, since insurance companies are charging more for coverage in climate-risk areas due to the increased risk that they will have to pay out claims, catastrophe bonds are gaining more market share. These bonds provide the insurance company sources of funding when such a condition occurs, also providing short-term diversification benefits against market and economic risks for the investor.

Week Ahead…

Looking ahead to next week, we anticipate a relatively quiet period for economic data. We will receive the first reports on Existing Home Sales and New Home Sales since the Federal Reserve began cutting interest rates, which will help us assess the current state of the residential real estate market. It’s important to note that the effects of interest rate changes take time to reflect in housing data indicators, and market participants are expecting minimal changes with these upcoming releases.

Market participants will closely monitor the Manufacturing and Services Purchasing Managers Index (PMI) on Thursday. The PMI offers a forward-looking view on the economy’s health, which will help shape the market’s expectations regarding future interest rate cuts.

The University of Michigan’s consumer sentiment data, set for release on Friday, will be closely observed. Last month’s sentiment was 1.2 index points lower than October, but remained well within the margin of error, following two straight months of gains. While inflation expectations have eased substantially, consumers will likely continue to express frustration over high prices. Consumers will likely remain cautious with elevated geopolitical tension and the upcoming election.

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 | October 14th, 2024

by lportee53 | Oct 14, 2024 | Blog, Market Commentary

Weekly Market Commentary | October 14th, 2024

Week in Review…

With all major indices posting positive results, the S&P 500 also ended at a fresh all-time high, closing above 5,800 for the first time. Meanwhile, the Nasdaq is now approximately 1.6% below its July 10 record close. Weekly performance for the week ending October 11, 2024 was:

The S&P 500 rose 1.11%
The Dow Jones Industrial Average climbed 1.21%
The Nasdaq finished the week up 1.31%
The 10-Year Treasury yield ended the week at 4.094%

The Federal Open Market Committee (FOMC) minutes from the September meeting provided additional context for the Federal Reserve’s decision to implement a 50-bps rate cut. A substantial majority of participants supported this larger cut, viewing it as a recalibration of interest rates rather than an emergency measure. This decision reflects the Fed’s confidence in the progress made towards its inflation goal, while also acknowledging the need to balance risks to both employment and inflation targets.

The release of Consumer Price Index (CPI) data on Thursday was crucial for shaping inflation expectations. Both headline and core CPI came in slightly above forecasts, with headline CPI (September year-over-year (YoY)) at 2.4% and core CPI (September YoY) at 3.3%. These figures suggest that inflation may remain persistent, potentially impacting future rate cut expectations and market pricing.

The impact of sticky inflation expectations was evident in the bond market. The 10-year Note Auction on Wednesday showed a significant increase in interest rates, rising from 3.648% to 4.066% over the past month. Similarly, 30-year bond rates climbed from 4.015% to 4.389%. Consequently, Freddie Mac reported a jump in the average 30-year fixed-rate mortgage to 6.32%, up from 6.12% the previous week. This was not welcomed news in an already sluggish residential housing market.

Two major regulatory decisions made headlines last week. The Department of Justice filed a 32-page document proposing sanctions against Google following its guilty verdict in an antitrust case. These proposed sanctions may have far-reaching implications for other tech giants like Apple, Microsoft, and Amazon. Separately in the banking sector, TD Bank pleaded guilty to violating federal anti-money laundering and bank transparency laws. The bank faces a record-breaking $3.1 billion fine under the Bank Secrecy Act and will have its total assets capped at $434 billion. This penalty underscores the increasing regulatory scrutiny in the financial sector.

Spotlight

Unpacking Factor Performance Year-to-Date in 2024

Factor investing is an investment approach that targets specific drivers of returns across asset classes, known as factors.

Traditional asset allocation typically involves dividing investments among broad asset classes like stocks, bonds, and cash based on an investor’s risk tolerance and goals. In contrast, factor investing goes a step further by focusing on specific attributes within those asset classes that have historically driven return. In other words, practitioners claim that factor investing offers a more granular, systematic approach to portfolio construction by targeting specific return drivers within asset classes, potentially enhancing diversification, risk management, and outperformance compared to traditional asset allocation. The research team had written a snapshot on factor investing in an earlier article that was published on November 27, 2023.

