With Chris Osmond, Director of Investment Services at Centura Wealth Advisory
Investing in today’s market can feel overwhelming, especially when headlines highlight record market highs or economic downturns. But as Chris Osmond, Director of Investment Services at Centura Wealth Advisory, emphasizes, the key to long-term wealth growth isn’t timing the market—it’s staying invested and diversifying effectively.
The Myth of Market Timing
Many investors hesitate to put cash to work when the market is at an all-time high, fearing an inevitable correction. However, market highs often lead to even higher returns over time.
“A bull market doesn’t have a timeline. Historically, returns are stronger when you invest at an all-time high than waiting for a correction that may never come.” — Chris Osmond, Centura Wealth Advisory
Case in point: in 2023, the S&P 500 reached 57 all-time highs and delivered a 25% return. Investors who stayed in cash waiting for a pullback missed out—not only on market gains but also on purchasing power due to inflation. Cash yields, though modest, were outpaced by inflation, leading to a negative real return.
The Cost of Sitting on the Sidelines
Avoiding market volatility can feel safe, but it often leads to long-term losses. Missing just a few of the market’s best days can drastically reduce overall returns. Historically, the best market days closely follow the worst, meaning pulling out during downturns can be costly.
“The best days in the market typically come right after the worst days. Reacting emotionally to short-term volatility can lock in losses and prevent recovery.” — Chris Osmond, Centura Wealth Advisory
For example, investors who sold during the COVID-19 market crash in March 2020 missed the rapid recovery that followed. Losses are mathematically harder to recover than gains—losing 20% requires a 25% gain to break even, while a 50% loss demands a 100% recovery.
Risk Management Through Diversification
At Centura Wealth, minimizing loss is just as important as pursuing gains. The focus is on delivering superior risk-adjusted returns by managing drawdowns and avoiding large losses that hinder long-term wealth accumulation.
Diversification is key. Portfolios are structured across a range of asset classes—public equities, bonds, and alternative investments—to reduce volatility and balance risk. Alternative investments like private equity, private credit, and real estate play a crucial role in reducing market correlation.
The Role of Alternatives in Wealth Growth
Alternative investments offer lower correlation to traditional markets, reducing overall portfolio risk while enhancing potential returns. Private real estate, for example, not only diversifies portfolios but also provides significant tax advantages through depreciation and bonus depreciation from cost segregation studies.
“Real estate offers a natural inflation hedge and delivers major tax benefits when held directly. Our clients benefit from personalized, thoroughly vetted opportunities that align with their wealth goals.” — Chris Osmond, Centura Wealth Advisory
Direct real estate investments, particularly in multifamily housing, allow clients to offset passive income with accelerated depreciation, improving cash flow and reducing tax liability.
The Centura Investment Philosophy
Centura Wealth Advisory believes in creating resilient, diversified portfolios tailored to each client’s unique financial goals. The firm prioritizes thorough due diligence, especially when selecting alternative investments, to ensure every investment aligns with clients’ long-term objectives.
Key principles include:
Risk Management: Limiting drawdowns to protect capital.
Diversification: Spreading investments across asset classes and geographies.
Tax Efficiency: Incorporating tax-advantaged strategies to maximize wealth growth.
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At Centura Wealth Advisory, we go beyond a traditional multi-family office wealth management firm to offer advanced tax and estate planning solutions which traditional wealth managers often lack in expertise, knowledge, or resources to offer their clients.
We invest heavily into technology and systems to provide our clients with fully transparent reporting and tools to make informed decisions around their wealth plan.
Connect with our team today to learn how we can help you navigate complex financial decisions and secure your financial future with confidence.
Disclosures
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Macro Indicators: Headline and core PCE inflation rose by 2.5% and 2.6%, respectively, in January. These increases matched expectations but, combined with higher CPI data, grew consumer worries that inflation may remain elevated. The January jobs report gave mixed signals, with only 143,000 jobs added in the labor market (vs. a 169,000 forecast), but another drop in the unemployment rate to 4.0%. Atlanta Fed GDPNow estimates for Q1 2025 GDP surprisingly turned sharply negative as of month-end.
Trump 2.0: Tariffs dominated headlines over the month, with a 10% tariff on China currently in place and possibly more tariffs coming on countries like Mexico, Canada, and the EU, in addition to reciprocal tariffs.
Fed & Monetary Policy: The Fed continues to reiterate its patient approach to interest rate cuts. The minutes from the January FOMC meeting revealed that tariffs are troubling the Fed, which could potentially result in fewer interest rate cuts than initially projected this year. As of the December “Dot Plot,” Fed officials have projected two 25-bps cuts in 2025.
Equity Markets: Major U.S. indices finished February in the red after a volatile month. The Q4 2024 earnings season is nearly wrapped up, with 97% of companies in the S&P 500 having already reported. The current quarterly earnings growth rate on a year-over-year basis is 18.2%, well above initial expectations.
Asset Class Performance
Somewhat surprisingly, Trump’s tariff announcements over the month hit U.S. equity markets hardest, whereas international equity markets posted modest growth. Real estate was the best performer over the month, a likely result of heightened inflation expectations, and bond markets saw positive growth, with investment grade outperforming high yield.
Source: YCharts. Asset class performance is presented using total returns for an index proxy that best represents the respective broad asset class. U.S. Bonds (Bloomberg U.S. Aggregate Bond TR), U.S. High Yield (Bloomberg U.S. Corporate High Yield TR), International Bonds (Bloomberg Global Aggregate ex-USD TR), U.S. Large Cap (S&P 500 TR), U.S. Small Cap (Russell 2000 TR), Developed International (MSCI ACWI ex US TR), Emerging Markets (MSCI EM TR), and Real Estate (Dow Jones U.S. Real Estate TR).
Markets & Macroeconomics
Trump’s Approach to Tariffs
February brought lots of action on the tariff front. President Trump applied tariffs on China (with possibly more to come) and threatened tariffs on neighboring countries Canada and Mexico, as well as commodities, like aluminum and steel. The administration also launched an investigation into the trading practices of copper, and in retaliation from impacted countries, Trump announced potential “reciprocal” tariffs, which could affect U.S. goods like electronics, motor vehicles, and pharmaceuticals. While most of these policies have not been implemented, taken in total, they could push tariff rates to their highest level since the 1930s, begging the questions: why higher tariffs now and should markets be concerned?
In answering the first question, it is important to remember that a tariff is a tax on imports, which typically raises prices for domestic consumers, but, theoretically, allows domestic producers to better compete globally – a stance that supports Trump’s “Make America Great Again” mantra. Higher tariffs should support domestic production of goods, making the U.S. less reliant on imports, hopefully to the dual benefit of promoting U.S. manufacturing and reducing the country’s trade deficit, which has been in deficit since the 1970s, illustrated in Exhibit 1. Trump’s tariffs are also meant to curb “national security” threats, including illegal immigration and drug trafficking, from places like China, Canada, and Mexico. When Trump focuses on “national security” measures, he is using tariffs as more of a negotiating tactic to end unfair trade practices and impose stricter border controls, all while producing government revenue to offset spending in other areas of his fiscal policy agenda. Whether or not all of Trump’s proposed tariffs will be implemented, there is no doubt that higher tariffs represent a departure from the low tariff environment that characterized much of the American 20th century, illustrated in Exhibit 2.
Exhibit 1: U.S. Goods Trade Balance to GDP
Source: Federal Reserve Bank of St. Louis
Tariffs in the context of 2025, however, have introduced concerns on their impact to inflation and economic expansion. So, should markets be concerned? The answer boils down to maybe. Tariffs can increase prices for the domestic consumer, and while this doesn’t always have a broader inflationary impact, they could threaten the progress the U.S. has made on inflation in the past two years, which investors worry could result in a potential slowdown in growth. If tariffs are indeed being used as a negotiating tactic, it could also spark trade wars with key trading partners (think China), which could have more lasting economic impacts. As with anything related to politics, uncertainty is perhaps the only thing that is certain, and investors should continue to focus on the potential economic impacts of tariffs while filtering through the political noise as best as possible. Tariffs are not the end of the world, but American consumers may feel some pain if (and when) implemented.
Exhibit 2: U.S. Average Effective Tariff Rate
Source: The Budget Lab
The Bottom Line: Tariffs are being used by the Trump Administration as a negotiating tactic to promote his “Make America Great Again” agenda and generate additional revenue for the government, prompting concerns from investors on the economic impacts to inflation and growth. The actual impact of tariffs remains uncertain, particularly as Trump continues to add to the tariff pile, potentially sparking trade wars with unknown timing and outcomes.
Looking Ahead
The Consumer Turns Gloomy
The American consumer has endured a great deal over the past few years: higher interest rates, which have raised financing costs (including the cost of owning a home), as well as inflation, which has resulted in higher prices in almost every pocket of the economy. Despite these trends, the consumer has remained steadfast in their spending and stayed relatively positive about the state of the U.S. economy, but uncertainty related to both fiscal and monetary policy in 2025 is causing the consumer to re-evaluate everything. There are multiple surveys and indicators that measure consumer confidence and expectations, which can provide important insight into what consumers are thinking, which is ultimately what drives consumer behavior and subsequently market performance and economic growth
Exhibit 3: Consumer Inflation Expectations
Source: The University of Michigan
The latest Consumer Confidence Index reading came in below forecasts, registering the largest decline since 2021. Similarly, the University of Michigan’s survey of consumer inflation expectations signified heightened uncertainty surrounding future inflation, illustrated in Exhibit 3. The results of these two surveys indicate that consumers have become more pessimistic about the future economy, and this is likely driven by multiple factors, including stubborn inflation that is causing the Fed to keep interest rates at current levels, in addition to a high degree of uncertainty coming from the White House, with policies that could negatively impact both inflation and growth.
Additionally, the yield curve, which normalized in August 2024 after being inverted for over 2 years, re-inverted in the 10-year to 3-month portion of the curve on February 26. Yield curve inversions are a well-known recession indicator, and the latest inversion added fuel to the consumer-gloom-fire. While the latest consumer data is concerning, the danger with measuring expectations is that they can sometimes become a self-fulfilling prophecy. Today, history can provide an important lesson and perhaps a potential opportunity: when consumer confidence bottoms, positive equity market returns have typically followed, illustrated in Exhibit 4.
Exhibit 4: Consumer Confidence vs. S&P 500
Source: J.P. Morgan Guide to the Markets
Even when consumer sentiment is negative, it remains critical to stay invested in markets because exiting the market could mean missing out on potential strong equity returns, like what was witnessed after the 2022 equity market bottom. Whether the U.S. is headed for a recession will depend on macroeconomic variables like inflation, the labor market, and GDP growth, not the results of consumer surveys, even though they can provide insights. Despite what consumers may believe, the U.S. economy is still faring relatively well, and while that doesn’t mean there aren’t risks, monitoring the incoming data and staying diversified will remain critical in both the current and future environments.
The Bottom Line: The most recent readings of consumer surveys indicate growing pessimism about the future state of the U.S. economy, but investors should remember that markets are subject to extremes, and it is better to stay prudently invested during these times of uncertainty to avoid missing out on the positive equity returns that can follow.
Capital Markets Themes
What Worked, What Didn’t
•Values Bests Growth (Again): Growth stocks continue to struggle in 2025, as AI and Mag 7 darlings couldn’t keep pace with high market expectations, continuing to support the story of equity market breadth, or broader participation.
•Flight to Quality: Investment-grade bonds outperformed high-yield counterparts by about 130 bps over the month, emphasizing the importance of maintaining core exposure to bonds.
•Long Duration Looks Favorable: Longer-duration bonds performed well over the month, an important reminder that this positioning stands to benefit from an investor flight to safety and even interest rate cuts.
Large vs Small Cap Equity
Growth vs Value Equity
Developed vs Emerging Equity
Short vs Long Duration Bonds
Taxable vs Municipal Bonds
Investment Grade vs High Yield Bonds
Source: YCharts. Data call-out figures represent total monthly returns
On Alternatives
Private Versus Public Equities
Public equity valuations remain rich, with the S&P 500 trading at 21.2x forward earnings as of month-end, above both the 5- and 10-year averages of 19.8x and 18.3x, respectively. Looking under the hood, the top 10 stocks in the index have a combined price-to-earnings ratio of 26.7x. The current state of public equity markets highlights the need for diversification in other, more favorably valued markets.
Looking at the broad private equity asset class, valuations are certainly more favorable, trading in the 47th percentile versus the 96th percentile for the S&P 500, illustrated in Exhibit 5. Looking only at valuations, private equity appears to be the more attractive choice, particularly when considering the level of concentration in technology stocks in public markets today. However, just as investors want to diversify concentration risk in the public tech sector, private equity markets are also dealing with their own concentration struggles as it relates to the limited partner (LP) secondary market.
The secondary market facilitates the trading of stakes in private equity funds by LPs, or investors, in those funds. This market has witnessed a surge in demand, resulting in higher, and, in many cases, less favorable pricing, with all secondary-focused funds trading at 88% of net asset value as of the most recent data, illustrated in Exhibit 6.
Exhibit 5: Equity Valuation Percentiles
Source: Bow River Capital
This supply/demand imbalance in the secondary market is a direct result of the slow exit environment seen in recent years, which has forced LPs to source liquidity in other parts of the market, like secondaries, often at a discount. General partner (GP)-led secondary funds have also seen increased interest, illustrated by record fundraising for private equity behemoths Ardian and Lexington, who raised a combined $51 billion last year. This surge in fundraising has added to demand pressures in the secondary space, making the asset class less attractive than other parts of private equity.
On the macro front, elevated interest rates are not helping the current situation, but Trump’s potential deregulation policies could incentivize activity in the initial public offering (IPO) market, which may help accelerate exits and bring much-needed supply to the private equity market. Investors don’t want to wait indefinitely for interest rates to drop or for a more favorable regulatory environment, and while parts of both public and private equity markets are overvalued today, opportunities still exist.
When valuations are high and activity is concentrated in one sector of the market, selectivity and quality become even more important, as does managing concentration risks—regardless of whether an investor is looking at private or public markets.
Exhibit 6: LP Secondary Portfolio Pricing
Source: J.P. Morgan Guide to Alternatives
The Bottom Line: Whether investors are looking at public or private markets, valuations and concentrations remain a critical determinant in the investment decision-making process, with caution warranted in the overvalued parts of any market, like tech in public equity and secondaries in private equity markets today.
Asset Class Performance Quilt
Markets are ever-changing, making diversification across asset classes and sectors a critical component of portfolio construction. As illustrated below, a Balanced 60/40 portfolio provides greater consistency of returns and less volatility over time.
Source: YCharts. Asset class performance is presented using market returns from an exchange-traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by Centura Wealth Advisory. The performance of those funds may be substantially different than the performance of broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High Yield Bonds (iShares iBoxx $ High Yield Corp Bond ETF); Intl Bonds (Invesco International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI ACWI ex US ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 40% U.S. Bonds, 12% International Stock, and 48% Large Blend.
https://centurawealth.com/wp-content/uploads/2024/11/iStock-1816227914.jpg12242448Taylor Mastershttps://centurawealth.com/wp-content/uploads/2024/07/Centura-Logo-Grey.pngTaylor Masters2025-03-05 17:23:212025-03-05 17:50:51Market Month in Review – February 2025
Macro Indicators: Headline and core PCE inflation increased 2.6% and 2.8%, respectively, in December 2024. The increases were in line with expectations but strengthen concerns that inflation will remain sticky. The December jobs report showed continued strength in the labor market, with jobs added exceeding expectations by over 100,000. The unemployment rate fell slightly from the prior month from 4.2% to 4.1%. After expanding 2.3% in 4Q, GDP grew 2.8% in 2024, signaling a relatively strong economy despite higher interest rates. Trump & Geopolitics: As of month-end, tariffs are expected to be levied on Mexico, Canada, and China, fueling the start of a potential trade war with uncertain impacts.
