Distressed Financial Assets Shine after Years of Poor Performance

October 5, 2024

By Mitchell Anthony

 

US Economy slows and market leadership takes a pause?

Financial markets across the board performed well in the third quarter of 2024.  Equities gained again after three straight quarters of solid returns.  Fixed income which had not performed well for many quarters saw strong gains as interest rates fell significantly, and alternative investments like bitcoin had another good quarter as well.  Opinions about the economy changed significantly from week to week throughout the quarter.  Many strategists were expecting soft growth or recession to emerge however this was not the case and GDP came in much stronger than expected at 3% which is well above the trend it had been on for several years.  These strategists were worried about a hard landing in the economy and that the Fed’s actions to tame inflation would ultimately bust this economic cycle.  Seems as though they were wrong!  The Inflation cycle for the most part ended and with it came lower interest rates across the board from short-term rates to longer-term mortgage rates. The decline in rates was as much as 50 basis points or one half of 1%. Investors hoping for rates to return to the near zero levels of the last decade rushed into bonds and ran prices up and yields down.  This seemed to most seasoned investors to be a bit premature?

Economic Review Q3 2024

Work from Home continues!  US employers were disappointed and were not able to get most of their employees back to the office as the strong employment backdrop allowed employes to continue to have it their way. This obviously seems like a headwind for productivity but is being offset by significant gains from artificial intelligence that are replacing employees with computers.

 US debt expanding hyperbolically 

Concerns rightfully developed about America’s hyperbolic expansion in debt which is now approaching 35 trillion (Figure 1). This seems to be the only rot that exists in the US economy but thus far has been manageable because the significant gains in debt have been offset by significant gains in GDP which is now close to 28 trillion. (Figure 2)

US GPD came in at a bit over 3% which is strong relative to recent past and seems to be accelerating.  This seems to be rooted in the fact that Employment is still strong and wages are still growing at or near the inflation rate.  The banking system is very healthy and eager to lend to healthy consumers, however the list is getting thinner of quality prospects.  So far no rot is visible in the banking sector and the majority of consumers don’t seem overextended with debt either.

Despite all kinds of concerns about the consumer and his own statements of having poor financial health and lacking confidence the consumer spending just keeps going…  Consumer services are still very strong and retail sales have turned upward after a long period of no growth. The most recent data on the consumer over the last few weeks shows weakness that seems to be emerging, but it is too early to tell.  Trends in travel and entertainment have been poor and restaurants are having a difficult time selling meals at the prices on their menu. Airlines are reporting softness to some degree but contrarily hotels are reporting strength and resilient pricing. MACM owns Marriott which is benefiting from the strength.

The manufacturing sector is the worst part of the US economy and is in a recession and hasn’t had growth in over a year (figure 3).  Existing home sales are still anemic because of the level of rates still being far above the average rate of the US mortgage. New home sales look much better but still are nothing close to the highs of 2006 or the pre-covid levels. Consumers just aren’t buying more durable goods and hence the sector has paused its production of goods.

Inflation Data

The inflation cycle seems over and is now benign as both CPI and PPI are at or very near the feds targets. The level of prices is still a major concern and is impacting lots of consumer spending that has not yet shown up in retail sales data or GDP data??  Go Figure…

 Financial Market Review

As noted above, all of the financial markets for the most part performed well in the quarter that just ended.  Stocks, bonds, bitcoin, real estate, utilities all had nice gains.  The leadership however changed significantly from what it had been for the last year where the magnificent seven and FAANG stocks led and value stocks and fixed income lagged.  Real estate was flat to modestly higher over the last few years not keeping up at all with equities.  As a result these areas that had performed well started to look cheap particularly after the big GDP number that gave investors hope that we would avoid recession and stay on the path of strong growth.  For the most part investors have been expecting slow growth ahead and have stuck with secular growth names that are doing well in this slow-growing economy.  Investors abandoned this idea at least briefly and embraced deeply cyclical stocks, fixed income, real estate, and utilities in Q3.  Can this continue? Seems unlikely but more below.

This move to value was further prompted by some market strategists who blew the horn about their belief that the spending on artificial intelligence cannot continue because it is not being monetized currently and there has been no ROI on these products.  These fears paralyzed the markets briefly and the leadership in artificial intelligent names like Nvidia suffered.  Nvidia fell from 140 to 99 per share briefly as these fears ran wild. Economists and market strategists that seemed to be a bit wiser were quick to knock down these misguided concerns with commentary about how artificial intelligence spending is not easily measured but is significantly changing the productivity of businesses and that the consumer sales of it are not what ii is intended for and hence the failure to monetize these products immediately is misplaced.

The Equity Markets have produced four quarters now of back to back levels of outstanding performance.  YTD returns are high with the S&P 500 up 21.9%, and the MACM Dynamic Growth portfolio up 24.7%.  For the quarter the S&P 500 gained 5.8% with Large Cap growth (IWF) up 3.1% vs Large cap Value (IWD) up 9.4%.  Small Cap Growth (IWO) +8.4%.   China gained 14.3% (Shanghai Composite).  Fixed Income had a great quarter getting out in front of FED action with Treasuries up 7.9%, and Utilities up 19.4% (XLU), and REITS up 17.1% (XLRE).  Bitcoin advanced 6.4%.

Economic Outlook

The economic forecast for growth is challenging with ever-changing views on the consumer and his ability to weather the higher prices that exist in the economy today. Global growth remains challenged.  It seems to be Manufacturing related weakness and a continued overhang from over investment in infrastructure in China that is giving the globe problems.  Steady growth in the US seems to be the easy forecast with things improving globally as China returns to stimulus. The US Consumer is resilient and absorbing higher prices with higher wages and wealth growth.  Travel, Web Computing, High density computers, leisure services, digital devices, Heavy Equipment, and Electrification services are the best part of the economy.   The hard question is Can Durable good consumption return? Will the manufacturing sector get better.  As mentioned above Manufacturing is in Recession (Fig 3)

Financial Market Outlook

Real Estate?

REITS skyrocketed in Q3 but actual property prices were flat or up modestly.  REITS likely will go flat as most of the advance was driven by a decline in interest rates and rates are unlikely to fall much further.  Real Estate is highly valued and office buildings and commercial property are untimely.  Single-family homes and apartments might be the best part of a weak sector.

Bonds?

Significant money moved to bonds already and the rally is likely over as economic growth is stronger than expected. Investors will likely realize very soon that the near zero % interest rates of the last decade are unlikely to ever return and that rates going forward will likely be in the 2 to 5% range which is still very low but where we are actually today.

Stocks?

It would seem that money will continue to remain in stocks and more money will move to stocks as the rally in fixed income fizzles. Equities seem better positioned than any other risk asset.  Earnings growth will drive prices higher and it is clear the magnificent seven are growing at a strong pace. Cyclical and Industrial names are no longer cheap relative to expected growth.  However, there is reasonable probability that global growth will improve significantly as monetary policy stimulates positioning industrial names for a return to growth. MACM has been market weight in industrial names but is now moving to an overweight position to benefit from this trend that seems likely.

We still believe that Secular growth stocks are the place to be for the foreseeable future. MACM’s equity strategies are loaded with secular growth stocks that are driving excess return in our managed portfolios over the S&P 500.  Healthcare and the industrial sector have also contributed to Alpha production.  We remain optimistic!

 

Figure 1

 

Figure 2

 

Figure 3