These factors are quantifiable characteristics that can explain differences in stock returns. The main types of factors include:

Style factors (e.g., value, momentum, quality, size)
Macroeconomic factors (e.g., economic growth, inflation, interest rates)

Performance Review

Using the MSCI Factor indices as the basis for performance, the following inferences can be derived:

MSCI USA Factors
- Top performers:
  - Minimum Volatility (Q3: 9.21%)
  - Momentum (YTD: 30.33%, TTM: 46.84%)
  - Quality (YTD: 24.48%, TTM: 39.30%)
- MSCI World ex USA Factors
  - Top performers:
    - Minimum Volatility (Q3: 11.51%)
    - Momentum (YTD: 18.90%, TTM: 30.92%)
  - Underperformer:
    - Yield (Q3: 0.74%, YTD: 2.24%, TTM: 3.04%)

Key Highlights

MSCI USA Factors Outperform World ex USA Counterparts

The stronger performance of USA factors relative to their World ex USA counterparts suggests:

Continued strength of the U.S. economy compared to other developed markets
Possible currency effects favoring U.S. investments
Differences in sector composition between U.S. and international markets

Momentum: A Standout Factor

Momentum emerged as a leading factor in both regions, particularly over longer timeframes
This implies:
- Continuation of existing market trends
- Strong performance in certain sectors and stocks
- Possible concentration in high-growth areas

Minimum Volatility Factors Gain Traction

Minimum volatility factors performed well in Q3 2024 in both regions
Strong Q3 performance suggests increased investor preference for lower-risk strategies
Possible drivers include economic uncertainty, market volatility concerns, and a shift towards defensive positioning

Equal Weighted Indices Show Solid Performance

Solid performance of equal weighted indices suggests:
- Healthy market breadth
- Possible rotation into mid-sized or small cap companies

Quality Factors Demonstrate Strength

Quality factors, although moderate in the near term, showed solid performance over the trailing 12 months, particularly in the USA
This suggests:
- Investor preference for companies with strong fundamentals
- Focus on stable earnings and low debt
- Possible “flight to quality” due to economic concerns

Other Factor Performances

Value factors performed moderately well, with better returns in World ex USA for Q3
Low size factors (large and mid-cap companies per MSCI definition) demonstrated strong performance, particularly in World ex USA
Yield factors significantly underperformed, especially in World ex USA markets
- Potential reasons include:
  - Rising interest rates
  - Shift away from traditional dividend-paying sectors
  - Preference for growth over income

In today’s investment landscape, factor-based ETF products have become increasingly popular among private wealth investors. These products, provided by prominent asset managers, seek to harness specific factor premiums while ensuring transparency and liquidity. Understanding factor interactions is also crucial for effective portfolio construction, as combining low-correlation factors can potentially improve risk-adjusted returns and reduce underperformance periods. Recent research favors multi-factor approaches over factor timing, a trend observed in both U.S. and international developed markets. While pricier than traditional index funds, factor strategies offer a cost-effective alternative to active management for investors seeking enhanced returns.

Definitions

MSCI Factor indices are designed to capture specific investment characteristics or “factors” that have been shown to drive risk and return in equity markets. These indices are constructed by modifying the weighting scheme of a parent index (e.g., MSCI World or MSCI USA) to tilt towards stocks exhibiting the desired factor characteristics

Size: Focuses on smaller companies within the parent index
Value: Targets stocks that appear undervalued based on fundamentals like book value and earnings
Quality: Emphasizes companies with strong balance sheets, stable earnings, and other “quality” metrics
Momentum: Aims to capture stocks with strong recent performance
Minimum Volatility: Seeks to minimize overall portfolio volatility
Low Size: Assigns higher weights to large and mid-cap companies, often using inverse of the traditional ‘size’ factor defined by Fama French
Equal Weighted: Allocates the same weight to each constituent in the index
Diversified Multifactor: Combines multiple factors (e.g., value, momentum, quality) to create a diversified factor exposure

Week Ahead…

Next week’s economic focus will center on demand indicators, with future interest rate speculation playing a secondary role. The health of the U.S. economy and consumer demand will take center stage in the week ahead.

Thursday will bring the release of headline Retail Sales and Core Retail Sales data. Core Retail Sales measures the change in total retail sales value, excluding automobile sales. These reports are crucial indicators of retail consumption strength, which is significant because consumption constitutes a large portion of U.S. gross domestic product (GDP). GDP, in turn, is a key factor in forecasting stock market returns and inflation expectations.