Trump & Geopolitics: As of month-end, tariffs are expected to be levied on Mexico, Canada, and China, fueling the start of a potential trade war with uncertain impacts.
Fed & Monetary Policy: After cutting 100 bps between September and December 2024, the Fed held rates steady at their January Federal Open Markets Committee (FOMC) meeting, reiterating their “higher for longer” narrative and dependency on macro data like inflation and jobs.
Equity Markets: Tech stocks witnessed volatility in January with the publication of a report from DeepSeek, an emerging artificial intelligence (AI) technology out of China. Key players, like Nvidia, lost more than 17% from the report, an important reminder that competition will be rampant as companies look to develop and incorporate AI, making portfolio diversification imperative to help protect against potential downside risks.
Asset Class Performance
Despite volatility surrounding President Trump’s return to office in January, positive monthly returns were posted across all asset classes with the largest gains coming from equity markets. Developed international performed the best over the month largely due to strong company fundamentals, and U.S. markets were up over 2.5% across both large and small-cap stocks.
Source: YCharts. Asset class performance is presented using total returns for an index proxy that best represents the respective broad asset class. U.S. Bonds (Bloomberg U.S. Aggregate Bond TR), U.S. High Yield (Bloomberg U.S. Corporate High Yield TR), International Bonds (Bloomberg Global Aggregate ex-USD TR), U.S. Large Cap (S&P 500 TR), U.S. Small Cap (Russell 2000 TR), Developed International (MSCI ACWI ex US TR), Emerging Markets (MSCI EM TR), and Real Estate (Dow Jones U.S. Real Estate TR).
Markets & Macroeconomics
Data Dependency Strikes Again
In the current environment, the Fed continues to reiterate its “data dependent” mode, with their January Federal Open Markets Committee (FOMC) statement expressing, “the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks” in determining the future path of monetary policy. The Fed is expected to keep interest rates at current levels until a catalyst emerges to support lower rates, which will likely come from inflation, the labor market, or GDP. Inflation data, including both PCE and CPI, increased relatively in line with market expectations in December 2024 but remains elevated above the Fed’s 2% inflation target. Core PCE, which excludes more volatile food and energy costs, increased 2.8% in December 2024 on a year-over-year basis, the third month in a row it has logged a 2.8% growth rate. Certainly, the “last mile of inflation” is proving difficult, supporting the Fed’s decision to hold interest rates steady.
This stickiness has ignited concerns that market inflation expectations are being re-anchored to a higher level long-term, which is illustrated by the rise in the 10-year Treasury yield, which partially reflects inflation expectations (among many other factors) and reached 4.8% earlier this month after falling back down to 4.5% by month-end, depicted in Exhibit 1. The Fed’s decision-making is also highly dependent on the health of the labor market, which remains strong. While this is a good thing, the market interprets this as bad news because it does not justify lower interest rates and ultimately keeps the Fed on pause.
Exhibit 1: 10-Year Treasury Yield
Source: YCharts
The Fed remains hyper-focused on the impact of inflation and the labor market on the U.S. economy, and, in turn, markets remain dependent on the Fed and its actions (or inactions) with interest rates. Complicating matters today, data dependencies have also arisen from the onslaught of data and news coming out of the White House, as well as data in equity markets related to earnings or market reports. On the latter, we recently witnessed the vulnerability of major U.S. indices, particularly the tech-heavy Nasdaq-100, when a report was published on a new artificial intelligence (AI) technology out of China, called DeepSeek, a competitor to AI giants in the U.S., like OpenAI, the creator of ChatGPT. The report, which was published on January 27, reverberated through markets, sending the Mag 7 darling and chipmaker, Nvidia, to close down nearly 17%, illustrated in Exhibit 2, resulting in nearly $600 billion of market cap lost – the largest single-day loss ever – due to the report’s claim that DeepSeek cost a fraction to build versus U.S. models, potentially threatening the future profitability of a chipmaker like Nvidia. The lesson learned from the DeepSeek drama is that competition will be rampant in the AI space, and this competition will continue to disrupt equity market performance as winners and losers are identified in the AI arms race, making diversification away from tech concentrations an important theme in 2025.
Exhibit 2: Impact of DeepSeek Report
Source: YCharts
The Bottom Line: Markets today are highly dependent on data, whether it be from the Fed, macroeconomic indicators, the White House, or the latest in AI technologies. These dependencies create hyper-sensitive markets prone to volatility, which is expected to be a continuing theme in 2025
Looking Ahead
Trump 2.0 – Tariffs, Tax Policy & Uncertainty
As Trump entered office on January 20, he signed 24 executive orders, the most any President has signed on their first day in office, illustrated in Exhibit 3, setting an important precedent that he intends to fiercely pursue his policy agenda. Despite Republicans holding a slim majority in the House and Senate, Trump’s aggressive policies will likely face opposition, making the overall success of his agenda uncertain. As his policies take shape over the coming weeks and months, investors should stay informed and cautious about making portfolio changes based on speculation or promises made by the government, focusing instead on the known facts.
Exhibit 3: Executive Orders Signed First Day
Source: Federal Register
What we do know is that Trump is proposing a comprehensive swath of changes, spanning stricter controls on immigration and border protection, greater government efficiency including the reduction of the federal workforce, tax policy reform and likely tax cuts, broader as well as tactical tariffs, expansion of cryptocurrency markets, and even more esoteric changes, like the renaming of landmarks, including the Gulf of Mexico, just to name a few. Clarity will emerge as his policies take physical shape, but, in the interim, there is much consternation in the investing community about the impact of some of these policies on federal finances, as well as on growth in the U.S. economy, which has already had to withstand years of restrictive monetary policy. One of the more significant pieces of legislation up for debate this year is the sunsetting of Trump’s 2017 Tax Cuts and Jobs Act (TCJA), which was passed during his first term and is set to expire at the end of 2025. There is a high probability that Trump will extend or even expand the TCJA, broadly reducing taxes and simultaneously putting further pressure on federal finances, which the Congressional Budget Office (CBO) has estimated would cost at least $4.6 trillion over the next 10 years. A ballooning federal debt could put strain on the demand for U.S. Treasuries, while changes to U.S. tax policy, particularly as it relates to alternative minimum tax (AMT) exemptions and the state and local tax (SALT) caps, could have implications for the municipal market.
Trump is hoping to fund part of these tax cuts through tariffs, which do not require congressional approval under the “national emergency” Trump is claiming for tariff enforcement. As of month-end, Trump was threatening tariffs on imports from key trading partners Canada, Mexico, and China, illustrated in Exhibit 4, who in turn, promised retaliation, introducing concrete concerns about a re-acceleration in inflation and even stagflation, which could trouble the Fed in their plight to reduce interest rates. As negotiations play out in the coming weeks, we could see changes to these initial tariffs and ensuing volatility in equity markets. The TCJA and tariffs are textbook examples of uncertainty surrounding Trump’s fiscal agenda. There are countless ways these policies could take shape with potential implications on federal finances, U.S. growth, inflation, labor market health, and both equity and bond markets that are difficult to predict, making uncertainty almost a guarantee.
Exhibit 4: U.S. Key Trading Partners
Source: Council on Foreign Relation
The Bottom Line: Trump is pursuing his policy agenda aggressively, focusing first on tariffs and tax policy. Investors should expect uncertain and likely volatile conditions in the weeks and months ahead and should remain cautious about making portfolio changes amidst this uncertainty.
Capital Markets Themes
What Worked, What Didn’t
•Values Bests Growth: After a volatile month for growth and tech stocks, fueled primarily by the DeepSeek drama that routed artificial intelligence-based companies, value stocks outperformed growth by nearly 250 bps in January, supporting the story of equity market breadth.
•Invest in Bonds for Income: Taxable and municipal bonds performed roughly in-line with one another in January, returning 50 bps for the month, but municipal markets continue to provide attractive tax equivalent yields for investors, particularly in the high yield muni sector, emphasizing the benefit of income when investing in bond markets.
Large vs Small Cap Equity
Growth vs Value Equity
Developed vs Emerging Equity
Short vs Long Duration Bonds
Taxable vs Municipal Bonds
Investment Grade vs High Yield Bonds
Source: YCharts. Data call-out figures represent total monthly returns
On Alternatives
2025 Outlook for Private Markets
Private Equity – After a slow exit environment in recent years, the tide may be changing for the initial public offering (IPO) market in 2025. With a new political regime and the Fed cutting interest rates by 100-bps late last year, optimism is rebounding for the ability of firms to sell portfolio companies at more attractive valuations; however, expectations for further cuts this year are uncertain given the Fed’s “higher for longer” stance. Private equity is also sitting on high levels of dry powder – assets raised for investments but not yet deployed – strengthening the potential for a boost in deal flow activity in 2025, illustrated in purple in Exhibit 5, particularly against Trump’s “deregulation” backdrop.
Exhibit 5: Alternatives Dry Powder
Source: Preqin, J.P. Morgan Asset Management. Data as of 11/30/2024.
Private Credit – The private credit asset class has seen more inflows in recent years than any other private market, largely due to its consistent return profile, high level of income production, and resilience against market volatility. This market-wide migration, however, caused spreads in the private credit market to compress, making the opportunity set potentially less appealing in the current environment, particularly as the Fed has cut rates 100-bps. Interest rates also play a critical role in the private credit market, and rates staying “higher for longer” could continue to put pressure on borrowers, testing the resilience of the asset class to deliver income during times of uncertainty, making the focus on high-quality lenders critical to success in 2025.
Private Real Estate – Interest rate volatility witnessed in the 10-Year Treasury yield in recent months has created a difficult environment for operators and valuations in the real estate market, a trend that is likely to continue in 2025 with a confluence of factors affecting the Treasury market. Zeroing in on multifamily real estate, perhaps the most significant factor affecting this sector in 2025 is the number of deliveries, a measurement of supply, falling off a cliff, as illustrated in Exhibit 6. Deliveries represent the completion of a property and lag starts, which have already seen a precipitous decline, meaning that 2025 could bring limited supply, which should help fuel rental demand and lead to robust rent growth in the multifamily sector this year and beyond.
Exhibit 6: Multifamily Real Estate Supply
Source: CoStar, J.P. Morgan Asset Management. Data as of 11/30/2024.
The Bottom Line: The 2025 outlook for private investments remains solid but is largely dependent on the direction of interest rates, which, of course, is dependent on the U.S. macroeconomic picture. Amidst this uncertainty in the macro environment, a focus on quality and diversification across private investments remains crucial to defend against potential downside risks.
Asset Class Performance Quilt
Markets are ever-changing, making diversification across asset classes and sectors a critical component to portfolio construction. As illustrated below, a Balanced 60/40 portfolio provides greater consistency of returns and less volatility over time.
Source: YCharts. Asset class performance is presented using market returns from an exchange-traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by Centura Wealth Advisory. The performance of those funds may be substantially different than the performance of broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High Yield Bonds (iShares iBoxx $ High Yield Corp Bond ETF); Intl Bonds (Invesco International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI ACWI ex US ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 40% U.S. Bonds, 12% International Stock, and 48% Large Blend.
https://centurawealth.com/wp-content/uploads/2024/11/iStock-1816227914.jpg12242448centurawealthhttps://centurawealth.com/wp-content/uploads/2024/07/Centura-Logo-Grey.pngcenturawealth2025-02-05 17:31:452025-03-03 02:19:17Market Month in Review – January 2025
Global markets saw significant developments in the fourth quarter of 2024, concluding a year marked by economic shifts, policy changes, and geopolitical events. The S&P 500 achieved 57 new all-time highs, delivering a remarkable annual gain of 25% and marking its strongest back-to-back performance since 1997/1998. In the fourth quarter, the “Trump Trade” returned in full force following the November election results, significantly influencing market dynamics and delivering the strongest monthly performance of the year.
With Donald Trump securing another term as President, market participants quickly shifted their strategies to align with expected policy changes, including key proposed initiatives like deregulation, international trade, and lower taxes. As investors anticipated a favorable environment for corporate profits, U.S. equity markets, particularly those sectors with high exposure to domestic economic activity, benefited immensely. Focus on the “Trump Trade” also fostered renewed optimism in venture capital and the small-cap sector, which gained from speculation that domestic-focused companies would be prime beneficiaries under Trump’s administration. Below are highlights from the fourth quarter and year:
The S&P 500 and NASDAQ 100 both rallied +25% through year-end despite geopolitical headwinds, economic challenges, and the final five trading days of the year failing to materialize a Santa Claus Rally. Their strong performance was aided by the tech sector, which benefitted from the AI boom and contributed significantly to their growth. Magnificent Seven giants like Nvidia (NVDA), Meta (META), and Tesla (TSLA) propelled the indexes to new heights as these companies harnessed the transformative potential of AI and similar technologies, capturing investor interest and driving substantial returns.
The Magnificent Seven, comprising the seven largest technology stocks (Apple, Amazon, Alphabet, Microsoft, Meta Platforms, Nvidia, and Tesla), make up approximately 35% of the S&P 500 and nearly 50% of the NASDAQ. Investors fueled inflows into the stocks given their expanding service segments and innovative product lines, which resonated well with consumers worldwide. Given their size and profitability, investors believe that the Magnificent 7 companies’ scale and financial flexibility best position these companies to capitalize on artificial intelligence. While there has been some rotation out of the Magnificent Seven, given their exorbitant valuations, their complex interplay of innovation, market leadership, and strategic expansions contributed 55% of the S&P 500’s gains for 2024, with Nvidia alone producing 21% of the index’s return. Leveraging their financial flexibility and technological prowess, these companies positioned themselves at the forefront of market trends, setting the tone for technology-driven growth as we transition into 2025.
Cryptocurrency, once considered a high-risk investment, is gaining greater acceptance among retail and, importantly, institutional investors. Bitcoin (BTC-USD) surged to an all-time high of $108,369 in December, pushing the global crypto market’s value over $3T for the first time in three years, as BlackRock, the world’s largest asset manager, stated that a Bitcoin allocation of up to 2% in portfolios is “reasonable.” The shifting regulatory environment with Trump’s victory further aided the advance of cryptocurrency. While Bitcoin contracted from its peak to close the year, as digital assets grow and regulatory acceptance increases, many investors may seek an opportunity to capitalize.
Bloomberg Barclays U.S. Aggregate Bond Index experienced a rollercoaster year, though it turned into a positive year for the second in a row. Driven by growth prospects, inflation, and monetary policy projections, the 10-Year Treasury entered 2024 at 3.88%, only to rise and peak at 4.70% before collapsing to 3.63%. As growth improved and the “Trump Trade” took hold, rates reversed sharply to end the year at 5.58%. Despite the yield rising 0.77% in 2024; the bond index eked out a positive 1.25% return.
Geopolitical Tensions and Volatility further supported the case for U.S. equities and pushed valuations higher. Tensions in the Middle East and Russia-Ukraine continued to escalate, as did tensions between China and Taiwan. Additionally, South Korea finds itself in the middle of a political crisis after their now impeached president briefly declared martial law, and both France and Germany saw their governments collapse in December, fueling geopolitical concerns.
Gold Bullion returned the best year since 2010 with gains of +27%. Strong global central bank purchases, rising geopolitical uncertainties, and monetary policy easing all propelled the safe-haven asset’s record-breaking rally near an all-time high of $2,790.15 on Halloween. While the surging U.S. Dollar took some of the air out of gold’s sail, the same catalysts that pushed gold higher in 2024 remain, potentially supporting further gains in 2025.
