Category: CIO Insights

April 5, 2024

Posted by Jason Edinger on Tuesday, April 2, 2024

Coming off a robust quarter to conclude 2023, US equities rode the momentum to a series of new all-time highs in Q1, delivering the strongest start to a year since 2019. The S&P500 rose by 10.6% on a total return basis and notched twenty-two record highs during the quarter. While the rally was uniform across the board, small-caps lagged large-caps by a wide margin (Russell 2000 +5.2% vs S&P500 +10.6%) as the market digested a less dovish rate cut environment moving forward. Growth outperformed value, and ten of the eleven GICS sectors were positive during the quarter, with real estate the only sector showing red as of March 31st. To put it mildly, the sailing continues to be smooth.

In contrast to last quarter’s rally – which was a result in large part due to the dramatic fall in bond yields – the extension of gains this quarter came despite a more hawkish repricing of future monetary policy. The Federal Open Market Committee held its benchmark rate constant for the fifth consecutive month (5.25-5.5%) as it seeks more economic data to show “greater confidence” that inflation is on the path toward the magical 2% number. As of this writing, the Fed dots show a projected three cuts in 2024, potentially beginning as early as June or July. This is in stark contrast to the approximately seven cuts seen by the market to begin the new year. With gas prices moving steadily higher to $3.53 per gallon on average, March inflation will be a major influence on the Fed’s decision to begin easing policy.

In terms of economic data, we saw Q4 GDP revised up to 3.4% from its initial 2% consensus, based on a strong consumer who just refuses to stop spending. And why would they? The labor market remains incredibly resilient, with 229K jobs created in January and 275K in February. At the same time, inflation as measured by the Fed’s favorite indicator continues to sink, affirming the goldilocks scenario comprised of cooling inflation, decreasing interest rates, and broadly supportive economic conditions. Not too hot, not too cold, but just right.

Equities are not the only asset class tagging all-time highs as we move into April. Both Bitcoin and gold prices touched unfamiliar territory during the quarter, with the latter now costing more than $2,250 per ounce, up nearly 40% from its recent bottom in 2022. Given gold’s status as a safe haven asset that typically rallies during risk-off markets, this recent uptrend is slightly unusual, but the precious metal continues to increase in value as both the US Dollar and interest rates are projected to fall during the back half of this year. The fact that gold easily blasted through the psychologically crucial $2,000 mark – and has not fizzled – shows that prices appear to be consolidating before the next move.

Finally, during the quarter former and current Presidents Trump and Biden secured enough delegates to clinch the nomination for their respective parties in the upcoming election later this year. While the election has heretofore been relegated to the back burner of investor interest, it should become a key component in future quarters as each candidate’s platform is firmed up, defined, and communicated to the public.

Q1 earnings season is rapidly approaching, and market’s current streak of gains will be highly dependent on those results. The ongoing rally is historic by the true definition of the word, as it is only the ninth time since 1940 that consecutive quarters have delivered back-to-back double-digit gains. Historically, this is a bullish signal and, against the goldilocks backdrop described above, the path to higher returns from here seems clear. However, it is likely that the remainder of the year will be increasingly challenging as the election unfolds and inflation levels bob and weave. Discipline and a sound long-term plan remain critical.

As ever, we thank you for your continued trust and support. Happy spring to all.

All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.

February 13, 2024

Posted by Jason Edinger on Friday, January 5, 2024

In Review:

Following a tumultuous and disappointing 2022, we faced a fork in the road in terms of what would lie ahead in 2023: a recovery and rally to claw back some or all the previous year’s losses or a continuation of the pain and tough times. It was a deciding moment and may we all be thankful for the road not taken. The market GPS guided in the right direction, and 2023 ended up being a surprisingly strong year for both stock and bond markets.

Despite widespread predictions for a follow-through of the 2022 bear market and an all-but-assured recession, equity performance was impressive. The NASDAQ 100 turned in its best year since 1999 (+55%) while the most widely quoted market index, the S&P500, had an admirable +26.3% year. The Dow Jones underperformed slightly, while small caps enjoyed a furious rally over the final nine weeks of 2023 to conclude the year with a +24.3% mark. All told, equity markets finished 2023 on a high note and on the brink of brand-new all-time highs. It was a good year, and we will take it.

While stocks did most of the heavy lifting, bonds also delivered impressive returns throughout the year. Much attention was paid to the benchmark 10-year Treasury yield, which round-tripped the year to end unchanged after falling as low as 3.3% before ripping up to 5%. All told, the total return on the 10-year note was close to 4% and the aggregate bond index delivered 5.65% of total return in 2023. These returns were achieved despite the Federal Reserve raising interest rates four times throughout the year, capping a 2022 campaign which saw a cumulative 5.25% of aggregate rate increases.

