Weekly Market Commentary | October 21st, 2024

by | 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:

  1. Flood
  2. Wildfire
  3. Wind
  4. Heat
  5. 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 | 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.