Equities – U.S. stocks continued their impressive run through Q4, building on gains from earlier in the year. The technology sector remained a key driver of market performance, buoyed by an ongoing enthusiasm for artificial intelligence and other emerging technologies. Nvidia (NVDA) continued its meteoric rise, solidifying its position as one of the world’s most valuable companies. The S&P 500 rose 2.41% for the quarter, bringing its year-to-date return to an impressive 25%.
Bonds – The bond market experienced significant volatility in Q4, largely driven by shifting expectations for the economy, hypothetical fiscal policy, Fed policy, and inflation. Entering the quarter at 3.81%, the 10-Year Treasury yield rose sharply over the course of 2024’s final months to end the year at 4.58%. Robust economic growth paired with a slower pace of Fed rate cuts and the prospects of pro-inflation fiscal policy initiatives caused the market to reassess both long-term growth and inflation expectations higher, lifting long-term bond yields. With the upward move in yields, the Bloomberg U.S. Aggregate Bond Index fell 3.06% in Q4, erasing earlier gains, though it still produced a positive calendar year, closing 2024 up 1.25%.
Source: YCharts. The Bloomberg US Aggregate Index was used as a proxy for Bonds; the Bloomberg US High Yield 2% Issuer Capped Index was used as a proxy for High Yield Bonds; the Russell 2000 Index was used as a proxy for Small Cap Equities; and the MSCI ACWI Ex USA Index was used as a proxy for Foreign Equities. All returns are based on total return levels as of 12/31/2024.
Economy: Robust Consumer Spending in 2024
Consumption has remained one of the biggest drivers for the U.S. economy, whose real GDP is on track to expand more than 3% in Q4 2024. The consumer discretionary sector was the top-performing sector in December and one of the top sectors in 2024. Major retailers and discretionary companies capitalized on this year’s seasonal surge in holiday sales, which saw record-breaking transactions amid consumers’ willingness to stretch budgets for year-end gifting.
Despite the optimistic consumption data, businesses remain cautious and keenly aware of the potential risks posed by fluctuating consumer sentiment and the specter of inflationary pressures lingering from policy shifts both domestically and globally.
During Q4 2024, consumer spending remained a pivotal component of the economic landscape, although it exhibited signs of moderation. Robust consumer activity, invigorated by wage growth and stronger purchasing power than previous years, continued to support the broader economy. Despite elevated borrowing costs, consumers showcased resilience, navigating a complex environment marked by geopolitical tensions and evolving fiscal policies. The U.S. economy continued to demonstrate resilience in Q4. According to the Atlanta Fed’s GDPNow model, as of Christmas Eve, Q4 growth is estimated at 3.1%, reflecting a continuation of the robust 3.1% expansion seen in Q3. This growth aligns with the Federal Reserve’s efforts to reach a “soft landing” and avoid recession while combating inflation.
Consumer spending is a bellwether for economic growth, but it also faces notable headwinds, most notably the rising levels of household debt. U.S. credit card defaults jumped to the highest level since 2010 as credit card lenders wrote off $46 billion in seriously delinquent loans through September (50% year-over-year increase); a sign that the financial well-being of lower-income consumers is waning after years of high inflation. Trump’s planned fiscal policy changes also have the potential to further erode consumers’ purchasing power, particularly if his policies lead to a resurgence in inflation.
Labor Market Dynamics
As one of the dual mandates of the Fed, the labor market remains a focal point of economic analysis. Marred by two hurricanes and a Boeing strike, October’s labor gains were anemic. Meanwhile, 227,000 jobs were added in November, beating expectations, as the unemployment rate inched up to 4.2%, which represents a 0.5% increase in unemployment from 3.7% to start the year.
Higher unemployment figures and reduced job openings tested the labor market’s resilience, with October job openings (JOLTs) around eight million, a palpable decline from nearly nine million openings in January 2024. Another signal of labor market softening is the ratio of job openings to those unemployed, which moved down over the year to 1.08:1. While the ratio of 1.08:1 is near historical levels, the ratio has fallen significantly from nearly two job openings for every job posting in 2022, indicating the labor market is showing signs of tightening.
As the number of open jobs trended lower, the number of unemployed job seekers trended higher, as evidenced by the more than one million additional unemployed persons from January through November. The current levels show signs of tightening, reflecting a labor market that remains healthy but is gradually moderating after an extended period of strength. More concerning is the reversal witnessed in wage growth. After bottoming in June at 3.83%, wage inflation has risen back above the critical 4% threshold. Robust wage gains have bolstered consumer spending but have also heightened the risk of reigniting inflation. Heading into 2025, the job market will serve as a key indicator of economic stability, with any significant downturn threatening consumer spending and overall economic growth, and also prompting potential shifts in monetary policy.
Inflation and Monetary Policy
Inflation trends remained a central focus for markets and policymakers. After showing signs of moderation in early 2024, inflation has remained sticky, with measures ticking up slightly in the latter part of Q4. The headline Consumer Price Index (CPI) edged higher to 2.7% year-over-year in November, while core CPI (excluding food and energy) held steady at 3.2%. In line with CPI, the Fed’s preferred inflation gauge ran into the proverbial wall mid-year and has proven stubborn during this last mile of contraction as the Core Personal Consumption Expenditures (PCE) price index has risen from 2.6% in June to 2.8% in November. While significantly lower than the peaks seen in 2023, these figures remain above the Federal Reserve’s 2% target.
Following their surprisingly aggressive 50 basis point rate cut in September, the Federal Reserve reduced interest rates by another 50 basis points in the fourth quarter, bringing the interest rate cut total to 100 bps for 2024. December’s meeting also provided insight into the Fed’s outlook for 2025 and beyond. The Fed’s updated Statement of Economic Projections showed a slower pace of rate reductions in 2025 than previously projected in September, cutting projections in half from 100 basis points of cuts, to 50 basis points, or two potential 25 basis point cuts in 2025. This deviation sent long-term bond yields surging and prompted a risk-off mentality as investors started repricing a “higher-for-longer” outlook, causing a sell-off in interest rate-sensitive small-cap and technology stocks. With persistent inflation, wage growth elevated, and Trump set to take office, we anticipate the Fed to adopt a patient and methodical approach to future rate reductions.
We believe the Fed will ultimately deliver on their goal to lower inflation to its 2% mandate and avoid a recession for the U.S. economy. However, the Fed will need to monitor the state of the labor market deterioration and reversal of inflation closely if they are to fully avoid an economic contraction and achieve their inflation target. Successfully delivering lower inflation and monetary policy normalization should bode well for equities and bonds. As always, there are several potential risks looming, and investors should proceed carefully.
By most measures, the S&P 500 remains overvalued. According to FactSet, as of December 15, the forward 12-month Price-to-Earnings Ratio (P/E) was 22.3x, which is higher than both the 5-year and 10-year averages of 19.7x and 18.1x, respectively. Valuations continue to pose a risk to the market, as negative sentiment can lead to sharper sell-offs. Furthermore, the concentration of the Top 10 largest stocks in the S&P 500 poses a significant concentration risk. According to JPMorgan Asset Management, the 10 largest constituents represent 38.7% of the index as of December 31. Concentrations of this magnitude make the index more sensitive to changes in its top constituents, particularly when those 10 companies are significantly more overvalued than the remaining 490 companies, as is the case in the current environment. The P/E of the top 10 is currently 29.8x, while the remaining stocks currently boast a P/E of only 18.2x, both of which are above their historical averages. Concentrations like this are precisely why we favor global diversification across several asset classes, both public and private. This high level of concentration also supported our decision to reduce overall large-cap exposure, particularly to large-cap technology stocks, in our public model allocations as we enter the new year.
Looking under the hood of public markets, corporate profits remain resilient despite elevated borrowing costs. This trend is illustrated by the S&P 500’s fifth consecutive quarter of positive earnings growth, rising 5.9% in Q3 2024. As of December 20, FactSet estimates fourth-quarter earnings to expand at a faster pace of 11.9% year-over-year.
Since 2023, the Magnificent Seven has been responsible for most of the market’s earnings growth, increasing 31%, versus the -4% contraction of the remaining 493 companies’ earnings in the S&P 500 last year. This trend is expected to persist in 2024, but we remain optimistic as JPMorgan predicts the remaining companies outside the Magnificent Seven to catch up and accelerate earnings growth in the forward-looking environment. Both groups are expected to experience robust year-over-year earnings growth of 21% and 13%, respectively, in 2025. A broadening of earnings growth should bode well for increased market breadth and carve a path for higher broad-based returns for equities outside the Magnificent Seven.
Perhaps even more encouraging is the rebound and contribution to earnings growth expected from both mid- and small-cap companies. While elevated rates will continue to cause issues for some smaller companies, earnings for small caps are expected to grow 44% in 2025. When coupled with easing monetary policy, potentially pro-business fiscal policies like deregulation, international trade, and lower tax rates, the backdrop appears encouraging for mid- and small-cap companies; hence supporting our decision to eliminate our underweight and increase exposure in our allocations to align with our long-term target allocations.
From the political crisis in South Korea, to the government collapses in France and Germany, to the armed conflicts, notably in the Middle East, where tensions between Israel and Iran escalated, and in Russia-Ukraine, and the threat of intensifying conflicts between China and Taiwan – international markets are on fragile ground. As these international disputes unfold, they have a cascading effect on market sentiment, influencing everything from currency valuations to sector performance. The specter of further geopolitical instability remains a crucial factor to monitor in the upcoming year, with potential policy responses from global leaders poised to have far-reaching consequences for economic forecasts and asset allocations worldwide. One of the most significant economic initiatives anticipated in 2025 is the resurgence of tariffs under President Trump’s administration. Known for a protectionist stance, Trump’s economic strategy could reignite trade tensions globally as the administration revisits import tariffs with the goal of reshoring jobs and boosting domestic manufacturing. This strategy is expected to lead to a more protectionist trade policy, potentially affecting global trade dynamics and introducing volatility into markets sensitive to international trade. Given the disruption abroad, paired with a strengthening dollar, we further reduced our allocations to foreign equities.
Interest rate volatility was once again prevalent in 2024, and while we expect this trend to continue in 2025, we do anticipate more moderate moves. Markets repriced their growth and inflation expectations over the second half of the year, pushing long-term rates (as measured by the 10-Year Treasury) back over 4.5%. At this point, with so much unknown on the path of inflation and the fiscal policy front with Trump entering office, barring an exogenous event, we would expect long-term yields to remain range-bound, producing a return relatively in line with the coupons on bonds. We also expect to witness further bull steepening – where shorter-term yields fall quicker than longer-term yields, eventually normalizing the yield curve back to upward sloping, albeit given the latest Fed rate projections, at a slower pace than previously anticipated.
In conclusion, Q4 2024 capped off another year of significant market gains and economic resilience. The Federal Reserve’s pivot towards monetary easing provided a tailwind for both stocks and bonds, setting the stage for an interesting 2025. With so much uncertainty surrounding the changing political landscape and resulting policy changes, we enter the year with our allocations balanced and in line with our long-term targets. The reset to our allocations reflects our expectations for volatility in 2025 as markets work through the political noise and reassess potential economic ramifications, and, on the other hand, our expectation for solid earnings growth across U.S. equities. Diversification across several public and private market asset classes should serve clients well in 2025. As always, investors should remain vigilant to potential risks while positioning themselves to capitalize on opportunities in the evolving market landscape.
Thank you for your continued confidence and support. If you have questions or concerns, please contact your Centura Wealth advisor.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Centura Wealth Advisory is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Centura Wealth Advisory and its representatives are properly licensed or exempt from licensure. 12255 El Camino Real, St. 125, San Diego, CA 92130.
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Inflation & Labor Data: Headline and core PCE inflation data increased in October to 2.3% and 2.8%, respectively (vs. 2.1% and 2.7% the month prior). The PCE increases were in line with expectations but introduce concerns that inflation will remain sticky. After September’s noisy labor report, the October report, published on December 6, will be widely anticipated. The unemployment rate remains at 4.1%.
U.S. Election: Since the election on November 6, markets have been assessing potential policy changes and cabinet appointees from President-Elect Trump, ushering in a “Trump Trade.”
Fed & Monetary Policy: The Fed continued their easing cycle by cutting interest rates another 25-bps in November. Inflation and labor market data remain hyper-important as the Fed continues to be data dependent. There is one final FOMC meeting in 2024 in December, which will likely witness another rate cut and an update to the Fed’s Summary of Economic Projections, providing insights into the possible monetary policy activity for 2025 and beyond.
Equity Markets: Equity markets continued their year-to-date run-up in November, with major equity indices continuing to notch record highs. The S&P 500 reached its 53rd all time high (ATH) in 2024 on November 29.
Asset Class Performance
The “Trump Trade” took full effect in November, as news of President Trump’s re-election reverberated through global markets. Emerging markets were hit the hardest, a direct result of Trump’s tariff threats and a surging U.S. Dollar. Conversely, U.S. equities fared the best, led by small cap stocks, which stand to benefit from expected Trump policies, including de-regulation and greater reliance on domestic companies.
Source: YCharts. Asset class performance is presented using total returns for an index proxy that best represents the respective broad asset class. U.S. Bonds (Bloomberg U.S. Aggregate Bond TR), U.S. High Yield (Bloomberg U.S. Corporate High Yield TR), International Bonds (Bloomberg Global Aggregate ex-USD TR), U.S. Large Cap (S&P 500 TR), U.S. Small Cap (Russell 2000 TR), Developed International (MSCI EAFE TR), Emerging Markets (MSCI EM TR), and Real Estate (Dow Jones U.S. Real Estate TR).
Markets & Macroeconomics
Elections and Rate Cuts and Earnings, Oh My!
Markets digested a lot of information in the month of November, including the results of the U.S. election, another Fed interest rate cut, and a slew of 3Q earnings reports. While markets experienced volatility intra-month, they ended the month solidly up, with major indices like the S&P 500 and Russell 2000 turning in their best monthly results of the year, gaining 5.7% and 11.0%, respectively, in November.
The results of the U.S. election in early November brought news of another Trump Administration and a “red sweep” across Congress. Markets reacted positively to this outcome, with small caps as measured by the Russell 2000 up nearly 8% from November 4, the day before the election, through November 6, the day after the election. The market enthusiasm in small caps was primarily due to Trump’s promise of “deregulation,” which has the potential to positively impact smaller companies more than larger ones. Market participants also started positioning around Trump’s stance on tariffs, immigration, and other potential policy decisions. Cryptocurrency is another asset class benefiting from Trump’s re-election, illustrated by Bitcoin’s run-up of over 140% in 2024. Fervor related to the so-called “Trump Trade” waned over the course of the month as much uncertainty remains around the extent of Trump’s policies.
Exhibit 1: Equity Markets Pre- and Post-Election
One day after the Presidential election results were declared, on November 7, the Federal Reserve cut interest rates by 25 bps, continuing their policy easing. The Fed has continued to reiterate its “data dependent” approach, particularly as it concerns inflation and labor data. Whether the policies outlined in the Trump agenda have the potential to impact the course of monetary policy is of no concern to the Fed – they remain independent from politics and focused on a broad set of data to determine their policy trajectory, not speculation of potential fiscal policy changes. The Fed meets one more time in 2024 in December, where they will publish a new set of economic projections, providing important data on what to expect in 2025.
Source: YCharts
Finally, 3Q earnings season is drawing to a close, with over 95% of companies having reported already. Earnings have now grown for five quarters in a row, and expectations for 4Q are expected to double the growth seen in 3Q, with broader contributions from companies outside the Magnificent Seven expected. Year-over-year earnings growth was led by the Health Care and Communication Services sectors, meanwhile the Energy sector was the most challenged in 3Q. As company earnings continue to grow, so too do major equity indices, with the S&P 500 and Dow Jones indices notching multiple all-time highs over the course of the month. The S&P 500 now has 53 all-time highs in 2024. Equity markets remain slightly overvalued, making it important to not just consider large cap stocks, but diversify across asset classes and sectors.
