Welcome to the latest edition of our Quarterly Investment Newsletter, where we reaffirm our unwavering commitment to providing our valued partners with the highest standards of fiduciary excellence. As a CEFEX-certified fiduciary, we take pride in upholding rigorous industry standards to ensure transparency, integrity, and accountability in every investment decision.
Through this newsletter, we aim to share relevant and insightful investment information that supports your financial goals and strengthens our partnership as we navigate the ever-evolving financial landscape together. Thank you for entrusting us with your continued confidence and stewardship.
ECONOMIC OUTLOOK
The economy’s resilience continues to surprise amid a robust labor market, ongoing consumer and business spending, and a favorable fiscal backdrop. However, there are early signs of small cracks that could derail the no-landing economic outcome the Federal Reserve has been able to deliver so far. Higher interest burdens, election uncertainty, and an increasingly narrow stock market landscape could limit future economic activity. Attempting to fill these cracks will be continued liquidity infusions by the U.S. Treasury, artificial intelligence (Al)-led productivity gains and expectations for an eventual Fed pivot to reduce today’s monetary policy headwinds.
HEADWINDS
Rising Real Rates Create Uncertainty
- Real yields are the primary measure of the Fed’s policy actions. Today, they’re at levels that have proven restrictive over the past 25 years.
Post-Election Reality Check
- The amount of stimulus required to support markets during election years can cause a hangover in inauguration years with an increasingly wide range of historical market outcomes. The next administration will face immediate fiscal, geopolitical, and monetary policy challenges.
Pressure Mounting from Higher Rates
- Borrowing costs on government debt have nearly doubled in the last three years, mostly due to rising interest rates and higher issuance. With a majority of debt maturing in the next three years, refinancing costs will be a key variable in future fiscal activity.
TAILWINDS
Fed Progress on Inflation
- While official measures remain above targets, the Fed continues to make progress in its fight against inflation with nearly 70% of the underlying components below the Fed’s 2% threshold. This could support a year-end Fed pivot.
Election Year Momentum
- Election years are usually good for markets, especially when incumbents are running for reelection. The U.S. Treasury tends to keep liquidity flowing, while the administration uses all the tools at its disposal to stimulate consumer spending.
Broader Corporate Profitability
- Like consumers, corporations have been surprisingly resilient in the face of higher interest rates. While initial strength has been concentrated with the mega-cap cash-flow giants, market strength is expected to broaden out over the coming quarters.
UNCERTAINTY CONTINUES AMID SHIFTING NARRATIVE
In the second quarter, a solid global economic backdrop supported equities, although euphoria around big tech and artificial intelligence continued to drive relative performance in U.S. favor. The disinflation narrative gained momentum, with many central banks starting to reduce policy rates, a positive for markets, especially those most rate sensitive. Now, political and geopolitical challenges seem poised to capture the narrative and drive volatility, given the number of elections this year.
Sources: Asset class returns are represented by the following indexes: Bloomberg U.S. Aggregate Bond Index (U.S. bonds), S&P 500 Index (U.S. large-cap stocks).
Russell 2000· (U.S. small-cap stocks), MSCI EAFE Index (international developed market stocks), MSCI Emerging Market Index (emerging market stocks), Dow Jones U.S. Real Estate Index (real estate), and Bloomberg Commodity Index (commodities).
- U.S. equity results were mixed with large tech stocks driving outsized returns. Interest rate – sensitive small-cap stocks felt the most pressure.
- Bond yields moved moderately higher as expectations eased for multiple 2024 Fed interest rate cuts.
- Commodities advanced. Long-term significant infrastructure needs and the ongoing renewable energy transition are expected to drive demand.
- Real estate sagged, although relative valuations and rate cut expectations drove improvement.
- Outside the U.S., performance varied by region. Currency weakness weighed on Japan, and political uncertainty hampered Europe. Conversely, emerging market stocks kept pace with U.S. equities. China was a top performer, although potential trade and geopolitical tensions remain a key risk.
FISCAL FIRE DRILL
On June 2, 2023, Congress suspended the U.S. debt ceiling, removing limitations on government spending. This suspension ends on January 1, 2025, requiring Congress to return to the negotiation table, likely starting the next installment in the ongoing fiscal default cliffhanger series. The U.S. fiscal landscape remains one of the largest sources of uncertainty for investors. These headwinds appear to be strengthening as the cost of debt continues to soar.
DOUBLE DOSE OF DEBT DRAG
Federal debt has experienced a 22.9% cumulative increase over the last three years as the government has added more than $6 trillion in new debt. In isolation, this pace of debt growth is unsustainable. However, what’s more alarming is the steady increase in the cost of debt, also called the interest expense, which has nearly doubled over this period.
Sources: Monthly Treasury Statement 5.31.2024, U.S. Department of Treasury; Strategas Research: CAPTRUST Research
INTEREST EXPENSES SQUEEZE DISCRETION
Net interest expense now accounts for a higher percentage of government expenditures than national defense. Today’s interest expense is projected to continue moving higher as the average interest rate on outstanding Treasurys is approximately 3.2% and roughly 55% of outstanding marketable Treasury debt is set to mature over the next three years.