Following last week’s surplus of 5.81 million barrels, the upcoming crude oil inventory report will be closely watched. Oil demand serves as an indicator of overall economic activity, affecting both stock prices and broader economic sentiment. A continued surplus could suggest weakening demand, potentially signaling economic slowdown.

September’s Housing Starts and Preliminary Building Permits will offer insights into both the supply and demand dynamics of the housing market. These metrics are particularly important given the significant leverage involved in construction and home purchases. Strong numbers could indicate economic confidence, while weak figures might suggest caution among investors and buyers due to high interest rates or economic uncertainty.

While not the primary focus, discussions about future interest rates will continue in the background. The market will likely interpret the week’s economic data through the lens of potential Federal Reserve actions, particularly regarding the timing and extent of future rate cuts.

These demand indicators will collectively provide a comprehensive picture of current economic conditions and consumer confidence, helping to shape market expectations for the near future.

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 Insights – September 30th, 2024

by lportee53 | Sep 30, 2024 | Blog

Weekly Market Insights | September 30th, 2024

Rate Cut Momentum; D.C. Averts Shutdown

Stocks moved higher last week, continuing to build on the momentum generated after the Federal Reserve decided to cut short-term rates by 0.50 percent.

The Standard & Poor’s 500 Index gained 0.59 percent, while the Nasdaq Composite rose 0.95 percent. The Dow Jones Industrial Average added 0.62 percent. The MSCI EAFE Index, which tracks developed overseas stock markets, gained an eye-catching 3.53 percent.^1,2

Congress Passes Spending Bill

Stocks started the week tepidly but in the green, as investors mostly shrugged off Tuesday’s weak consumer confidence report. Then, at midweek, markets put on the brakes as investors appeared to take profits after a four-day winning streak.^3,4

On Thursday, markets rallied on news that the final Q2 gross domestic product estimate showed the economy increased at an annual rate of 3.0 percent. Then Friday, the PCE, or Personal Consumption and Expenditures Index, showed inflation had cooled slightly more than expected in August, which some believe may influence the Fed’s decisions on short-term rates at its November meeting.⁵

Finally, a continuing resolution was passed by both houses of Congress last week and signed by President Biden Friday morning, assuaging concerns over a government shutdown. The resolution funds the government until December 20.⁶

^{Source: YCharts.com, September 28, 2024. Weekly performance is measured from Monday, September 23, to Friday, September 27.}^{TR = total return for the index, which includes any dividends as well as any other cash distributions during the period.}^{Treasury note yield is expressed in basis points.}

China’s Stimulus Package

This week, the head-turning performance came from outside the U.S.

As measured by the MSCI EAFE (Europe, Australia, and Far East) Index, international stocks rose more than 3 percent following news of China’s stimulus package, which could be as much as 2 trillion yuan, or $284 billion. China’s program also cut banks’ reserve requirements and lowered a key short-term interest rate.

While the EAFE Index doesn’t track stocks from Mainland China, the stimulus package had far-reaching implications for other countries.^7,8

This Week: Key Economic Data

Monday: Fed Chair Jerome Powell speaks. Fed Official Michelle Bowman speaks.

Tuesday: ISM Manufacturing Index. Construction Spending. Fed Official Raphael Bostic speaks.

Wednesday: ADP Employment Report. Motor Vehicle Sales. Fed Officials Beth Hammack, Alberto Musalem, Michelle Bowman, and Thomas Barkin speak.

Thursday: Jobless Claims. Factory Orders. ISM Services Index. 10-Year Treasury Note announcement. Fed Officials Raphael Bostic and Neel Kashkari speak.

Friday: Employment Situation. Fed Official John Williams speaks.