The Bottom Line: November was an eventful month, with the U.S. election, an interest rate cut, and the 3Q earnings season keeping markets busy. As the “Trump Trade” took effect, we saw markets end the month higher, as illustrated by the number of all-time highs by major U.S. equity indices. The Fed continues its easing policy which may come into conflict with Trump’s fiscal agenda in 2025.
Looking Ahead
Wrapping Up 2024
With 2024 drawing to a close, there are still a few events left that have the potential to drive market activity in the final month of the year: the December Federal Open Markets Committee (FOMC) meeting, including the publication of the Fed’s latest economic projections, and, of course, Santa Claus!
Every quarter, the Federal Reserve updates their projections for future GDP growth, unemployment, inflation, and interest rates in a publication titled the Summary of Economic Projections, the “SEP” or “Dot Plot” for short. Updates to the Dot Plot inform market participants about the trajectory of interest rates, both in the short- and long-term, and this trajectory can shift course as economic data changes. Throughout 2024, the Fed has been extremely “data dependent” with monetary policy, meaning their decisions have been heavily influenced by monthly macroeconomic data points, particularly inflation and unemployment data. This data has guided the Fed in their decision-making and has resulted in changes to their economic projections, as illustrated in Exhibit 2 below, which shows the March, June, and September SEP or Dot Plot projections. What we learned from these projections is that the latest Dot Plot in September showed interest rates elevated at a higher level in the long-term (2027 and beyond) than previous projections in March and June, indicating a slower pace of rate reductions. The December Dot Plot, which will be published on December 18, will provide important clarity on whether the Fed’s thinking has changed based on the latest macroeconomic data. We could also see an additional rate cut at the December FOMC meeting.
Exhibit 2: Changing Fed Funds Projections
Source: The Federal Reserve
As markets assess the Fed and the direction of monetary policy, they may also get to experience the magic of Santa Claus this December. The “Santa Claus Rally” is a technical market phenomenon explaining why equity markets advance in the final week of the year. This phenomenon is illustrated in Exhibit 3 below, where four out of the past five years saw equity market gains in the last week of December. There are numerous reasons why this phenomenon can occur, with one major explanation being the lower institutional trading volume during the holidays. Some believe a Santa Claus Rally can help set expectations for market performance in the coming year; however, skeptics believe it to be a self-fulfilling prophecy. Either way, wrapping up 2024 could see continued growth in equity markets, and depending on the commentary and decisions from the Fed, may introduce short-term volatility to close out the year.
The Bottom Line: 2024 is wrapping up and two events have the potential to keep markets busy through year-end: the last FOMC meeting, where an interest rate cut is largely expected, in addition to updates to economic projections, and a potential for a Santa Claus Rally, which could drive equity markets even higher to end the year.
Exhibit 3: S&P 500 Recent December Returns
Source: YCharts
Capital Markets Themes
What Worked, What Didn’t
•Small Caps Take Off: Small cap stocks, as measured by the Russell 2000 Index, were up nearly 11% in November, spurred by the “Trump Trade” and policy implications that would stand to benefit smaller domestic companies.
•Growth vs. Value Equity: While growth equities have largely outperformed value equities in 2024 due to the tech- and AI-boom, these two styles performed roughly in-line with one another in November, illustrating how equity market participation may be starting to broaden outside of tech.
Large vs Small Cap Equity
Growth vs Value Equity
Developed vs Emerging Equity
Short vs Long Duration Bonds
Taxable vs Municipal Bonds
Investment Grade vs High Yield Bonds
Source: YCharts. Data call-out figures represent total monthly returns
On Alternatives
The Outlook for Private Credit
The private credit market is around $1.7 trillion in size and has grown nearly two-fold in the past 10 years. Most of this growth has been in the direct lending sector of the market, which represents close to 50% of the entire private credit market, illustrated in Exhibit 4 below. Direct lending is a form of private lending to small- or medium-sized companies without the use of an intermediary, typically in the higher quality, or senior, portion of the company’s capital structure.
Exhibit 4: Private Credit AUM
Source: Preqin. Data as of 6/30/2024
Direct lending, and private credit as a whole, is predominately floating rate, meaning that the underlying debt instrument is tied to a rate, typically the secured overnight financing rate (SOFR), that can fluctuate over its life, i.e., the rate “floats.” SOFR is an interest rate that is directly tied to the federal funds rate, meaning that as the fed funds rate increased in 2022 and 2023, so did SOFR, and, subsequently, the yields for private credit. Conversely, this means the opposite also holds true in the current environment: as the Fed cuts interest rates, the yields across private credit are expected to decline, albeit at a delayed cadence to rate cuts.
Illustrated in Exhibit 5, private credit has recently enjoyed elevated yields of close to 12%, measured by the private credit benchmark, the Cliffwater Direct Lending Index (“CDLI”). Compared to the public credit alternative, short-term Treasury bills, private credit offers a yield advantage of nearly 6%. This yield advantage helps explain why private credit has seen such strong inflows in recent years.
While declining interest rates typically lead to lower yields for private credit, they also reduce the interest burden on companies, particularly the smaller companies that direct lending targets. Smaller-sized companies are more sensitive to interest rates, meaning they benefit more when rates fall. This creates a double-edged sword in the private credit market: lower rates mean lower yields, but they also ease the burden on borrowers, potentially reducing default risks and overall investment risk.
Although investors may not see yields of 11% or higher moving forward, private credit still offers elevated yields and other advantages, such as diversification from traditional fixed income – a key benefit that has become even more important in the falling rate environment.
Exhibit 5: Private vs. Public Credit Yields
Source: Cliffwater
The Bottom Line: The outlook for private credit is changing, driven by falling interest rates which will reduce yields within the asset class over time. Falling rates should also reduce the interest burden on companies targeted by direct lending. Private credit still offers advantages against traditional fixed income, including higher yields and diversification benefits, which remain paramount in the current environment.
Asset Class Performance Quilt
Markets are ever-changing, making diversification across asset classes and sectors a critical component to portfolio construction. As illustrated below, a Balanced 60/40 portfolio provides greater consistency of returns and less volatility over time.
Source: YCharts. Asset class performance is presented using market returns from an exchange-traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by Centura Wealth Advisory. The performance of those funds may be substantially different than the performance of broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High Yield Bonds (iShares iBoxx $ High Yield Corp Bond ETF); Intl Bonds (Invesco International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares Core MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 40% U.S. Bonds, 12% International Stock, and 48% Large Blend.
Disclosure: CCG Wealth Management LLC (“Centura Wealth Advisory”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Centura and its representatives are properly licensed or exempt from licensure. Insurance products are implemented through CCG Insurance Services, LLC (“Centura Insurance Solutions”). Centura Wealth Advisory and Centura Insurance Solutions are affiliated. For current Centura Wealth Advisory information, please visit the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with Centura Wealth Advisory’s CRD #296985.
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Inflation & Labor Data: With inflation data continuing to decline, illustrated by the latest headline and core PCE data of 2.1% and 2.7%, respectively, the focus has turned to the labor market. September’s labor report included noise related to Hurricanes Helene and Milton and the Boeing strike, making it difficult to assess the latest reading of labor market health. The unemployment rate remains at 4.1%.
U.S. Election: Donald Trump was elected the 47th President, and markets are likely to experience short-term volatility as they adjust to the results and the subsequent implications for broader markets.
Fed & Monetary Policy: The Fed cut interest rates by 50-bps in September, with an additional 50-bps of cuts forecasted by Fed officials through the end of 2024. Monetary policy decisions continue to be data dependent, meaning markets have become more data dependent, creating volatility ahead of future Federal Open Market Committee (FOMC) meetings, including the next one on November 6.
Equity Markets: As of month-end, the S&P 500 is experiencing the best first 10 months of an election year since 1936. Additionally, the third quarter earnings season is off to a solid start, with positive, albeit slowing, quarter-over-quarter earnings growth.
Asset Class Performance
International markets fared the worst in October, with bonds, developed international equities, and emerging market equities all down over 4%. U.S. large cap equities were slightly down for the month and experienced volatility ahead of the November U.S. election but remain up 20% on a year-to-date basis. High yield bonds performed better than investment grade bonds in the U.S.
Source: YCharts. Asset class performance is presented using total returns for an index proxy that best represents the respective broad asset class. U.S. Bonds (Bloomberg U.S. Aggregate Bond TR), U.S. High Yield (Bloomberg U.S. Corporate High Yield TR), International Bonds (Bloomberg Global Aggregate ex-USD TR), U.S. Large Cap (S&P 500 TR), U.S. Small Cap (Russell 2000 TR), Developed International (MSCI EAFE TR), Emerging Markets (MSCI EM TR), and Real Estate (Dow Jones U.S. Real Estate TR).
Markets & Macroeconomics
3Q Earnings Season – Slower but Solid Growth
U.S. equity markets continue to surprise investors in 2024 with their solid performance. Even amidst the volatility and uncertainty in the lead-up to the U.S. Election throughout October, major equity indices, like the S&P 500 and Nasdaq-100, continued their run-up and reached all-time highs over the month, with both indices up 20% year-to-date through October 31. In fact, the S&P 500 experienced the best first 10 months of an election year since 1936, and this trend may continue depending on the election outcome.
Looking at third quarter (Q3) earnings data, 70% of companies in the S&P 500 have reported earnings as of month-end, with eight out of the eleven sectors reporting year-over-year growth. A lot of this has to do with the larger macroeconomic picture, where the U.S. is seeing a resilient consumer and a strong labor market, both of which have contributed to solid corporate profits. Additionally, the percentage of companies in the S&P 500 reporting earnings above consensus estimates is the predominant trend across most sectors, depicted by the green bars in Exhibit 1 below.
Exhibit 1: Earnings Scorecard
The S&P 500 is currently reporting 5.1% earnings growth as of month-end, and, if this trend continues through the end of earnings season, it will mark the fifth-straight quarter of earnings growth. The magnitude of growth, however, illustrates a slowing trend, compared to the 10.9% and 11.3% growth seen in Q1 and Q2 of this year, respectively. This slowdown in Q3 is largely being driven by the energy sector.
Source: FactSet. Data as of 11/01/24
With the slower growth trend in Q3 earnings, investors may be wondering why equity markets continue to reach new highs, and, while earnings are generally supportive of current market valuations, the S&P 500 remains relatively rich in today’s environment, placing even greater focus on future company earnings growth potential.
Prudent investors understand that markets don’t go up forever, nor do company earnings, and while we have witnessed solid performance in the ongoing Q3 earnings season, as well as in 2024 as a whole, it does not mean this trend will continue in perpetuity. The U.S. will have to contend with falling interest rates, a new political regime, and potential policy changes, all of which could have trickle-down effects on corporate earnings, making this and future earnings seasons ever-important to watch.
The Bottom Line: Thus far, third quarter earnings have been relatively solid, surprising investors to the upside, illustrated by above-estimate earnings growth, and while we are starting to see this growth moderate from recent quarterly trends, corporate profits remain on solid footing amidst an uncertain macro and fiscal backdrop.
Looking Ahead
U.S. Election, Fiscal Policy & Muni Markets
The 2024 U.S. Presidential election has shaped up to be one for the history books, with major policy decisions surrounding international trade, health care, and, perhaps most importantly, taxes, on the docket. The uncertainty surrounding these potential policy changes may concern some investors, but it is important to keep in mind that policy implementation takes time and is not a foregone conclusion given how close races across Congress have been.
One of the most important policy decisions that will have to be addressed is the Tax Cuts and Jobs Act (TCJA), which is scheduled to sunset at the end of 2025, unless the newly elected President moves to extend it. Choosing to extend all, or part, of the TCJA could impact corporate tax rates, individual income tax rates, alternative minimum tax (AMT) exemptions, to name a few, and most importantly, any extension is expected to increase the federal deficit. The Congressional Budget Office (CBO) estimates that, if extended, the TCJA could cause federal net debt-to-GDP to increase to nearly 132% by 2034, as illustrated in Exhibit 2, from the current level of approximately 98%.
Exhibit 2
Source: J.P. Morgan Asset Management. Data as of 10/31/24
These potential tax changes offer investors the opportunity to assess their tax ramifications and diversify their fixed income exposure, particularly in the tax-exempt, or municipal, bond market. Municipal bonds are issued to fund local projects and agencies, including initiatives related to schools, parks, airports, and toll roads. The interest on municipal bonds is typically exempt from federal, often state, and even local taxes, making them attractive for higher-taxed individuals and entities. Unlike the federal government, municipal governments are not facing the same level of fiscal challenges as they are required to have a balanced budget, making them a potentially important diversifier as the federal deficit expands.
It does not appear either party in the U.S. is equipped to deal with the rising federal deficit, and, while worrisome, investors should focus on what they can control: managing risk and exposure of their investments. Diversifying exposure by looking to other areas of fixed income, like municipal bonds, can help provide greater stability and manage risk related to fiscal and tax policy decisions on the horizon.
Remember, policy changes take time and require collective government action, and, while investors wait for any changes to occur, they can enjoy elevated tax equivalent yields across the municipal curve and a strong outlook for fixed income amidst the falling interest rate and fiscally challenged environment.
The Bottom Line: With voting for the U.S. Election closed and markets digesting the results, the focus will begin to turn to fiscal policy, particularly as it relates to tax policy and the 2017 Tax Cuts and Jobs Act. Given continued rising fiscal deficits, the timing may be appropriate for investors to consider diversifying exposure across the entire fixed income spectrum, including in municipal securities, which are currently offering higher income advantages relative to historical averages, and, in many cases, traditional fixed income on a tax-adjusted basis.
Capital Markets Themes
What Worked, What Didn’t
•International Markets Had Tougher October: International markets, including both developed international and emerging markets equities, performed the worst for the month of October, down over 5% and 4%, respectively.
•Municipal Bonds Outperform Taxable: Municipal bonds underperformed in October but outpaced taxable bonds by 100 bps, with high yield municipals delivering the strongest performance and highest yield advantages.
Large vs Small Cap Equity
Growth vs Value Equity
Developed vs Emerging Equity
Short vs Long Duration Bonds
Taxable vs Municipal Bonds
Investment Grade vs High Yield Bonds
Source: YCharts. Data call-out figures represent total monthly returns
On Alternatives
Supply/Demand Dynamics in Multifamily Real Estate
The multifamily real estate market is currently experiencing a historic wave of new supply in 2024, with over 671,000 units projected to be completed this year according to RealPage, the highest level since 1974. This supply/demand dynamic is illustrated in Exhibit 3, where deliveries in the multifamily sector have outpaced absorption since 2022 when the Fed started raising interest rates. While this current surge in supply is meaningful, it is likely to be temporary, as the increased cost of financing due to higher interest rates have halted new construction projects. Experts project multifamily supply will start to dry up after 2025, causing the supply/demand dynamic to shift once again.
Exhibit 3
Source: J.P. Morgan Asset Management. Data as of 9/30/24
The current oversupply within multifamily severely hampers rent growth, which benefits tenants, but restricts the property’s ability to drive revenue growth. Coupled with higher interest rates, operating expense growth has outpaced rent growth, a trend that is expected to continue until supply dwindles in 2026.
While the multifamily sector is trying to absorb the excess supply hitting the market, demand remains somewhat strong, due in large part by the lack of home affordability across the nation. Along with high interest rates, mortgage rates have also been historically high, with the 30-year mortgage rate around 6.7%, causing home affordability to reach a 10-year low, both illustrated in Exhibit 4. In fact, the median price of a home in the U.S. is currently around $420,000, a 32% increase over the past 5 years.
While the home affordability metrics are grim, they create a significant tailwind for multifamily housing as the double-whammy of high mortgage rates and low home affordability have priced many tenants out of single-family homes, pushing them into multifamily housing instead.
