Q2 MARKET SUMMARY AND CONSIDERATIONS
Market Commentary
Global equities continued to march higher in the second quarter with the S&P 500 up 4.3%, resulting in its twelfth best start, up 15.3% for the year, since 1950. Contextually, since 1900, total returns in the first half of the year of at least 15% have delivered a positive return 72% of the time in the second half of the year (1). For the quarter, breadth narrowed with seven sectors ending lower. Technology and communication services continued to pull the index higher, led by members of the “Magnificent 7” that in aggregate, ended the quarter representing 32% of the index (2). NVIDIA joined the three trillion-dollar capitalization club, along with Microsoft and Apple, rising nearly 150% in the first six months of the year. Non-U.S. developed markets failed to follow suit despite an initial interest rate cut by the European Central Bank and continued accommodations from the Bank of Japan, ending down 0.42% (1). Emerging markets gained 5.0%, helped in part by stocks in China bouncing off their recent lows (2). Fed easing expectations were pulled forward near the end of the quarter driving yields lower, which helped the Bloomberg U.S. Aggregate end roughly flat, up 0.1%, though the Bloomberg Global Aggregate fell 1.1% as credit spreads widened ahead of French and UK elections in late June (3).
Market Considerations
Earlier this year we introduced a framework based on three scenarios that we consider to be most likely, each of which carries unique investment considerations. Over the course of the second quarter our highest conviction shifted from a “no landing” to “hard landing” scenario, the latter of which reflects a slowing environment that has historically resulted in the economy contracting. The other two scenarios we now see as equally likely, given measurable progress that has been made on inflation, though we recognize the potential policy missteps that could easily result in an over-heating economy, our “no landing” scenario, or just as likely an economy that narrowly escapes a recession as growth gradually continues with labor markets and inflation normalizing. (Please see our “Sticking the No Landing” blog posting for a detailed review of each scenario.) We explore the investment implications of our “hard landing” scenario and our updated portfolio allocations below.
Hard Landing Scenario (50%)
The long and variable lags of monetary policy are finally beginning to bite. In the first quarter, delinquencies for auto loans rose to an annualized 7.9% with credit cards rising to 8.9% (4). Softening labor market conditions and higher interest rates likely contributed to the increase, as did shrinking cash and excess savings balances (5). The latter factors are evident in lower average deposit cash balances held at banks and in money markets (6). Importantly, the rise in reported first quarter delinquencies does not reflect more recent data including the drop in JOLTS job openings and the quit rate, or the drop in consumer sentiment and recent uptick in unemployment claims. While this shift has not yet impacted total consumption activity, consumers have fewer resources left to tap that will allow them to maintain current spending. Given that consumption activity in the US drives almost 68% of total economic activity (7), any meaningful slowdown would have an impact. Using this as a backdrop, the portfolio implications are as follows:
Equities: Historically, as activity slows defensive sectors such as utilities, health care, and consumer staples benefit. Dividend paying stocks and small caps, also benefit presuming an easing monetary policy backdrop is pursued to stimulate activity. This quarter we tilt modestly into these themes, keenly aware that any immediate action taken by the Fed will take months, if not quarters, to have an impact just as higher rates did not immediately slow activity during this rate hiking cycle. Additionally, small caps are somewhat unique in this cycle given elevated debt levels that are often issued with floating rates, high levels of negative earnings at the index level, and the impact that private equity and large cap stocks have had on IPOs. Nonetheless, relative valuations offer an attractive entry point and should offer downside protection if a rotation amongst stocks begins.
Bonds: Interest rate volatility continues to be driven primarily by shifting Fed expectations and to a lesser extent fiscal spending and the current election cycle. While rate expectations are an expression of investor confidence in the future decisions of the Federal Reserve, even high levels of conviction can fail to materialize as we witnessed earlier this year. As such, our decision to add quality and duration to our fixed income exposure is driven by historically tight credit spreads and the increased probability of the economy slowing, headwinds to high yield bond prospects. While Fed easing would likely be a tailwind to our positioning, the election backdrop prevents us from having greater confidence as we remain cognizant of several risks, including but not limited to, unsustainable fiscal spending, a weak US dollar policy, challenges to Fed Independence, and a reduction in the legal protections available to investors. Should any one of these risks materialize, we would expect the term premium for bonds to rise, resulting in higher nominal interest rates.
