August 2024 Market Commentary

While we are only a few days into August, at the time of this writing, overall equity returns have seen significant downward pressure. Through the close on 8/2, the S&P 500 was down 3.2% for the month led by the tech sector as seen with the Russell 1000 Growth decline of 3.9% offset slightly by the 2.7% decline in Russell 1000 Value. Selling pressure has extended into the date of this writing with the S&P further down 3.4% as of late morning on 8/5. There is a lot reflected in these return numbers.

Over the last several days we have seen a good bit of news and data come up which by themselves are of limited to moderate importance. At a high level, major news items over the last few days are listed below:

• The Federal Reserve kept its key rate at 5.25% to 5.5%. Of major importance Fed Chair Powell indicated that the Fed is better able to weigh both the employment situation and prices as inflation has moderated saying, “When we were far away from our inflation mandate, we had to focus on that. Now, we’re back to a closer-to-even focus.” This coupled with other indications from the Fed that an interest rate cut of 25 basis points was on the table for the September meeting was cheered by investors.
• The Bank of Japan increased its target for unsecured overnight rates to 0.25% from 0.0% - 0.1% while also saying it would begin tapering it’s purchases of Japanese Government Bonds. This was a clear indication that Governor Ueda is focusing primarily on inflation as opposed to slack in the economy. This resulted in a surge in the Japanese yen.
• On August 2nd, an “insider” reportedly told Page Six that Taylor Swift and Travis Kelce are about to get engaged. Reportedly, “The engagement is happening soon,”
• Warren Buffet reported on August 3rd that Berkshire Hathaway had sold a net $75.5 billion of Apple stock in 2Q24.
• The US unemployment rate increased unexpectedly to 4.3% from 4.1% for July in a
release seen on August 2nd.. The US Economy added 114,000 jobs for the month which reflects the second lowest since late 2020. For reference the US unemployment rate was 3.4% in early 2023 or well below full employment.
• Corporate earnings as a whole have been somewhat underwhelming so far this earnings season. Taken as a whole, earnings season has not been bad but given the extent of market gains both in 2023 and 2024, valuations in some areas of the economy continue to look elevated when viewed in the context of the earnings updates.

That is a lot of news over a short period of time. In one of the best movies ever made, the character Maverick requests a fly by of the tower. The Air Boss had denied the fly by because the pattern was full so he was shocked when Maverick buzzes the tower resulting in him spilling hot coffee on himself as he felt he had the landing pattern well in hand.

Of late, many investors have been quite complacent about returns. Buy mega-cap tech stocks, maybe sprinkle in some near-term treasuries/CDs and don’t worry too much. Get coffee, sip coffee, watch planes fly around and land. What we are seeing over the last few days is an injection of a large amount of uncertainty into the minds of global market participants. Any of these events taken in isolation might not be that big a deal but when they are all put together it is more of a concern..

The Fed keeping rates the same was a positive. It is only a negative when you look at it in light of the data that came out after the announcement. With knowledge of that information, it now looks like the Fed should have reduced rates. This could well happen between now and the “Buy mega-cap tech stocks, maybe sprinkle in some near-term treasuries/CDs and don’t worry too much.”September meeting but we think there is an elevated chance of a larger rate cut in September as opposed to a cut in between meetings. The unemployment rate ticking up is not in and of itself a bad thing. When an economy operates at above full employment that often results in higher labor costs i.e. higher wages which can in turn fuel inflation. But this was a large jump.

We would prefer seeing the Fed wait for additional data rather than rush to make an adjustment to rates. We are very much of the opinion that we are looking at lower rates going forward, especially at the front end of the curve. As can be seen in the above chart, the inversion of the 2 year and 10 year was erased for the first time since 2022. This does bode well for going longer duration ahead of rate reductions especially for long-term investors holding large allocations to short-term maturities.

Most significant of concern from the news mentioned above is the news from Japan as this has a higher probability of contagion. The reason for this is that it is starting to unwind the carry trade in Japan. A carry trade is where someone borrows in a currency with low interest rates (Japan) and reinvests those proceeds in higher yielding assets (everywhere else). With higher rates in Japan and indications of lower rates elsewhere, investors need to start exiting positions. This can pick up steam dramatically and play into other markets as investors are forced to sell positions in say the US or Emerging Markets to pay back assets in Japan which funded the purchase. We do believe that this will be a somewhat short-term dislocation measured in weeks or months and should be a short-term blip measured over the next several years.

So what does this mean for your portfolio? For long-term investors with a well diversified strategy at a correct risk tolerance, not a huge amount. There is an elevated risk that growth will continue to decline over the short- to intermediate-term. Segments of the market such as that have a higher level of income production and trade at more attractive valuations relative to longer-duration tech stocks have an elevated probability of outperforming the larger market as these events take place. With lower interest rates in the future, we continue to eschew short-duration fixed income maturities in favor of more intermediate term ladders where there are fewer near term maturities thus reducing the reinvestment risk. The kind of dislocation we have seen in equity markets over the last few days is disconcerting to many but should have limited impact long-term.