It may be a bumpy ride along the way as supply/demand dynamics shift back into favor, but beyond 2025, we expect properties to perform well and rent growth to pick back up in the multifamily sector, particularly as the Fed continues to cut interest rates.
Exhibit 4: Home Affordability vs. Mortgage Rate
Source: YCharts. Data as of 10/31/24
The Bottom Line: The multifamily real estate sector is currently experiencing a surge of new supply, hampering rent growth amid rising expenses due to high interest rates, labor costs, and insurance. Demand remains robust as home affordability in the U.S. has reached a 10-year low. These supply and demand dynamics are expected to shift after 2025 when the influx of new supply falls off a cliff.
Asset Class Performance Quilt
Markets are ever-changing, making diversification across asset classes and sectors a critical component to portfolio construction. As illustrated below, a Balanced 60/40 portfolio provides greater consistency of returns and less volatility over time.
Source: YCharts. Asset class performance is presented using market returns from an exchange-traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by Centura Wealth Advisory. The performance of those funds may be substantially different than the performance of broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High Yield Bonds (iShares iBoxx $ High Yield Corp Bond ETF); Intl Bonds (Invesco International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares Core MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 40% U.S. Bonds, 12% International Stock, and 48% Large Blend.
Disclosure: CCG Wealth Management LLC (“Centura Wealth Advisory”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Centura and its representatives are properly licensed or exempt from licensure. Insurance products are implemented through CCG Insurance Services, LLC (“Centura Insurance Solutions”). Centura Wealth Advisory and Centura Insurance Solutions are affiliated. For current Centura Wealth Advisory information, please visit the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with Centura Wealth Advisory’s CRD #296985.
https://centurawealth.com/wp-content/uploads/2024/11/iStock-1816227914.jpg12242448centurawealthhttps://centurawealth.com/wp-content/uploads/2024/07/Centura-Logo-Grey.pngcenturawealth2024-10-31 16:39:002024-12-06 16:56:15Market Month in Review – October 2024
Markets in the summer months are historically sleepy as individuals go on vacation and gear up for a new school year, but the third quarter brought anything but sleep to investors worldwide. Equities were marred with bouts of negative activity throughout the quarter – markets experienced a historic 180% surge in the VIX to an intraday high of 65.7 on August 5, yet, despite the volatility, both stocks and bonds pushed higher to end Q3. The market’s resilience caused the month of September to post its first gain in five years. While initially overreacting to adverse events, markets quickly put them in the rearview mirror as the S&P 500 witnessed the best nine-month start to a year since 1997, which also coincided with the best start to an election year ever, all while registering its 42nd all-time high of the year. The busy quarter witnessed the following:
Yen Carry Trade – On the heels of the Bank of Japan’s rate increase announcement, global hedge funds that capitalized on the arbitrage opportunity presented by zero long-term rates in Japan for years, realized the music was about to stop in early August. Quickly unwinding their trades, Japan’s Nikkei stock market experienced the largest single day loss dating back to “Black Monday” in 1987, resulting in a single-day decline of 12.4% on August 5.
Softening Labor Market – The Bureau of Labor Statistics announced an 818,000 revision lower for the prior 12-months jobs added through March of 2024. The labor reports for June, July, and August confirmed softening with the revised additions of 118,000, 61,000, and 142,000, respectively. Every month in the quarter came in below expectations, as the unemployment rate continued to rise – ending at 4.2% through August.
Assassination Attempts – Former President Trump survived two assassination attempts in the quarter as the Presidential race picks up steam, further adding to the market’s anxiety amid election uncertainty.
Candidate Swap – President Biden dropped out of the Presidential race, paving the way for Vice President Kamala Harris to grab his bid. Since Harris’s party nomination, Democrats have seen a sharp reversal of fortunes, and now hold a slight advantage in the polls as of 10/1.
Fed Rate Cut– In line with traders’ expectations — though surprising to many economists and investors — the Fed aggressively cut rates in September for the first time since 2019, front-loading their easing cycle with a 0.50% reduction in their overnight borrowing rate. This led many to question the Fed’s perception of the economy and whether the central bank could manufacture a soft landing and avoid a recession.
Port Strike– As of 12:01 am Eastern Standard Time on October 1, a union labor strike forced ports on the Eastern US and Gulf Coasts to shut down, threatening the economy. JPMorgan Chase & Co. anticipate the closures will result in economic losses between $3.8 billion to $4.5 billion per day, and will likely cause supply chain disruptions and perhaps transitory inflation. Oxford Economics projects a week-long strike would take about a month to clear the shipping congestion.
Israel-Iran – Iran fired nearly 200 missiles into Israel escalating tensions in the Middle East. Israel cited it would retaliate, and this pledge caused Gold (GLD) prices to reach record highs, a U.S. stock market sell off, losses in Crude oil (USO), and a gain in defense sectors.
In face of the strife and a broadening out in earnings growth, the Fed signaled the start of its easing cycle in July, pointing markets to their first rate cut at the September FOMC meeting. While markets experienced hurdles throughout the quarter, economic growth, fueled by resilient consumer spending, continued to surprise to the upside, and investors chose to focus on these positives, causing both the S&P 500 and bonds, as measured by the Bloomberg U.S. Aggregate Index, to advance more than 5% over the quarter. This solid performance in the face of market angst and during a historically slow period demonstrated that investors’ animal spirits are alive and well.
Market Recap
Equities – After contracting 3.62% in the second quarter, rate cut speculation supported higher returns among the profit-hungry and interest-rate sensitive small caps. The Russell 2000 led the way, up 9.27% in 3Q. Lagging their small cap counterparts, the S&P 500 witnessed a broadening out of market participation away from the Magnificent Seven on its way to a 5.89% return for the quarter, and a 22.08% advancement for the year.
Bonds – Amidst moderating yet conflicting economic growth signals, bond yields fell aggressively during the quarter in anticipation of the first Fed rate cut. Entering July, the yield on the 10-year U.S. Treasury dropped sharply from 4.48% to 3.66%, leading up to the looming rate cut in mid-September. Generating fewer headlines over the quarter, the Treasury market continued to grapple with robust U.S. debt issuance and weakening demand for U.S. Treasury securities. We believe supply absorption concerns will likely continue to apply upward pressure on yields, illustrated by yields slightly reversing course to close the month of September. The 10-Year U.S. Treasury closed the quarter at 3.81%. The Bloomberg U.S. Aggregate Bond Index rose 5.20% in the quarter, erasing the negative 0.71% return in the first half of 2024, finishing up 4.45% through September 30.
Source: YCharts. The Bloomberg US Aggregate Index was used as a proxy for Bonds; the Bloomberg US High Yield 2% Issuer Capped Index was used as a proxy for High Yield Bonds; the Russell 2000 Index was used as a proxy for Small Cap Equities; and the MSCI ACWI Ex USA Index was used as a proxy for Foreign Equities. All returns are based on total return levels as of 09/30/2024.
Economic data remains mixed, and base case expectations still call for the Fed to successfully achieve a ‘soft landing’ and avoid recession. However, as the Federal Reserve’s attention shifts from price to job stability, the path of monetary policy will likely be driven by the health of the labor market.
Economy: The Consumer Surprises
In contrast with the nation’s revised first quarter GDP growth of 1.6%, which was held down by softer consumer spending of 1.9%, the second quarter surprised to the upside. A lift in personal income fueled a resurgence of consumers’ penchant to spend, as spending jumped to a 2.8% pace, and an 8.3% increase in business investment helped push U.S. growth higher at a 3% annualized pace. Building on the first two quarters of 2024, as of September 27, 2024, the Atlanta Fed’s GDPNow model for Q3 has been revised from 2.9% to 3.1%, indicating a stable, albeit moderating economic growth engine. This revision reflects the sustained trends of a resilient consumer and further business investment, though an economy hindered by negative residential investment.
August’s Labor Market Report registered the 44th consecutive month of job gains. Estimates called for 161,000 jobs in August, and the market once again surprised to the downside with the addition of 142,000 jobs and further downward revisions to June and July’s reports to 118,000 and 61,000, respectively. Conversely, the unemployment rate retraced slightly to 4.2%, which is still nearly 1% higher than the 55-year low of 3.4% in April 2023. The deterioration of the labor market has quickly grabbed the attention of the Fed, as softness became evident across several pockets of the economy.
The Bureau of Labor Statistics announced an 818,000 revision lower for the prior 12-months jobs added, through March of 2024, reflecting weaker job growth than anticipated. Since peaking in 2022, job openings (JOLTs) have continued to trend lower, bouncing around from month-to-month. For example, job openings fell to their lowest level since January of 2021 to 7.71 million in July, only to reverse course back above eight million in August, bringing the ratio of job openings to those unemployed down to 1.13:1. While the ratio of 1.13:1 is above historical levels, the ratio has fallen significantly from nearly two job openings for every job opening in 2022, indicating the labor market is showing signs of tightening. Over the course of the year, the number of open jobs has trended lower, while the number of unemployed job seekers has trended higher, as evidenced by the additional 991,000 unemployed persons from January to August.
Since the Fed embarked on its tightening journey and increased rates, the strength and resiliency of the labor market gave them confidence to keep rates higher for longer. Ultimately, the Fed would like to see wage growth continue to trend lower from its current, elevated level of 3.83%. Given the slowing pace of hiring and the increase in unemployment figures, labor market stability has become a primary concern for the Fed. Fears surrounding further labor market weakening cast doubt on the Fed’s ability to avoid a recession and produce a soft landing. The surge in late July Unemployment Claims helped fuel the market selloff in early August that witnessed the S&P 500 enter a nearly 10% correction, although claims have since retraced. Unemployment Claims (both Initial and Continuing) are released weekly and provide the most up to date insight on the health of the labor market. As mentioned, Initial Claims have fallen from 250,000 on July 27 to 218,000 on September 21, while Continuing Claims have been range-bound between 1.73 million and 1.87 million since the start of the year. Both of these levels are nowhere near levels seen in prior periods leading up to a recession, though remain important to monitor.
Inflation
The Fed appears to be in a position to win the war on inflation. However, we would not be surprised to see a few battles lost from month-to-month as pricing pressure moves towards the Fed’s 2% target. All inflation measures are below wage growth of 3.8%, with both of the Fed’s preferred inflation measures (PCE) coming in at 2.7% or lower. Core inflation, as measured by CPI and PCE, remains stickier: core CPI stayed at 3.2% year-over-year, while core PCE saw a slight uptick in August to 2.7%.
Further evidence of falling price pressures should provide Federal Reserve Chair Jerome Powell the confidence to continue down the path of monetary easing, supporting further rate cuts. Threatening the falling trend in inflation measures are the recent port closures across the Eastern seaboard and the Gulf. We are paying close attention to these closures and hoping for a quick resolution. A prolonged strike could result in serious supply chain constraints, potential price increases for goods, and a slowing in economic output.
Fed Starts Strong Out of the Gate
The Federal Open Market Committee (FOMC) elected to lower rates by 0.50% (50 bps) at their September meeting, while leaving the size of future rate cuts open. The Fed’s decision to cut rates was largely expected. The surprise centered around the size of the Fed’s cut and the subsequent updates to their Summary of Economic Projections (SEP). This surprise was best illustrated by the Fed’s updated median projection for total rate cuts in 2024, which increased from a mere 0.25% of cuts projected in the June SEP to a total of 1.00% worth of cuts in the September SEP, signaling to markets that interest rates would be cut at a more accelerated pace than initially expected.
Many expected the Fed to start slow with rate reductions, pointing to the health of the overall economy. A larger cut can indicate the Fed believes the economy is deteriorating quickly and that they waited too long to cut rates; however, the Fed has downplayed this rhetoric, stating that a 50 bps cut was warranted due to the strength the economy has exhibited.
The Committee held its projection for 2025 at 1.00% (100 bps) of cuts, indicating a slower pace of change as the Fed adopts a more patient data-dependent position after front-loading their easing in the final four months of 2024. Barring any exogenous event or resurgence of inflation, we believe Powell’s plan is to settle into a predictable cadence in terms of size and timing as we transition into 2025. We believe the Federal Reserve will align further rate reductions with their quarterly meetings and updated Summary of Economic Projections to the tune of more traditional 0.25% policy changes. We fully anticipate the Fed will hit its policy target for 2024 with 100 bps of cuts. However, the question remains whether they will do so in the form of one more 0.50% or elect a more traditional policy change and reduce the terminal rate by 0.25% in November and December: we are in the latter camp.
Centura’s Outlook
The Fed’s goal to lower inflation to its 2% mandate and avoid recession is still our base expected outcome. However, the Fed will need to monitor the state of the labor market deterioration closely if they are to fully avoid an economic contraction.
Successfully delivering lower inflation and monetary policy normalization should bode well for equities and bonds, however, as always, there are several potential risks looming and investors should proceed carefully.
By most measures, the S&P 500 is overvalued. According to FactSet, as of September 27, the forward 12-month Price-to-Earnings Ratio (P/E) is 21.6x, which is higher than both the 5-year and 10-year averages of 19.5x and 18.0x, respectively. Current valuations pose a risk to the market, as negative sentiment can lead to sharper selloffs. Also posing a risk to the overall market is the concentration of the Top 10 largest stocks in the S&P 500. According to JPMorgan Asset Management, the 10 largest constituents represent 35.8% of the index, as of August 31, while contributing to 28.1% of the earnings. Concentrations of this magnitude make the index vulnerable to significant changes stemming from those underlying companies, which is one of several reasons we favor global diversification across a multitude of asset classes – both public and private.
In the face of higher borrowing costs, corporate profits remain resilient, illustrated by the fourth consecutive quarter of positive earnings growth by the S&P 500, rising 5.1% in the second quarter. As of September 27, FactSet estimates third-quarter earnings to expand at a slower pace, only advancing 4.6% year-over-year. We are encouraged by the positive earnings growth trends, though the second quarter saw investors punish negative earnings surprises more than they rewarded positive beats. Relative to the five-year average, stocks that beat earnings guidance in 2Q rose less (0.9% vs. 1.0%), while those companies that missed guidance fell nearly double the 5-year average (-4.3% vs. -2.3%), indicating the market appears overvalued, and investors are overreacting to news and resetting expectations.
Since 2023, the Magnificent Seven have been responsible for most of the market’s earnings growth, increasing 31%, versus the 4% contraction of the remaining 493 companies’ earnings in the S&P 500 last year. While third quarter earnings for the 493 companies are expected to be flat for 3Q, we remain optimistic by the fact that JPMorgan is expecting the remaining companies outside the Magnificent Seven to catch up and accelerate earnings throughout the remainder of the year. Both the Magnificent Seven and the S&P 500 ex-Mag Seven are expected to experience double-digit year-over-year earnings growth in the fourth quarter of 21% and 13%, respectively. A broadening of earnings growth should bode well for increased market breadth and carve a path for higher broad-based returns on equities, outside of the Magnificent Seven.
Persistent, elevated rates will continue to cause issues for certain companies, such as small caps, though earnings are expected to grow broadly through the remainder of 2024 and 2025; the Fed’s pivot to lowering rates should alleviate some of the pressure on company financials.
While equities generally produce positive returns during election years, we expect volatility will likely increase as we approach the election through October and early November. The recent political turmoil has created a great deal of market uncertainty, particularly given the differing policy initiatives of both candidates. In the face of uncertainty, we generally avoid making changes to investment portfolios in advance of an election, as the policy expectations could change greatly. Markets tend to rally once the election has concluded. We encourage clients to avoid making rash decisions and stay invested, as we are strong believers that long-term investment outcomes are improved by time in the market, rather than timing the market. We suggest investors concerned with historical market behavior leading up to, and after an election, listen to the podcast we recorded with Michael Townsend, Managing Director, Legislative and Regulatory Affairs at Charles Schwab & Company.