Real Assets: Real assets are often the last asset class to rally near the end of a bull market cycle. As such, we maintain our target allocations but adjusted positioning to favor renewable infrastructure and real estate given our revised outlook, the progress on inflation, interest rate expectations, and shrinking demand from China, whose bursting property bubble and debt woes reduce the global demand for commodities.
No landing Scenario (25%)
Fed officials recently acknowledged the progress that has been made reducing inflation, as well as a softening labor market acknowledging that the Fed must now focus on maximum employment and price stability. This shift in guidance is indicative of a soft landing not an overheating economy. However, the outcome of this year’s elections could result in inflation reigniting tied to higher tariffs, a shrinking workforce, a weaker US dollar, etc. Additionally, while we believe the economy is set to slow, election years often result in the incumbent party “priming the pump”, hence our assigned probability.
Soft Landing Scenario (25%)
The market has embraced a “soft landing” as consensus (8). While we are not seeking to be different, our modest conviction is rooted in the absence of historical evidence that suggests increasing delinquencies and rising unemployment will slow and normalize around long-term averages, a necessary outcome in this scenario. When coupled with elevated concentration risks and buoyant earnings expectations most often forecast only in the earliest portion of a new business cycle, we require more convincing evidence.
Conclusion
In the last several weeks a former President and current nominee was convicted on 34 felony counts, an assassination attempt was made on the same former President, global trade tensions escalated on proposed semiconductor trade restrictions, and an incumbent President withdrew after receiving his party’s nomination – events that on the surface scream uncertainty. Yet, capital markets have behaved relatively well, reinforcing the precept that investors should not let their politics inform their portfolio positioning. While campaign talking point drive headlines, they are merely hints of what policies to expect based on an unknowable outcome. Consequently, we continue to prepare portfolios based on the outcomes that we see as most likely, rather than trying to predict what cannot be known with certainty.
Disclosures
This material is provided for informational purposes only and is not solely intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt and investment strategy. The views and strategies described may not be suitable for all investors. They also do not include all fees or expenses that may be incurred by investing in specific products. Past performance is not guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. You cannot invest directly in an index. The opinions expressed are subject to change as subsequent conditions vary. Advisory services offered through Thrivent Advisor Network, LLC.
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Index Benchmarks presented within this report may not reflect factors relevant for your portfolio or your unique risks, goals or investment objectives. Past performance of an index is not an indication or guarantee of future results. It is not possible to invest directly in an index.
The Bloomberg Global Aggregate® Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
The Bloomberg U.S. Aggregate Bond® Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the U.S. bond market.
The Bloomberg Magnificent 7 Total Return Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System.
The MSCI (Morgan Stanley Capital International) China® Index captures large and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 657 constituents, the index covers about 85% of this China equity universe.
The MSCI EAFE® (Morgan Stanley Capital International Europe, Australasia, and the Far East) Index is a broad market index of stocks located within countries in Europe, Australasia, and the Middle East.
The MSCI (Morgan Stanley Capital International) Emerging Markets® Index is a selection of stocks that is designed to track the financial performance of key companies in fast-growing nations.
The Standard & Poor’s 500 (S&P 500) is a market-cap weighted index comprised of the common stocks of 500 leading companies in leading industries of the U.S. economy. You cannot invest directly in an index.
The SPDR® S&P 500® ETF (symbol SPY), an exchange traded fund that tracks the performance of the S&P 500® Index. SPY, managed State Street Global Advisors, aims to replicate the performance of the S&P 500® Index as closely as possible by investing in the same stocks that are included in the index in the same weightings. SPY is traded on the New York Stock Exchange (NYSE Arca) and is highly liquid, making it a popular choice for investors looking to gain broad exposure to the US stock market.
SPDR Sector ETFs are unique Exchange Traded Funds (ETFs) that divide the S&P 500 into eleven sector index funds.
