3Q:2024 Capital Markets Outlook Video

Hello, everyone, and welcome. The big story during the quarter was once again the S&P 500, continuing its surge higher and once again pushing to new highs. If we look at the price movements of the S&P, you’ll see macro data at the center—with the notable exception of Apple, which pushed the S&P higher on the back of growth expectations. But if you’re looking for the primary driver, all we have to do is overlay Treasury yields, and once again the pattern is clear. As yields rose in the first month, stocks struggled, and as they eased, it provided upward support to prices. So in summary, the S&P hit new highs, again. It did so on the back of the Mag Seven, again. Rates continue to be a driver, again. And a new entrant—keep an eye on the election, because it will impact markets as we get closer. As you can see at the back end here, that one little dot post the debate.

Now, staying with rates, inflation is still a primary driver, of course. And if we think in terms of the four components of headline inflation, the last bastion standing is services. And inside of those services prints, the driver is shelter, still. One really easy way to illustrate that is to simply remove shelter from CPI, and you can see that it’s pretty much back to pre-pandemic levels. And I don’t want to understate the potential for other areas to rise again, but that mix has largely been the story for some time now. And we’ve also talked about the unique lag effect of shelter, and with price changes showing up in the data about 15 months later. In rent, we see largely declining or stabilizing levels with increased supply, and in homes, prices moderating towards similar pre-pandemic bands.

We expect this component to continue to moderate over the coming months and support the beginning of rate cuts in the second half of this year. And from a labor perspective, unemployment has ticked up somewhat, but that has happened not because of job cuts—job gains continue to be healthy on a month-over-month basis—but [because of] increases in the size of the labor market, which takes pressure off of wage inflation. Likewise within job openings, quit rates, hires—all elevated during post-COVID—they appear to be making their way back toward pre-pandemic levels, further reducing inflationary pressures. And this is all translating into moderation on both the consumer and the producer fronts, with consumer spending and ISM services and manufacturing moderating from ’21 and ’22 levels. Putting it all together, we expect that growth will moderate this [year] and next year to slightly below long-run expectations.

And CPI will reach a two handle, alongside its friend PCE, later this year. Such a combination would be quite a feat and very soft-landing-ish, should it play out this way. Falling rates have been a key support of equities, as it boosted multiples, but current valuations sit at the high end of the range. So while falling rates will certainly be supportive, the heavy lifting in ’24 and ’25 is likely going to have to come from the E rather than the P. For some time now, quarterly earnings and expectations have largely been in a range, but going forward, those expectations have risen substantially. I mentioned Apple earlier. That surge was much less about, say, current earnings than forward expectations. And so for S&P performance going forward, the proof will be in the earnings pudding, if you will. But all of this is at an index level.

Performance has been a story of the Mag Seven, of course, versus the rest. And performance has been historically concentrated in those names—I mean really historically concentrated. The second quarter underscored that. Whereas the first [quarter] had tides lifting all boats, in the second, the S&P 493, if you will, generated negative returns, which is highlighted by the striking decline in correlations of individual stock returns to the index itself. Fortunately, history also tells us that at times of greatest concentration, like right now, the forward returns broadened out in each case, which will also be supported as rate and inflation volatility subsides. Which leads us to “Where should we be looking for opportunities of returns broadened?” And as many of you know, we’ve talked about these before, and there’s a reason for it. It’s because they fit the bill in terms of expectations for growth and current valuations. Value, as one example, has lagged growth meaningfully since the GFC.

But current valuations and earnings expectations versus broad growth are compelling, trust me on that one, particularly amongst market leaders. We’ve talked for years about high yield as an equity surrogate. But rather than going to the reasons why, today I’m simply going to highlight the general benefits of that over the past year. Despite lower drawdown and volatility, high-yield returns have acquitted themselves very well over the past 12 months, and with a starting yield-to-worst around 8%, the expectation for forward five-year returns is quite strong. And lastly—I know it’s boring—but as I’ve said for a while, the candy-coated center of yields today is high-grade sovereign bonds.

Yields are elevated, and meaningful capital-gains potential is there. But as the likelihood of rate cuts increases, the likelihood of sustained declines in yields—and fast—increases as well. Let’s make sure we’re not overlooking that source of returns over the next 18 months. And speaking of yields, for the rest of this year, in case we don’t have enough to do, just be mindful that as investors, we’ll be digesting both macro and election data, and both will impact markets. So pay attention to both, and with both, please look to separate the signal from the noise. As always, thanks for joining, and we’ll see you next quarter.