The stock market’s resilient momentum, a more favorable rate environment, a potential post-election rally, and expected earnings growth all serve as potential tailwinds to push equities to further highs. However, a fair amount of uncertainty and risks pose headwinds for markets. Outside of further labor market deterioration or a resurgence of inflation leading to a Fed policy misstep, significant geopolitical risks are present and could result in additional volatility, especially if there are escalations in the Middle East, Eastern Europe, or China. For instance, on October 1, Iran fired nearly 200 missiles into Israel escalating tensions in the Middle East. Israel cited it would retaliate, and, as a result, Gold (GLD) prices reached record highs, U.S. stocks sold off, Crude oil (USO) experienced losses, and investors flocked to safe haven investments and sectors.
Real estate tends to be an interest rate-sensitive asset class; as rates continue to move lower, we anticipate a pick-up in activity and a subsequent reversal of valuations over the next several years. We may not have found the bottom of the real estate market cycle quite yet, though based on improving fundamentals and discussions with our real estate partners, we may be bouncing off the bottom, from a valuation adjustment perspective. Access to nearly-free credit post-pandemic resulted in record numbers of new construction, particularly in commercial real estate sectors like multifamily and industrials. As a result of the Fed’s rate hiking cycle, those new constructions screeched to a halt as the cost to borrow and build has been unfeasible. However, 2024 is still expected to deliver more than 650,000 multifamily units, the most since 1974. Like most goods, price is determined by supply and demand, and real estate is no different. Currently, demand, or absorption, is failing to keep pace in multifamily, applying downward pressure on rents. Furthermore, new higher-quality inventory generally attracts higher rents, forcing older vintage properties to offer rent concessions to remain competitive and applying downward pressure on net operating income (NOI). On the opposite side of the ledger, expenses have outpaced income, particularly the cost of insurance and labor.
We believe we are approaching the light at the end of the tunnel. While valuations may trend sideways over the next 12-18 months, we are optimistic that increased activity resulting from lower interest rates, combined with supply concerns evaporating as we enter 2026 and few-to no new construction starts, should bode well for private real estate in the long-term, with 2024 and 2025 vintages potentially producing strong results at disposition. We continue to remain extremely cautious and selective, focusing on select submarkets, signs of possible distress, and attractive risk-adjusted returns.
Private equity, particularly lower middle market buyouts, appears to have stabilized, potentially presenting attractive investment opportunities relative to public market alternatives. Current yield levels still present challenges for private equity valuations, though, like real estate, lower rates should lead to increased exit activity and higher valuations moving forward. With limited private equity exit opportunities since mid-2022 and our expectation for increased activity, we favor managers specializing in co-investments, GP-led secondaries, and late-stage primaries that offer the potential for superior risk-adjusted returns in this environment, a potentially quicker return of capital, and generally lower fee structures.
Private credit is predominantly floating and tied to a base rate such as the Secured Overnight Financing Rate (SOFR) and closely linked to the Fed Funds overnight rate, as such the asset class has benefited from the Fed’s restrictive monetary policy, though we believe the asset class remains attractive. However, yields on private credit will start to come down as the Fed continues to cut rates, though with a lag to the Fed’s timing as the floating rate on private loans does not adjust immediately. Rather, there is a delay before the loan terms reset lower. Should our Fed rate path expectations prove accurate, we expect private credit to continue to produce a high level of income, particularly on a relative basis.
While the third quarter brought both hurdles and strong market performance, we remain laser-focused on long-term objectives and minimizing volatility in the short-term amidst this data-dependent backdrop.
Thank you for your continued confidence and support. If you have questions or concerns, please contact your Centura Wealth advisor.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
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https://centurawealth.com/wp-content/uploads/2024/10/iStock-1699822168-scaled-1.jpg11592560centurawealthhttps://centurawealth.com/wp-content/uploads/2024/07/Centura-Logo-Grey.pngcenturawealth2024-10-03 21:59:242024-10-03 21:59:24Q3 2024 MARKET WRAP: Despite Hurdles, The Hot Streak Continues
After rising more than 10% in the first quarter of 2024, the S&P 500 stumbled out of the gate in the second quarter. The index contracted more than 4% in April and produced the first negative month of the year as the market reassessed the timing of the Fed’s first rate cut. While the Fed’s higher for longer mantra has not changed, they are stressing their dependence on data, which has proven mixed. The market, on the other hand, has become Fed-dependent, placing great emphasis on each major economic reading, primarily inflation, labor, and economic production. With hopes that the Fed will initiate rate cuts sooner, the market applauds lower inflation and negative growth signals, like a slowing economy or consumer spending. Conversely, traditionally well-received data points, such as a robust and resilient labor market, can trigger market selloffs. This counterintuitive reaction occurs because positive economic news suggests that the Federal Reserve might delay its first rate reduction, extending the timeline for monetary easing.
Following two positive reports that inflation is trending lower, the S&P 500 witnessed solid rebounds of 4.80% and 3.47% in May and June, respectively, driven primarily by gains in Big Tech stocks. With hopes of an early rate cut, the equity markets continued to fuel the Nvidia-led AI frenzy. The sustained AI rally is heavily influenced by expectations surrounding the timing of monetary policy adjustments.
In line with the April selloff in equities, bonds saw the yield on the 10-year US Treasury whipsaw 0.37% higher, from 4.33% to 4.70%, before peaking on April 25. Like their equity counterparts, longer-dated bonds have become too reliant on the path of monetary policy, with return expectations tied to the timing of the Fed’s first cut. As the Fed provides clarity on their path forward, yield volatility should ultimately subside, leading to more stable outcomes. Until then, we expect continued bond volatility.
Market Recap
Equities – Unlike the ‘everything rally’ that closed out 2023, where small caps and technology stocks – both sensitive to elevated interest rates – were the largest benefactors, 2024 has witnessed further decoupling amongst asset classes. Any projected rate cut speculation has tended to support higher returns by the Magnificent Seven and technology stocks, though small caps have lagged behind. Small caps, measured by the Russell 2000, produced only about half the return of their large cap counterparts in the first quarter. The second quarter witnessed smaller companies contract -3.62%, bringing the year-to-date gains to a paltry 1.02%. Meanwhile, the S&P 500’s price advances for the second quarter was 3.92%, bringing the index’s return for the year to 14.48%.
Bonds – As yields reversed course, bonds kicked off the quarter in the red, adding to their multi-year downward trend. With stronger-than-expected economic data and Fed uncertainty, the market repriced Fed expectations, and the yield on the 10-year U.S. Treasury rose sharply. As inflation readings and consumer spending data continued trending lower, the market again reassessed their rate cut projections, sending the 10-year U.S. Treasury yield back to 4.2% and bringing the bond index back into positive territory for 2024. The Fed’s messaging that it needs to witness several months of sustained data before feeling comfortable lowering rates prompted another yield reversal upward with the 10-Year U.S. Treasury closing the quarter at 4.36%. While the market has appeared to reprice monetary policy changes, robust U.S. debt issuance and the demand for U.S. Treasury securities remains relatively weak, failing to absorb supply and applying additional upward pressure on yields. The Bloomberg U.S. Aggregate Bond Index rose by a modest 0.7% in the quarter, while it declined -0.71% for the year.
Source: YCharts. The Bloomberg US Aggregate Index was used as a proxy for Bonds; the Bloomberg US High Yield 2% Issuer Capped Index was used as a proxy for High Yield Bonds; the Russell 2000 Index was used as a proxy for Small Cap Equities; and the MSCI ACWI Ex USA Index was used as a proxy for Foreign Equities. All returns are based on price returns as of 06/30/2024.
Though economic data remains mixed, base case expectations still call for the Fed to successfully achieve a ‘soft landing’ and avoid recession. However, many growth metrics continue to moderate, leading many to question the Fed’s decision to keep rates elevated for longer.
Economy: The Consumer continues to slow
After growing approximately 2.5% in 2023, the U.S. economy continues growing at a moderate pace. Driven primarily by softening consumer spending, the first quarter of 2024 GDP grew 1.4%. Reflecting an uptick over the first quarter, as of July 2, 2024, the Atlanta ‘Fed’s GDPNow model for Q2 has been revised from 2.2% to 1.7%. This revision is primarily due to lower projections for consumer spending and net exports, which have contracted from the initial growth forecast.
The combination of unwavering spending in the face of rising prices and a robust labor market has underpinned the strong economic growth of recent years. However, with the $2 trillion of pandemic savings now exhausted as of March, household debt has reached record levels, and delinquencies are beginning to mount, threatening the sustainability of the nation’s growth. Despite elevated borrowing costs, the consumer continues to spend, albeit at a slower pace, thanks in large part to a strong labor market, producing wage increases that have outpaced inflation for more than a year. While the market is hoping for the labor market to soften and result in an earlier Fed rate cut, too much labor market deterioration could result in further spending reductions, ultimately leaving little room for the Fed to thread the needle and both produce a ‘soft landing’ and avoid a recession.
Unemployment
June’s Labor Market Report registered the 42nd consecutive month of job gains. Estimates called for 200,000 jobs in May, and the market once again surprised to the upside with the addition of 206,000 jobs. On the other hand, the unemployment rate edged up slightly to 4.1%, the highest level since October 2021.
The labor market continues to post robust results. While trending lower since peaking in 2022, job openings (JOLTs) surprisingly broke its three-month trend of fewer job openings in May. They reversed back above eight million (8.14 million), bringing the ratio of job openings to those unemployed to down to 1.22:1. While the ratio of 1.22:1 is still elevated above levels historically witnessed, the ratio has fallen significantly from nearly two job openings for every job posting in 2022, indicating slack is working itself out of the system and the labor market is showing signs of tightening. The number of open jobs has fallen, while the number of unemployed job seekers has trended higher, as evidenced by the additional 687,000 unemployed persons from January to May.
For now, the strength and resiliency of the labor market have given the Fed the confidence to keep rates higher for longer. However, the data point that is giving the Fed continued anxiety is wage growth. Despite falling below the key level of 4% in April for the first time since 2021, wage growth has exhibited stickiness and has been hovering around the 4% threshold, rising 4.1% and 3.9% year-over-year in May and June, respectively. While wage growth outpacing inflation bodes well for continued consumer spending, prolonged, elevated wage growth raises concerns about a potential resurgence in inflation. Several readings below the 4% threshold would certainly be welcomed by the Fed.
Inflation
On the surface, all major inflation readings have fallen below 4%, with both PCE readings coming in at 2.6% in May. Core services increased by 0.2% in May, lifted by higher housing, utilities, and healthcare, and financial services, while insurance costs declined by 0.3% after five consecutive months of growth. Housing, financial services, and insurance costs were among the major drivers supporting elevated services costs, so witnessing a reversal in two of the three variables presents a positive affirmation that inflation is indeed heading lower.
Just as elevated wage growth is troublesome to the Fed, the stickiness of core services, particularly housing, fortifies the decision to exercise patience before cutting rates. Federal Reserve Chair Jerome Powell stated “we want to be more confident that inflation is moving down towards 2%” before lowering rates.
More Evidence Needed
The Federal Open Market Committee (FOMC) elected to keep rates unchanged in June for the seventh consecutive meeting. While the Fed’s decision was largely expected, the big news was centered around the Fed’s changes to their Summary of Economic Projections, particularly their median projection for rate cuts, where policymakers adjusted their expectations from three rate cuts in 2024 to only one 0.25% rate cut. The Committee also raised its projection for 2025 as well, indicating a slower pace of change as the Fed adopts a more patient data-dependent position. The number of Fed officials who projected no cuts in 2024 doubled from two to four, and not one official anticipated cutting rates more than twice. We also saw the Fed lift economic projections for 2024 increasing their 2024 inflation expectations and revising their 2025 rate normalization path.
Powell acknowledged that inflation has begun trending lower, yet expressed concerns that cutting rates too early may jeopardize the progress made towards reducing inflation. Interestingly, the Core PCE print in May was 2.6%, which is higher than the Fed’s year-end projection for Core Inflation. This indicates that the Fed anticipates a slight increase in prices from this point, which would likely be accompanied by ensuing market volatility.
Barring any resurgence of inflation, we believe the Fed has finished its rate-hiking regime and is nearing its first rate cut. Our base case assumptions have not changed given the Fed’s steadfast commitment to bringing inflation down. We continue to believe the earliest the Fed will cut rates is September, which now aligns with current market expectations. However, any prolonged stickiness or resurgence of inflation would likely push our expectations for rate cuts into the fourth quarter this year.
Centura’s Outlook
The Fed’s goal to lower inflation to its 2% mandate and avoid recession is now the base outcome expected by the Fed and most market participants. However, given the slowdown in consumer spending, the Fed will need to monitor the state of the labor market deterioration closely if they are to fully avoid an economic contraction. Successfully delivering lower inflation and monetary policy normalization should bode well for equities and bonds. However, there are several potential risks looming and investors should proceed carefully.
In the chart below, Pitchbook outlines four likely paths forward: scenarios of stagflation, higher for longer, recession, or a soft landing. While any of the four scenarios could occur and the risk of recession has fallen, this risk remains above average due to the restrictive level of interest rates. Ultimately, our expectations fall into the lower right-hand corner: the soft-landing camp. We believe inflationary pressures will continue to ease while labor demand and wage growth will soften, resulting in the Fed slowly beginning to bring short-term rates down.
In the face of higher borrowing costs, corporate profits have remained surprisingly resilient, illustrated by the S&P 500 posting positive earnings growth for the third consecutive quarter in the first quarter of 2024, rising 5.9%. As of June 21, FactSet estimates second-quarter earnings to accelerate and grow at 8.8% year-over-year. Last year, the Magnificent Seven were responsible for most of the market’s earnings growth, increasing 31%, versus the -4% contraction of the remaining 493 companies’ earnings in the S&P 500. While this trend is expected to hold in 2024, with gains of 30% and 7%, respectively, we are encouraged that JPMorgan is expecting the remaining companies outside the Magnificent Seven to catch up and accelerate earnings over the remainder of the year. Both groups are expected to experience year-over-year earnings growth of 17% in the fourth quarter. A broadening of earnings growth should bode well for increased market breadth and carve a path for higher broad-based returns on equities.
The market remains too dependent on the Fed, which has become dependent on poor economic data. Following worsening conditions, the Fed is more likely to pivot and cut rates sooner. We believe economic activity will continue to surprise moderately, putting the Fed on pace to start lowering rates in either September or November, yet any resurgence of inflation will likely spur bouts of volatility in both stocks and bonds.
Persistent, elevated rates will continue to cause issues for some companies, like small caps, though earnings are expected to grow broadly in 2024 and 2025. While equities generally produce positive returns during election years, we expect volatility is likely to increase as we approach the election in the third and fourth quarters. The recent political turmoil in France and India, the first U.S. Presidential Debate, and the ensuing market volatility remind us how sensitive the markets are to political uncertainty. While we anticipate increased volatility as November nears, we do not believe this volatility source is sustainable. Outside of a resurgence of inflation or Fed policy misstep, we believe geopolitical risks pose a major threat and are more fearful of those potential exogenous events that are harder to predict.
While the path may be bumpy, we believe yields should continue to grind lower over the course of the year, presenting attractive opportunities to produce asymmetric returns in bonds. Extending duration within portfolios should allow investors to clip an attractive yield, while also providing them with the opportunity to experience capital appreciation for a total return exceeding what they might clip sitting in money market funds or short-term Treasury bills, particularly in municipal bonds on an after-tax basis.