The Bureau of Economic Analysis (BEA) is an agency of the Department of Commerce that produces economic accounts statistics that enable government and business decision-makers, researchers, and the American public to follow and understand the performance of the nation’s economy. To do this, BEA collects source data, conducts research and analysis, develops and implements estimation methodologies, and disseminates statistics to the public.
BCA Research was founded by A. Hamilton Bolton in 1949 in Montreal, Quebec, Canada. The firm is also known by the title of its first publication, The Bank Credit Analyst.
The CME FedWatch Tool is a tool created by the CME Group (Chicago Mercantile Exchange Group) to act as a barometer for the market’s expectation of potential changes to the fed funds target rate while assessing potential Fed movements around Federal Open Market Committee (FOMC) meetings.
An exchange-traded fund (ETF) is a type of pooled investment security that operates much like a mutual fund. Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.
An IPO is an initial public offering, in which shares of a private company are made available to the public for the first time. An IPO allows a company to raise equity capital from public investors.
The Job Openings and Labor Turnover Survey (JOLTS) tells us how many job openings there are each month, how many workers were hired, how many quit their job, how many were laid off, and how many experienced other separations (which includes worker deaths).
The material presented includes information and opinions provided by a party not related to Thrivent Advisor Network. It has been obtained from sources deemed reliable; but no independent verification has been made, nor is its accuracy or completeness guaranteed. The opinions expressed may not necessarily represent those of Thrivent Advisor Network or its affiliates. They are provided solely for information purposes and are not to be construed as solicitations or offers to buy or sell any products, securities, or services. They also do not include all fees or expenses that may be incurred by investing in specific products. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. You cannot invest directly in an index. The opinions expressed are subject to change as subsequent conditions vary. Thrivent Advisor Network and its affiliates accept no liability for loss or damage of any kind arising from the use of this information.
Any specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable. A summary description of the principal risks of investing in a particular model is available upon request. There can be no assurance that a model will achieve its investment objectives. Investment strategies employed by the advisor in selecting investments for the model portfolio may not result in an increase in the value of your investment or in overall performance equal to other investments. The model portfolio’s investment objectives may be changed at any time without prior notice. Portfolio allocations are based on a model portfolio, which may not be suitable for all investors. Clients should also consider the transactions costs and/or tax consequences that might result from rebalancing a model portfolio. Frequent rebalancing may incur additional costs and/or tax consequences versus less rebalancing. Please notify us if there have been any changes to your financial situation or your investment objectives, or if you would like to place or modify any reasonable restrictions on the management of your account.
(1) MSCI EAFE NR USD Index fell 0.42% from 4/1/2024 – 6/30/2024. Source: Morningstar Direct.
(2) MSCI EM NR USD Index rose 5.0% from 4/1/2024 – 6/30/2024. The MSCI China NR USD Index rose 7.09% over the same period. Source: Morningstar Direct.
(3) The Bloomberg US Agg Bond TR USD Index rose 0.07% from 4/1/2024 – 6/30/2024. The Bloomberg Global Aggregate TR USD Index fell 1.10% over the same period. Source: Morningstar Direct. According to the CME’s Fed Watch Tool investor expectations for the Federal Reserve to cut interest rates in September rose more than 20% in the second half of June.
(4) New York Federal Reserve, Quarterly Report on Household Debt and Credit, May 14, 2024
(5) Excess savings is defined as savings above estimates of pre-pandemic trend levels that were funded from fiscal stimulus and COVID shutdowns that initially impeded spending.
(6) Source: Federal Reserve Board, Haver Analytics, Apollo “Daily Spark”, as of March 2024.
(7) Source: Bureau of Economic Analysis
(8) Expectations for a recession in the US fell to 30% and 20% in Europe according to Bloomberg and Torsten Slok, Apollo Chief Economist, as of July 22, 2024. Additionally, high levels of equity exposure, low cash balances (dry powder), and a dearth of bear market forecasts, are anecdotal evidence supporting a soft-landing scenario. BCA, Third Quarter 2024 Strategy Outlook.