The economy proved exceptionally resilient in 2023. A banking crisis in March resulted in the second largest bank failure in US history, with regional banks selling off nearly 30% in just three trading days. Although steadily decreasing, inflation remained high and the Fed seemed intent on hiking the economy into a recession. Nevertheless, a slew of fiscal and liquidity support was introduced to combat the drag from balance sheet unwinding, an inverted yield curve, and inflation. The labor market was robust throughout the year, as the unemployment rate is holding near generational lows as it appears increasingly likely that the Fed will achieve its highly coveted soft landing. From an economic standpoint, 2023 will be remembered for the recession that never materialized.

In Prediction:

Looking forward, the stage appears set for a continuation of the positive trends that played out in 2023. The economy, far from slowing down or contracting as many economists were convinced would happen, remains robust especially in the areas of job growth, consumer spending, and GDP. The so-called Goldilocks economy – not too soft, not too cold – is likely to set in and act as a foundation for full employment, economic stability, and continuously declining inflation. Against this backdrop, the economy can offer just enough support for financial markets to do well, without the threat of overheating and further potential rate hikes.

Inflation and interest rates will remain important going into the new year, but all signs point to a leveling out (finally). We have seen inflation cool steadily over recent months, largely a result of declining prices for food, energy, and commodities. However, services inflation and shelter (e.g., rent and housing costs) remain high and often operate on a lag, which could support price levels into 2024. In this case, it would be unlikely that the Fed would enact four interest rate cuts during the year as the markets currently predict. While one or two cuts may be in the offing, interest rates are likely to remain elevated as the Fed continues to try and pull inflation down to its 2% target rate.

From political and geopolitical standpoints, we are entering an election year which as always will include its share of fireworks and theatrics. But it is unlikely that the runup to the November vote will influence the financial markets to a large degree. Neither party wants a government shutdown, and even some of the most obstructionist politicians have shown signs of bipartisanship in recent months. More important than the election are policy risks, which include the deficit, debt, taxation and government spending. Any unforeseen developments in these key arenas could reset growth and economic expectations for the new year. Similarly, from a geopolitical view, the takeaway is that we need to be aware of the inherent risks (Ukraine war, Israel-Hamas war, China financial crisis), but markets do a very good job of pricing in such risk and can even rise in the face of them.

As we begin anew, we note that the S&P500 closed out 2023 with nine straight weekly gains, the longest streak since 1985. Ironically, 2023 was also the first year since 2012 that the bellwether index did not register a new all-time high during the period. With the Fed hiking cycle likely behind us, the broad indices are within striking distances of all-time highs. Upside momentum has been broadening in recent weeks, with increased participation, which could be yet another good sign for sustained market performance.

Thank you for your confidence and continued support. Happy New Year, and all the best for 2024.

February 5, 2024

Asset allocation. An idiom as conventional to the investment management industry as “block and tackle” is to sports and “keep it simple” is to management consulting. And for good reason. Nearly always, asset allocation is the first crucial step taken in the portfolio construction process. As a result, its importance is broadly accepted and agreed upon – serving as the cornerstone of portfolio construction while simultaneously being the key determinant of overall risk and return. Important stuff, indeed.

At its core, asset allocation is a “big picture” exercise – it examines an investment portfolio in the aggregate to determine which asset classes should be included in the portfolio and in what amounts. What the proper mix of assets should be. Examples of common asset classes included in allocation portfolios include equities, fixed income, cash, and alternative investments. The type and amount of each respective asset class to include is driven primarily by the relationship between long-term capital market assumptions and the investor’s investment objectives, constraints, and overall financial situation. Dividing one’s investment exposure across a variety of complementary and opposing asset classes ensures that the portfolio is well-diversified and not unduly exposed to a single type of idiosyncratic asset class risk.

Rather than choosing just a single asset class in which to invest – say equities for example – asset allocation supporters argue for allocating pieces of the pie to several asset classes to achieve a higher risk-adjusted return over a longer period. The idea underpinning this theory is that, by combining various asset classes that are not perfectly correlated with one another – e.g. they move independently of each other – overall portfolio risk is reduced and therefore aggregate return, after adjusting for risk, is enhanced. A similar and often interchangeable term for this dynamic is diversification.

Over time, diversification works and has proven to be a sensible strategy. During the 15 years ending in December 2022, investors have been challenged by a multitude of unexpected and intimidating issues. From natural disasters to geopolitical conflicts to a global pandemic and two major market selloffs, the last 15 years have been a volatile and tumultuous ride for investors. While the individual returns for stocks, bonds and cash were decidedly mixed during that time period, an asset allocation portfolio of stocks, bonds and other assets held together returned approximately 6% per year, and around 150% on a cumulative basis (source: JPMorgan Asset Management).

The below graphic, brought up to date through July 31^st, 2023, depicts a standard asset allocation portfolio in the white box connected with black lines. As one can see, the allocation portfolio typically lands somewhere in the middle of the pack relative to all other asset classes for any calendar year. Never the best, yet never the worst. Never the hottest, but never ice cold. This is by design, and the result over a long time horizon is a smoother, less volatile, and more comfortable ride for investors than they would realize by simply picking one or two asset classes to invest in isolation.