Elevated interest rates continue to punish private real estate returns, with further slight downward valuation adjustments expected from their previous marks. Real estate serves as an interest rate-sensitive asset class; as rates move lower, we anticipate a pick-up in activity and a subsequent reversal of valuations over the next several years. While we believe we are nearing the light at the end of the tunnel for several real estate sectors like multifamily and industrial, unfortunately, we believe more pain will be experienced, particularly with the underlying debt that real estate operators hold. We anticipate a pickup in defaults across several real estate sectors, likely resulting in further pain across both public and private markets. For the foreseeable future, we remain extremely cautious and selective, focusing on select submarkets and attractive risk-adjusted returns.
Private equity, particularly lower middle market buyouts, appears to have stabilized, potentially presenting attractive investment opportunities relative to public market alternatives. Current yield levels present challenges for private equity valuations, though according to Pitchbook, elevated and expanding public equity market valuations position new buyout investments favorably when compared to their public market counterparts. Generally, when public market valuations are well above historical norms, buyout strategies launched during these periods tend to outperform, particularly smaller and emerging managers, which aligns with our natural preference. With limited private equity exit opportunities today, we also align with Pitchbook’s stance that secondary investments should also create attractive opportunities for investors in this environment.
Given that private credit is predominantly floating and tied to a base rate such as the Secured Overnight Financing Rate (SOFR), closely linked to the Fed Funds overnight rate, we believe the asset class remains attractive. Yields on private credit should remain similar to current levels until the Fed begins to cut rates. Even as the Fed cuts rates, the floating rate on private loans does not adjust immediately. Rather, there is a delay before the loan terms reset lower. Barring a catastrophic event, the Fed is likely to lower rates slowly, supporting higher yields for longer in private credit. According to commentary shared with us from Cliffwater, companies appear to be navigating the higher financing costs well, as interest coverage in their pipeline has increased from 1.75x to 1.93x.
Like markets and the Fed, we are digesting data points as they print, but we remain laser-focused on long-term objectives and minimizing volatility in the short-term amidst this data dependent backdrop.
Thank you for your continued confidence and support. If you have questions or concerns, please contact your Centura Wealth advisor.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Centura Wealth Advisory is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Centura Wealth Advisory and its representatives are properly licensed or exempt from licensure. 12255 El Camino Real, St. 125, San Diego, CA 92130.
After experiencing zero in 2023, the S&P 500 took more than two years before making a new all-time high. Fast forward to the end of the first quarter, witnessing the S&P 500 march its way to 22 new all-time high levels, on pace for the most ever. While much uncertainty surrounding monetary policy still exists, the equity markets brushed off the noise, experiencing minimal volatility. The quarter’s maximum S&P 500 drawdown of -1.7% would mark the smallest drawdown in history if the year ended as of March 31. Even gold and Japan’s stock market joined the all-time highs party, with the latter doing so for the first time since 1989.
Unlike recent quarters, chinks in the armor of the Magnificent 7 appeared to form, as three of the seven constituents (Apple, Alphabet, and Tesla) failed to outpace the broad index return of 10.8%. Ten of the eleven S&P sectors turned in a positive return. On the other hand, Nvidia continued its AI-fueled meteoric ride on way to a Q1 return of more than 82%, and we witnessed a reawakening of the meme stock mania as traders poured into the Reddit Inc., Trump Media, and Technology IPOs.
A year removed from the collapse of Silicon Valley Bank, we were reminded of the stress that higher rates have applied to the balance sheets of small and regional banks. New York Community Bank reported surprise losses on their multifamily commercial real estate loan portfolio, reminding investors that there could still be another shoe to drop. Regional banks tend to have a very large percentage of commercial real estate loans on their books, with many experiencing a high number of defaults, though the market quickly shrugged off the news and risks.
Highlighted last quarter, we felt the bond market got ahead of itself and overpriced the timing and magnitude of Fed rate cuts. Entering 2024, the market anticipated the U.S. central bank would cut six times, resulting in a projected 1.50% (150 basis points) in rate reductions, starting as early as March. As the market reassessed the Fed’s rhetoric and repriced their expectations, market yields for longer dated bonds rose sharply by 0.46% before the 10-Year U.S. Treasury rate settled and ultimately ended the quarter at 4.20%.
Market Recap
Equities – 2023 witnessed a positive correlation between yields on longer dated bonds and equity prices, which resulted in higher equity levels as yields fell and downward pressure as yields rose. This was particularly highlighted over the final two months of 2023, when the yield on the 10-Year U.S. Treasury fell from nearly 5% to 3.88% and ignited the ‘everything rally.’ The largest benefactors were asset classes like small caps and technology, which tend to be the most sensitive to higher interest rates. In contrast to last year, 2024 has seen a significant decoupling of the relationship between equities and bond yields. Fueled by AI-driven enthusiasm, expectations of Fed cuts, and unexpectedly robust earnings, the S&P 500 surged 10.8% for the quarter. This performance marks the best first quarter for the U.S. large-cap index since 2019, delivering consecutive quarters of double-digit returns.
Conversely, higher yields continue to plague smaller companies with today’s higher cost of debt marring their outlook. As the market reassessed monetary policy and rates rose in the first quarter, the small-cap Russell 2000 index experienced turbulence to start the year, but ultimately eked out a 5.18% YTD return.
With a ‘soft landing’ to ‘no landing’ all but expected, the market appears to have accepted the Fed’s latest projections and are closely observing economic data for signals the Fed has the green light to lower rates. As important indicators surrounding inflation, jobs, and overall economic health flood the market, we expect the market to continue reacting counterintuitively to good news, treating it as bad news, while reacting to bad news as though it is good news. Should core inflation remain sticky and economic data remain strong, we would not be surprised to see volatility return as investors start to extend expectations surrounding a June Fed pivot.
Bonds – As yields reversed course, bonds kicked off 2024 adding to their multi-year downward trend. With stronger-than-expected economic data and Fed uncertainty, the market repriced Fed expectations and the yield on the 10-Year U.S. Treasury shot from 3.88% to as high as 4.34% in mid-March. While the market has appeared to reprice monetary policy changes, robust U.S. debt issuance and the demand for U.S. Treasury securities continues to wane, failing to absorb supply and applying upward pressure on yields, exemplified by the Bloomberg U.S. Aggregate Bond Index falling 0.78% over the quarter.
Source: YCharts. The Bloomberg US Aggregate Index was used as a proxy for Bonds; the Bloomberg US High Yield 2% Issuer Capped Index was used as a proxy for High Yield Bonds; the Russell 2000 Index was used as a proxy for Small Cap Equities; and the MSCI ACWI Ex USA Index was used as a proxy for Foreign Equities.
With stronger economic data, base case expectations call for the Fed successfully achieving a ‘soft landing’ and avoiding recession. However, as data has continued to surprise to the upside, many growth metrics continue moderating.
Economy: The Consumer starts slowing
After avoiding the widely anticipated recession of 2023, and growing approximately 2.5%, the U.S. economy continues to grind higher at a moderate pace. As of March 29, 2024, the Atlanta ‘Fed’s GDPNow model for the first quarter is projecting growth of 2.3%, with the largest contribution expected to come from consumer spending, once again, and net exports expected to detract from growth.
Despite higher borrowing costs, the U.S. continues to outperform its global peers, largely due to a stable labor market that has consistently produced wage increases outpacing inflation for 10 consecutive months, through February. March’s labor report is due Friday, April 5 and wages are expected to continue to outpace pricing pressures for an 11th straight month, further supporting consumers’ ability to spend.
Unemployment
February’s Labor Market Report registered the 38th consecutive month of job gains. Estimates called for 198,000 jobs in February, and the market surprised to the upside with the addition of 275,000 jobs, though unemployment jumped 0.2% to 3.9%.
February’s unemployment rate also marked the 27th consecutive month unemployment has held below 4%, which is the longest streak since the 1960s. The labor market continues to post robust results. While trending lower since peaking in 2022, job openings (JOLTs) have been a mixed bag from month-to-month, and still remain elevated at 8.86 million. This brings the ratio of job openings to those unemployed to 1.371. While the ratio of 1.37:1 is still considered elevated above levels historically witnessed, the ratio has fallen significantly from nearly two job openings for every job posting in 2022. This indicates slack is working itself out of the system and the labor market is showing signs of tightening. The number of open jobs has fallen, while the number of unemployed job seekers has trended higher, as evidenced by the additional 334,000 unemployed persons from January to February.
For now, the strength and resiliency of the labor market has given the Fed the confidence to keep rates higher for longer. However, sticky wage growth continues to give the Fed anxiety, as this metric has been effectively stuck around 4.3% since October 2023. While persistent and elevated wage growth brings fears of an inflation resurgence, any break below the 4% threshold would temper those fears and be well received by the Fed.
Inflation
The Fed appears to be winning their battle against inflation, as pricing pressures look to be tamed and headed towards the Fed’s 2% target – though it is still too early for the Fed to declare their victory lap. On the surface, all major inflation readings reside below 4%, with both PCE readings printing below 3% over the last year, through February.
Shelter and gasoline represented approximately 60% of the monthly gain in Headline CPI in February, with additional pricing pressure from used cars, apparel, motor vehicle insurance, and airfares at the highest levels since May 2022. Boeing woes are forcing airlines to cut their flight capacity and we expect further pricing pressure on air travel over the next several months. Additionally, we anticipate continued upward pressure on energy prices, leading to volatility on the headline CPI numbers as we progress through the summer months.
Just as elevated wage growth remains troublesome to the Fed, the stickiness of core services, particularly shelter costs, supports their decision to exercise patience before cutting rates. The rolling three-month core CPI is running at an annualized rate of 4.2%, which is the highest since June 2023.
Too Soon to Pivot
Defying market expectations of a March rate cut, the Fed met twice in the first quarter and left rates unchanged, illustrating their unflagging commitment to bring inflation back to its long-term target of 2%. Since initiating rate increases in March 2022, the Fed raised rates eleven times, bringing the target range for the Fed Funds rate to the current range of 5.25% to 5.50%. During this period, Fed Chair Jerome Powell has also been reducing the Fed’s balance sheet by $95 billion per month, resulting in a decrease in assets of nearly 16.5%, or approximately $1.48 trillion, since its peak in April 2022.
The Federal Open Market Committee (FOMC) elected to keep rates unchanged in March for the fifth consecutive meeting. While the Fed’s decision was largely expected, the big news was the Fed’s changes, or lack thereof, to their Summary of Economic Projections. Of particular interest was their median projection for rate cuts, which policymakers held unchanged at three cuts in 2024. Only two Fed officials projected no cuts in 2024, while two anticipated only two cuts. Only one member voted in favor of more than three rate cuts in 2024, signifying a stark contrast to the Fed’s December 2023 projections where five members anticipated more than three cuts in 2024. We also saw the Fed lift economic projections, like GDP, for 2024, while also increasing their 2024 inflation expectations and revising their 2025 path of rate normalization.
Powell recognized that inflation has been stickier than anticipated the last couple of months, though the latest data “haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes-bumpy road towards 2%.” He further reiterated “we’re not going to overact…to these two months of data, nor are we going to ignore them.”
Barring any resurgence of inflation, we believe the Fed has finished its rate-hiking campaign and are nearing their first rate cut. Given the Fed’s steadfast commitment to bringing inflation down, our base case assumptions from the last several quarters have not changed. We continue to believe the earliest the Fed will cut rates is June, which now aligns with current market expectations. However, any prolonged stickiness or resurgence of inflation would likely push our expectations for rate cuts into the third quarter of this year.
Centura’s Outlook
The Fed’s goal to lower inflation back to its 2% mandate and avoid recession is now the base outcome expected by the Fed and most market participants. The successful delivery of lower inflation and Fed policy normalization should bode well for both equities and bonds. However, we continue to believe the market appears priced to perfection, and investors should proceed with caution as any resurgence or sustained stickiness of inflation could result in monetary policy uncertainty and lead to bouts of market angst or volatility.
In the face of higher borrowing costs, corporate profits have remained surprisingly resilient as the S&P 500 posted positive earnings growth for the second consecutive quarter in the fourth quarter of 2023, rising 4.2%. Interestingly, those companies with more than 50% of their revenue generated outside of the U.S., generated better profits than companies generating most of their profits domestically. As margins continue to face pressure, FactSet has witnessed revisions for first quarter earnings, dropping from 5.8% on December 31 to 3.6% as of March 28.
Forward 12-month P/E ratios are approximately 20.9x, above both their five-year and ten-year averages of 19.1x and 17.7x, respectively. This indicates that equities are slightly overvalued and thus priced to perfection. For further confirmation, the earnings yield relative to the yield on the 10-Year U.S. Treasury also indicates that equities are relatively valued today, as the S&P 500 earnings yield (Earnings/Price) is 4.30%, compared to the yield of on the 10-Year U.S. Treasury of 4.33% as of April 1.
The market remains too dependent on the Fed, which has become dependent on poor economic data; with worsening conditions, the more likely the Fed is to pivot and cut rates sooner. However, we believe economic activity will continue to surprise to the upside, realistically extending the timing of the widely anticipated rate cut. Should expectations shift from June to later in the year, we would expect markets to react negatively, and volatility would ensue.
We entered the year with our allocations aligned with our long-term targets. While higher rates will continue to cause issues for some companies, earnings are expected to grow from 2023 levels in 2024. While equities generally produce a positive return during election years, we expect volatility will likely increase as we approach the election in the third and fourth quarters. However, the improving market breadth, as evidenced by the roughly 70% of S&P 500 companies trading above their 200-day moving averages, gives us optimism that markets should continue to grind higher. Outside of Fed policy-related market volatility, we are more fearful of potential exogenous events that are harder to predict.
As expected, yields rose to start the year as the market repriced its expectations surrounding Fed rate cuts. When yields reversed higher, we took the opportunity to further extend the duration of our fixed income allocations. While the path may be bumpy, ultimately, we believe yields should continue to grind lower over the course of the year, presenting attractive opportunities to produce asymmetric returns in bonds. Extending duration should allow investors to clip an attractive yield, while also providing them with the opportunity to experience capital appreciation for a total return exceeding what they will clip sitting in money market funds or short-term Treasury bills.
Elevated interest rates continue to punish private real estate returns, with further slight downward valuation adjustments expected from their previous marks. Real estate is an interest rate-sensitive asset class, meaning as rates move lower, we anticipate a pick-up in activity, and a subsequent reversal of valuations over the next several years. While we believe we are nearing the light at the end of the tunnel for several real estate sectors like multifamily and industrial, unfortunately, we believe more pain will be experienced, particularly with the underlying debt that real estate operators hold. There is a reason S&P Global just downgraded five regional banks based on their commercial real estate loan exposure. Like S&P Global, we anticipate a pickup in defaults across several real estate sectors, which will likely result in further pain across both public and private markets.
Private credit presents an opportunity to earn attractive returns, given private credit is predominantly floating and tied to a base rate such as the Secured Overnight Financing Rate (SOFR), closely linked to the Fed Funds overnight rate. Yields on private credit should remain at their current levels until the Fed begins to cut rates. Even as the Fed cuts rates, the floating rate on private loans does not adjust immediately. Rather, there is a delay before the loan terms reset lower, typically every three months. Barring a catastrophic event, the Fed is likely to lower rates more methodically than they hiked them, supporting higher yields in private credit. Fortunately, private companies have weathered the elevated rate storm better than anticipated. As Cliffwater recently shared with us, borrowers demonstrated strong performance, as evidenced by the 15% year-over-year revenue growth and 13% EBITDA growth. Lower rates should support improved health of borrowers and support attractive returns, relative to traditional fixed income going forward. Combining traditional bonds with private credit should produce a balanced and diversified approach toward income production and total return in 2024.
Thank you for your continued confidence and support. If you have questions or concerns, please contact your Centura Wealth advisor.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.