^{Source: Investors Business Daily – Econoday economic calendar; September 27, 2024}^{The Econoday economic calendar lists upcoming U.S. economic data releases (including key economic indicators), Federal Reserve policy meetings, and speaking engagements of Federal Reserve officials. The content is developed from sources believed to be providing accurate information. The forecasts or forward-looking statements are based on assumptions and may not materialize. The forecasts also are subject to revision.}

This Week: Companies Reporting Earnings

Tuesday: NIKE, Inc. (NKE), Paychex, Inc. (PAYX)

Thursday: Constellation Brands Inc (STZ)

^{Source: Zacks, September 27, 2024}
^{Companies mentioned are for informational purposes only. It should not be considered a solicitation for the purchase or sale of the securities. Investing involves risks, and investment decisions should be based on your own goals, time horizon, and tolerance for risk. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. Companies may reschedule when they report earnings without notice.}

Food for Thought…

“The emblem of a philosophy is not that it contains a set of specific thoughts, but that it generates a way of thinking.”

– Samuel R. Delany

Tax Tip…

Selling Your Car or Buying From a Private Seller?
Here Are the Tax Tips You Should Know

If you’re selling your car for less than what you paid, you likely won’t need to pay any sales tax because the Internal Revenue Service (IRS) considers selling a used car for less than what you paid a capital loss. However, if you’re selling your car for more than what you paid (like if it’s a classic car you’ve restored and it’s increased in value), you may need to pay sales tax.

If you’re buying a car from a private seller, you may need to pay sales tax, but this sales tax doesn’t go to the seller – it goes to the Department of Motor Vehicles and is part of your car’s registration.

This information is not a substitute for individualized tax advice. Please discuss your specific tax issues with a qualified tax professional.

Tip adapted from CarGurus⁹

Healthy Living Tip…

Stretches to Complement Your Workout

Here are some great stretches that will open up your hips, stretch out your hamstrings, and give your quads some love after a long run or lifting session:

Hamstring Stretch – Lay on the ground with your legs straight up. Gently pull one leg toward you until you feel pressure. Repeat with the other leg.
Figure Four – Sit on the ground with your legs bent and knees up. Gently rest one ankle on the quad of the opposite leg. If this is too much, straighten one leg on the floor and rest your ankle on your thigh while it’s on the ground.
Child’s Pose – This everyday yoga movement can also be a great stretch. Hold the regular child’s pose with your knees about hip-width apart, or intensify the stretch by bringing your knees out wider.

Tip adapted from Runner’s World¹⁰

Weekly Riddle…

What invention permits you to peer through any wall?

Last week’s riddle: 8549176320 is a large number and unique for two reasons. First, it presents all numerical digits from 0 to 9 without repeating; what is the other reason?
Answer: When the ten numerals are spelled out and expressed as words, the words are in alphabetical order from start to finish (eight, five, four, nine, one, etc.)

Photo of The Week…

Beijing National Stadium

Chaoyang, Beijing, China

,

Footnotes And Sources

^{1. The Wall Street Journal, September 27, 2024}

^{2. Investing.com, September 27, 2024}

^{3. CNBC.com, September 24, 2024}

^{4. CNBC.com, September 25, 2024}

^{5. BEA.gov, September 26, 2024}

^{6. The Wall Street Journal, September 22, 2024 OR
The Hill, September 25, 2024}

^{7. The Wall Street Journal, September 27, 2024}

^{8. The Wall Street Journal, September 27, 2023}

^{9. cargurus.com, May 8. 2024}

^{10. Runnersworld.com, May 8. 2024}

Investing involves risks, and investment decisions should be based on your own goals, time horizon, and tolerance for risk. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost.

The forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.

The market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results.

The Dow Jones Industrial Average is an unmanaged index that is generally considered representative of large-capitalization companies on the U.S. stock market. Nasdaq Composite is an index of the common stocks and similar securities listed on the NASDAQ stock market and is considered a broad indicator of the performance of technology and growth companies. The MSCI EAFE Index was created by Morgan Stanley Capital International (MSCI) and serves as a benchmark of the performance of major international equity markets, as represented by 21 major MSCI indexes from Europe, Australia, and Southeast Asia. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general.

U.S. Treasury Notes are guaranteed by the federal government as to the timely payment of principal and interest. However, if you sell a Treasury Note prior to maturity, it may be worth more or less than the original price paid. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors.

International investments carry additional risks, which include differences in financial reporting standards, currency exchange rates, political risks unique to a specific country, foreign taxes and regulations, and the potential for illiquid markets. These factors may result in greater share price volatility.

Please consult your financial professional for additional information.

This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG is not affiliated with the named representative, financial professional, Registered Investment Advisor, Broker-Dealer, nor state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and they should not be considered a solicitation for the purchase or sale of any security.