The returns for an asset allocation portfolio would naturally change depending on the mix of assets selected, the relative sizes of the assets within the portfolio, and the time period under measurement. At all times, a portfolio constructed with asset allocation as its foundation will have different parts of the portfolio performing differently during diverse underlying market environments. That is the entire point. Some asset classes will be “working” while others might not be. And while there is no perfect position or allocation that applies universally to all investors, and in some cases the asset allocation model may be out of favor relative to other philosophies, we can conclude that asset allocation is one of the most important elements of a sound investment plan.

It allows investors to prepare for a wide range of outcomes without having to lean into a crystal ball to predict the future or engage in the folly of market timing. By building a portfolio that encompasses a wide selection of securities and a broad range of asset classes and investment styles, the investor can help protect the portfolio from sudden changes in the financial markets. Additional benefits that can potentially be realized through this approach include reduced risk via lower volatility, opportunities for more consistent returns as the impact of poorly performing asset classes is lessened, and a greater focus on long-term goals as the need to constantly adjust positions or chase trends is minimized.

There is no doubt that asset allocation is a key factor in determining portfolio risk and return over time – in some cases accounting for 90% or more of portfolio performance. As there may be considerable value to be realized in focusing on the right mix of asset classes, rather than relying on stock picking or market timing as the primary driver of portfolio returns, it is worth returning to asset allocation principles early and often in the portfolio management process.

Asset allocation and diversification does not assure a profit or protect against loss in declining markets, and they cannot guarantee that any objective or goal will be achieved.

Posted by Jason Edinger on Monday, February 5, 2024

After a strong rally to conclude 2023, the new year rang in with a more cautious tone as small caps slid and large caps led. Stocks have now rallied for the third straight month, marking the longest streak since August 2021. Unlike the last two months, which saw positive returns for both stocks and bonds, this January provided performance dispersion across asset classes, as treasuries experienced weakness with interest rate cuts taking center stage. Small caps also struggled, lagging their large cap brethren and losing nearly 4% of value during the month. Still, strength was seen across the broad indices, with the S&P500 notching a gain of 1.7% and large cap growth names gaining 2.5%. Party on, Wayne.

Mega-cap tech names, to include the vaunted “Magnificent 7,” continued to drive positive performance. Microsoft, a card-carrying member of the Mag7, eclipsed the $3T market capitalization level just as the NASDAQ and S&P500 were making new all-time highs[1]. Despite weakness to begin the month, the overall market direction was higher as the soft-landing scenario was supported by stronger than expected GDP and retail sales numbers which show consumers continuing to defy expectations and spend, spend, spend. This backdrop should support ongoing strength for equities as we move into February.

The treasury yield curve steepened during the month, resulting in modest weakness in the fixed income space. The 10Y treasury yield was essentially flat, but 30Y yields rose as high as 4.4% before pulling back slightly. Broadly speaking, treasury yields behaved as expected after the Federal Reserve left rates unchanged at its January meeting. While the central bank left some options open, it threw cold water on the possibility of a March rate cut, expressing caution about such cuts until there’s more confidence that inflation is moving sustainably toward that magic 2% number. As of this writing, the target rate remains in the 5.25-5.5% range and futures markets are pricing in just a 35% of a March cut. Not great odds for treasury bulls.

Meanwhile, in the “real economy,” both hard and soft data continue to come in strong. The preliminary reading of Q423 GDP was 3.3% annualized, reflecting healthy vigor in the overall economy. The GDP number was driven primarily by personal consumption (contributing 1.9%) and government spending (contributing 0.6%). For the full year, GDP grew by 2.5%, well exceeding expectations. At the same time, the labor market added 3.5M jobs for the full year, resulting in a generationally low unemployment rate of 3.7%. Strong to quite strong.

The one outlier in this slew of bullish data was inflation. The year-over-year pace of inflation ramped up again in December but remains solidly in the 3-4% range that we have observed since May of last year. The reluctantly strong shelter index contributed the most to higher prices, even while core CPI (which strips out select items such as food and energy) eased down to a 3.9% annual pace. Subsequent reports reinforced flat core prices.

Lastly, we did see geopolitical risk increase during the month, as attacks against shipping in the Red Sea by the Houthis are having a dramatic impact on logistics. The implications for global trade and supply chains could be devastating, especially for select areas already reeling from several wars and drought conditions in places like the Panama Canal. Oil prices, as we would presume, rose during January to log their first gain in four months. And while geopolitical factors have failed to materially affect the capital markets in recent years, they remain a wildcard and could easily escalate, along with domestic political uncertainty as the US presidential campaign gears up.

All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.

[1] Microsoft is now bigger than Apple, and Amazon is now bigger than Google