Centura Wealth Advisory is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Centura Wealth Advisory and its representatives are properly licensed or exempt from licensure. 12255 El Camino Real, St. 125, San Diego, CA 92130.
https://centurawealth.com/wp-content/uploads/2024/07/Market-wrap-2024-q2-scaled.jpg9872560centurawealthhttps://centurawealth.com/wp-content/uploads/2024/07/Centura-Logo-Grey.pngcenturawealth2024-04-04 07:58:002024-08-19 19:07:00Q1 2024 Market Wrap: Equities Keep the Good Times Rolling
For the past several quarters, the market has seemingly ignored communications from the Fed, particularly the point that interest rates will continue to rise and remain elevated for as long as it takes to restore inflation to their 2% target. This trend persisted up until August in the aftermath of Chairman Powell’s Jackson Hole speech and the subsequent September Federal Open Market Committee (FOMC) meeting. After over a year of repetition from Chair Powell, the market finally appears ready to listen to sentiment coming from the Fed.
Successful childhood tug-of-war matches typically rewards the side with the best anchor. In a quest to predict the future, both the economy and the Fed have entered into a game of tug-a-war, with the market as the rope. Good news is no longer good news, rather, good news is bad news, and bad news is good news. The market hates uncertainty and must predict whether the Fed will raise rates again and, perhaps more importantly, when they will begin lowering. Good news signals that the Fed can continue increasing rates and likely prolongs the duration that rates must remain elevated. Conversely, bad news signals conditions are softening, and the Fed is likely done raising rates, with a pivot to rate cuts shortly to follow. The struggle is finding a better anchor than the side wielding the most power – the Fed. Hence why they said, ”Don’t fight the Fed.” With this constant push-and-pull between monetary policy deployed by the Fed and economic reality, it is hard to predict what will happen next.
Market Recap
Equities – The combination of stronger economic data and revised projections from the Fed has finally gotten through to market participants. The Fed does not intend to repeat the mistakes made during the Volcker regime. The Fed will keep rates elevated longer to stifle inflation and ensure prices do not reverse course and reaccelerate. The market acceptance of the Fed’s thesis, coupled with higher Treasury yields, has finally chinked the armor of the interest rate ‘sensitive,’ tech-heavy NASDAQ-100.
While the index was flat for the quarter, the NASDAQ-100 was down 6.61% since the yield on the 10-Year U.S. Treasury first began to surge on July 31st. This effectively erased the gains the index enjoyed during the quarter’s first month, bringing the index’s 2023 return to 34.51%.
On the other hand, recent performance of the S&P 500 has been characterized by the ten largest stocks, which currently comprise more than 30% of the overall index. In fact, 90% of the benchmark’s return has been driven by those large constituents, which are mostly Big Tech. This is the highest level of concentration the index has seen with data going back to 1990.
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management. The top 10 S&P 500 companies are based on the 10 largest index constituents at the beginning of each month. As of 9/30/2023, the top 10 companies in the index were AAPL (7.0%), MSFT (6.5%), AMZN (3.2%), NVDA (3.0%), GOOGL (2.2%), TSLA (1.9%), META (1.9%), GOOG (1.9%), BRK.B (1.8%), XOM (1.3%), and UNH (1.3%). Guide to the Markets – U.S.
Through three quarters, the S&P 500 is up 11.68%, while the average stock, represented by the S&P 500 Equal Weight ETF (RSP), is up a mere 0.17% through September. Elevated rates, tighter financial conditions, and more stringent lending standards continue to dampen the outlook for smaller companies, as the small-cap Russell 2000 index sold off 10.89% amid the late July 10-Year U.S. Treasury yield surge, bringing the small company gains to 1.35% for the year.
Talk of the most anticipated recession has quickly evaporated, and a ‘soft landing’ is all but expected. The market appears to have accepted the ‘higher for longer’ mantra the Fed has been telegraphing all year. Participants are digesting the data and reacting counterintuitively to the good news is bad news and bad news is good news drum. As we enter what is traditionally a strong quarter for equity markets, investors in the fourth quarter will look for clarity from the Fed as they start to shift focus and position portfolios for 2024.
Bonds – As yields spiked, bonds continued their downward trend, adding to losses accumulated since August 2020. On the heels of a U.S. credit downgrade from Fitch and stronger-than-expected economic data, the demand for U.S. Treasury securities continues to wane, failing to absorb supply and forcing yields much higher. The U.S. Department of Treasury’s spending spree of nearly $1.7 trillion in U.S. debt since early June is also adding to the supply glut and forcing yields higher. The yield on the 10-Year U.S. Treasury surged 0.78% in the third quarter, seeing its highest yield since 2007. Bonds, as measured by the Bloomberg U.S. Aggregate Bond Index, fell 3.23% in the third quarter, dragging the performance for the year to -1.21%.
Source: YCharts. The Bloomberg US Aggregate Index was used as a proxy for Bonds; the Bloomberg US High Yield 2% Issuer Capped Index was used as a proxy for High Yield Bonds; the Russell 2000 Index was used as a proxy for Small Cap Equities; and the MSCI ACWI Ex USA Index was used as a proxy for Foreign Equities.
With stronger economic data, expectations have quickly gone from a certain recession to a high expectation that the Fed will successfully pursue a ‘soft landing’, avoiding a recession altogether. While the data has continued to surprise to the upside, many growth metrics continue to moderate.
Economy: Still Waiting on that Recession?
Defying expectations, the last week of September delivered the final, unchanged revision to second-quarter GDP growth of 2.1%. The September GDP reading saw strong fixed business investment of 7.4%, and upward revisions to inventories and net exports to help offset an unexpected slowdown in consumer spending. Early projections for second-quarter growth saw personal consumption cut in half as consumer spending was revised from 1.7% to 0.8% — the weakest advance in our nation’s primary economic driver in over a year. While consumer behavior is important to monitor, the slowdown does not appear troublesome to the Fed. After reaching 5.8% in mid-August, the Atlanta Fed’s GDPNow model for the third quarter was pushed lower to a robust 4.9%, signaling continued economic strength.
While real GDP may be growing moderately, several factors have the potential to push growth lower. Battling 40-year high inflation has applied pressure to consumers. According to Bloomberg, outside of the wealthiest 20% of Americans, the consumer has run out of extra savings. Consumers have less cash on hand than they did when the pandemic began. Adding to budgetary constraints, 40 million people collectively owe more than $1.6 trillion in student loans, and these individuals are starting to make payments on student debt for the first time since the onset of the pandemic. Given the lack of savings, the payments of $300 on average are causing concerns that discretionary spending will continue to trend lower. Not to mention, credit card debt has risen to record highs, exceeding $1 trillion and underscoring the severity of this consumer strain. With approximately 70% of our growth tied to the consumer, their financial health should be seen as a harbinger of what could unfold.
Inflation & Interest Rates
Inflation remains elevated, though the downward trends are welcome. August’s headline Consumer Price Index (CPI) came in at 3.67%, while core CPI (excluding energy and food) remained above the 4% threshold, registering 4.39% year-over-year. The once persistent pricing pressure on core services, particularly, shelter, appears to have finally broken lower. Shelter represents about 1/3 of CPI, making the variable impactful on the overall basket of goods. Given the Fed’s focus on core inflation, the downward trend is seen as positive. However, dampening excitement is the sharp reversal of energy. Gasoline and energy rose 5.6% and 10.6%, respectively, in August, from the prior month, forcing headline inflation to reverse course and go higher.
While the downward trend in CPI is a reason for optimism, we are more concerned with the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE). After remaining mostly flat at 4.62% for the first half of the year, the gauge finally broke below the 4% level, to 3.88%. Breaking through the 4% milestone has many economists and market participants anticipating the possibility that the Fed is done raising rates for the year.
Just like the debt ceiling negotiations consumed headlines through June, the government shutdown dominated chatter leading up to the close of the government’s fiscal year on September 30th. Like the debt ceiling, the proverbial can was kicked down the road, avoiding a shutdown at the eleventh hour. While negotiations were essentially a non-event, one of the most meaningful outcomes has been the U.S. government’s subsequent issuance of new debt, which has been ongoing since June 5th.
Following the debt ceiling extension, markets anticipated the issuance of $1 trillion in new Treasury securities by the end of the third quarter, however, their estimates were off the mark. Surpassing expectations, the U.S. Treasury has issued approximately $1.7 trillion of new debt just since June 5th, pushing the nation’s deficit beyond $33.125 trillion. Issuance of new securities floods the market with new supply and, with few buyers, this massive issuance serves as additional quantitative tightening to support higher yields.
‘Higher for Longer’
The Fed is undoubtedly committed to doing whatever is necessary to bring inflation back to its long-term target of 2%. After embarking on their most aggressive tightening cycle in March 2022, the Fed has raised rates eleven times over eighteen months, bringing the target range for the Fed Funds rate to 5.25% to 5.50%. During this period, Federal Reserve Chairman Jerome Powell additionally led a $95 billion monthly balance sheet reduction. This reduction shed nearly 11%, equivalent to $960 billion, off the federal balance sheet, illustrating that the Fed is willing to deploy any and all tools in their war on inflation.
After pausing rate hikes in July, the September Federal Open Market Committee (FOMC) meeting marked the second time since March last year that the FOMC voted not to hike rates further. The decision to pause was all but expected, but revisions to the Fed Dot Plot and forward-looking expectations for the Fed Funds rate sent markets reeling. Their September projections adjusted what was previously 1.0% of rate cuts expected in 2024 to only 0.50% and subsequently raised their projections for rate cuts in 2025 by 0.50%. These upward revisions indicate to the market that the Fed intends to keep rates elevated and will plan to slowly lower them over time to ensure their fight to pull inflation back to their long-term target of 2% is successful.
September’s FOMC release and updated economic projections show a target peak Fed Funds rate unchanged at 5.6%, indicating another 0.25% of increases in 2023, though the market is anticipating the Fed is finished raising rates for now. Following the Fed’s September decision and updated Dot Plot, the market is finally accepting our base case and listening to what the Fed has been saying: rates will remain elevated for the foreseeable future, and barring a catastrophic event, cuts won’t likely come until mid-2024.
One of the Fed’s primary concerns continues to be wage growth. Although wage inflation has been trending lower, it remains elevated at 4.3%, which at the time of this writing is now higher than both PCE inflation readings, causing some anxiety for the Fed. Strong wage inflation increases the risk of a wage-price spiral, increasing the likelihood of a reacceleration of inflation or at the very least, persistent, elevated inflation.
August’s Labor Market Report registered the 32nd consecutive month of job gains, showing signs of optimism for the Fed. Estimates called for 170,000 jobs added in August. Instead, markets were hit with the addition of 187,000 jobs. Unemployment jumped 0.3% to 3.8%, matching the large monthly bounce in May. Perhaps the most comforting data point in August’s job report was the significant increase in the participation rate, which notched a 62.8% reading. When coupled with job openings (JOLTs) falling sharply below nine million, this data point brought the ratio of job openings to those unemployed to 1.5:1, a welcome reading from previous months. The Labor Force Participation is driven by two primary factors, the labor force, which is defined as those employed or actively seeking employment, and the working age population. More people entering the labor force coupled with fewer job postings means wage growth may not turn out to be a source of inflation. As supply continues to increase and demand for labor wanes, wage growth should start to subside; a welcome development by the Fed.
Centura’s Outlook
As the Fed remains committed to battling elevated inflation, interest rates have spiked to levels not seen since before the Great Financial Crisis and will likely continue to trend higher, or at least stay elevated for the foreseeable future. The Fed’s goal to tighten financial conditions and slow the economy just enough to lower inflation back to their 2% mandate and avoid recession is now the base outcome expected by the Fed and most market participants. However, if rates continue to march higher, we believe it could turn into a matter of not if, but when something in the economy will break.
Earnings for the second quarter were once again stronger than expected, leading many to believe higher rates and inflation aren’t wreaking as much havoc as initially feared. However, with consumer spending trending lower and margins being pressured by both inflation and higher rates, revenues were effectively flat and the -4.6% year-over-year contraction marks the third consecutive quarter of negative year-over-year earnings.
According to FactSet, the estimated earnings growth for the S&P 500 in the third quarter has been revised higher from the expected -0.4% in June to -0.1%. The negative forecast highlights companies’ challenges over the last year to produce profits. Given that higher rates are expected to persist, a company’s ability to service debt will remain negatively impacted, adding sustained pressure over the coming quarters.
Forward 12-month P/E ratios are approximately 17.9x, slightly above their ten-year average of 17.5x, indicating that equities are slightly overvalued. The inverse of the P/E ratio is known as the earnings yield, which can be compared to the 10-Year U.S. Treasury yield to gauge the relative valuation of equities. A higher earnings yield would indicate equities are undervalued, while a lower earnings ratio indicates that equities may be overvalued, as equities should demand a risk premium above prevailing Treasury rates. With the earnings yield currently at 4.26%, versus the 10-year U.S. Treasury yield of 4.59%, equities appear slightly overvalued at this juncture, and additional drawdowns may be in store before equities become attractive from a valuation standpoint.
With recent Federal Reserve rhetoric and inflation still elevated, we remain cautious. The market is pinned to the Fed’s monetary policy tightening and has become dependent on poor economic data: the worse the economic conditions become, the greater the likelihood the Fed will pivot from their current posturing. Many variables in the third quarter surprised to the upside, and looking backwards, conditions appear somewhat stable. However, as all investors should know, past performance is not an indicator of future returns. As we look forward, the potential deterioration of consumer’s financial health gives us pause, as does the impact of prolonged elevated rates on corporate balance sheets. We believe the two largest risks to 2023’s economic and market rallies are a misstep or abrupt change to the expected Fed outcomes and a potential resurgence of inflation, both of which are closely intertwined. As communicated in , until inflation breaks lower, we remain cautious and anticipate that equities will continue to experience turbulence, particularly if inflation resurges.
We remain steadfast in our belief that markets are discounting the impact of the Fed’s aggressive monetary tightening actions. Defaults and bankruptcies continue to rise, and as rates go higher, we expect further stress on companies and consumers. However, the artificial intelligence craze led to robust gains in technology-based and growth-oriented companies, causing many investors to jump in the market for Fear-of-Missing-Out (FOMO) and creating a large disconnect between economic fundamentals and market technicals. Given these disconnects and overall uncertainty, we returned our portfolio allocations to their long-term neutral targets. In addition to removing our underweight to equities, we have been actively replacing underlying investments to enhance the focus on quality. To navigate the forward-looking environment, we have added actively-managed investments in asset classes where active management has a proven track record of delivering superior risk-adjusted returns relative to respective benchmarks.
Asset classes we believe warrant active management in this phase of the market cycle include international equities, large cap value, and fixed income.
Surging interest rates have hurt private real estate, with further downward valuation adjustments expected. We prefer to focus on real estate industries possessing favorable supply/demand imbalances, like multifamily and various types of industrial real estate. These imbalances should help mitigate losses relative to other real estate sectors not possessing similar disparities, though further paper losses are expected. Ultimately, we believe a focus on quality and conservative underwriting, coupled with diversification across real estate asset types, geography, and sponsors will only benefit client portfolios.
While higher rates negatively impact several financial markets, we continue to find great opportunities in private credit. Given private credit is predominantly floating rate with short durations, and generally lower price sensitivity to spiking interest, private credit should continue to deliver strong returns and high levels of income production over similar public credit instruments. Defaults are climbing but remain below historical averages. Our focus in private credit aligns with our focus across all major asset classes, which is a focus on quality and relative value, anchored in our core investing principles.
We recognize the uncertain backdrop may provide cause for concern. We remain vigilant in our process, with an emphasis on protecting clients’ wealth, while delivering value over multiple market cycles.
Thank you for your continued confidence and support. If you have questions or concerns, please contact your Centura Wealth advisor.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Centura Wealth Advisory is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Centura Wealth Advisory and its representatives are properly licensed or exempt from licensure. 12255 El Camino Real, St. 125, San Diego, CA 92130.
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