Happy Summer!
What better way to mark the summer solstice than with a historic Boston Duck Boat Parade?! While New England is no stranger to sports victories, the Celtics finally broke a 16 year NBA championship drought with their win over the Dallas Mavericks. Scorching temperatures notwithstanding, an estimated one million fans lined the streets of Boston to celebrate. Similarly, higher for longer interest rates are not curbing investors’ enthusiasm, with the S&P 500 finishing the quarter up 4.3% despite a 4.1% decline in April.
We started the year optimistic that inflation was contained and the U.S. Federal Reserve (Fed) could reverse course and begin to reduce interest rates. Buoyed by how rapidly price growth slowed despite strong spending and hiring in the second half of 2023, the majority of Fed officials expected 0.75% or 75 basis points worth of rate cuts in 2024 and 100 basis points worth of additional cuts in 2025. However, inflation unexpectedly crept up at the start of 2024. As a result, the Fed held off on cutting its benchmark rate at each of its four policy meetings so far this year. New economic projections showed 15 of 19 officials expect the Fed to cut rates this year, with that group roughly split between one or two rate cuts. Despite some improvements in recent inflation readings, Fed Chair Jerome Powell said in his June press conference “we will need to see more good data to bolster our confidence that inflation is moving sustainably toward 2%” before cutting rates. For now, the benchmark rate remains steady at a 23 year high of 5.25% to 5.5%, unchanged since July 2023. Fed officials meet four more times this year, in July, September, November and December.
The consumer price index (CPI), which measures costs of goods and services across the economy, slowed more than expected in June, falling to 3% from 3.3% in May and 3.4% in April. By comparison, at this time last year it was 4%, and two years ago it peaked at 9.1%. While the rate of inflation has slowed significantly, it remains above the Fed’s 2% target. Meanwhile, core inflation, which excludes more volatile food and energy, slowed to 3.3% annually, the lowest rate since April 2021. Helping to slow inflation in June were falling gas prices, which dropped 3.8% after declining 3.6% in May, despite more Americans hitting the road for spring trips.
Similarly, the personal-consumption expenditures (PCE) price index, which reflects changes in the prices of goods and services purchased by consumers in the U.S. and is the Fed’s preferred indicator of inflation, dipped to 2.6% in May from the same month one year ago, down from 2.7% in April and March. Excluding food and energy, the annual core PCE price index dipped to 2.6% in May, down from 2.8% in prior three months.
Despite a backdrop of easing inflation, many Americans remain frustrated about the state of the economy. Consumers are taking little comfort from milder annual inflation rates because of the run-up in the price of everything from housing to groceries to cars since 2021. Over the last four years, prices are up 22%, compared with 7% in the four years before that. Add to that, slower inflation has not yet translated to lower borrowing costs. The 30-year fixed-rate mortgage has hovered around 7% in recent months, near the highest level since 2001, while banks are charging upwards of 20% interest on credit cards. The Conference Board’s confidence index, which measures consumer attitudes on prevailing business conditions and likely developments for the months ahead, dipped to a reading of 100.4 in June from 101.3 in May. Likewise, the University of Michigan’s consumer sentiment index preliminary reading for June, which is used to estimate future spending and saving, showed sentiment levels were at a seven month low.
Home prices are at a record high and have been climbing for 11 straight months as housing shortages persist. With many homeowners who locked in low fixed mortgage rates in recent years unwilling to move (and forfeit those loans to take on a different mortgage at a significantly higher cost), the supply of houses plummeted. In turn, this drove up prices, making it especially difficult for first time buyers to afford a home. In turn, many would-be homebuyers are renting for longer than they otherwise may have, which is driving rents higher, too.
Meanwhile, the labor market remains strong, albeit showing signs of cooling. The unemployment rate rose to 4% in May, up from 3.9% in April, ending a 27 month streak of below 4% unemployment. Simply put, that means job seekers might find it harder to get hired. In particular, the job market for recent college graduates has weakened. The unemployment rate for bachelor’s degree recipients aged 20 to 29 is above 12%, an almost four-percentage-point increase from a year ago, according to Bureau of Labor Statistics data.
| Asset Class | Benchmark | Q2 | YTD |
|---|---|---|---|
| US Stocks | S&P 500 | 4.28 | 15.29 |
| US Gov't Bonds | Bloomberg US Govt Intermediate | 0.58 | 0.23 |
| Cash | Bloomberg US Treasury Bill 1-3 Mon | 1.34 | 2.68 |
Despite some signs of weakness in the economy, the stock market remained resilient, with the S&P 500 climbing 4.3% in the second quarter, up 15.3% year to date. Technology (+13.8%) and Communication Services (+9.4) were the best performing sectors in the quarter, whereas Materials (-4.5%), Industrials (-2.9%) and Energy (-2.4%) were the biggest detractors. Notably, the artificial intelligence (AI) theme extended beyond technology as attention to AI revolution's enormous electricity needs fueled Utilities (+4.7%) in the second quarter. Ten of eleven sectors are positive year to date, led by Technology (+28.2), Communication Services (+26.7%), Energy (+10.9%) and Financials (+10.2%). Only Real Estate, which continues to struggle amidst high interest rates, is negative (-1.9%) year to date.
It seems that Big Tech, not the Federal Reserve, is driving the rally across U.S. equities. AI momentum aside, another explanation for the resilience in the stock market is the expectation that the Fed is willing to step in to provide policy support and loosen the financial conditions whenever the economy slides to keep the markets afloat. This so-called “Fed put” is not a confirmed notion by the central bank, but it has become widely accepted by market participants over the past decades. In his prepared remarks after the June meeting, Powell said “if the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated, we are prepared to respond.”
During the first quarter 2024, we saw rates rise across the interest rate curve and this continued through April. The 10-year U.S. Treasury note closed on April 30th at 4.72%, nearly 0.50% or 50 basis points higher for the month. Investors began to question if the Federal Reserve may need to consider raising interest rates at their May 1st meeting. Ultimately, the Fed decided that despite the unfavorable CPI reports they would leave rates unchanged and remain steadfast in their approach of wait-and-see.
Interest rates declined from their April levels as a result of inflation finally trending downward. The U.S 10-year Treasury note ended the quarter at 4.40%, 0.19% or 19 basis points higher than where the first quarter ended at 4.21%. While the U.S. left rates unchanged during the period, the European Central Bank (ECB) voted for its first cut and the Swiss Central Banks cut for the second time.
Fixed income markets are showing positive returns year to date across nearly every sector despite U.S. interest rates rising approximately 0.50% or 50 basis points year to date. In addition to compounding interest, the U.S. Investment grade and High Yield credit markets continue to perform well with healthy corporate balance sheets.
As we head into the second half of 2024, fixed income investors will be closely watching future CPI releases and speeches by Fed board members all while keeping in mind this is an election year. Election cycles impact interest rates as investors assess how possible changes in policies may impact future economic growth and inflation. While there will be plenty of information for investors to digest, we were left with the reminder this quarter that higher interest rates are good for bonds and this continues to be a great opportunity to earn income.
| Asset Class | Benchmark | Q2 | YTD |
|---|---|---|---|
| US Mid Cap Stocks | Russell Mid Cap | (-3.35) | 4.96 |
| Foreign Stocks | MSCI EAFE NR | (-0.42) | 5.34 |
| Emerging Markets Stocks | MSCI Emerging Markets NR | 5.00 | 7.49 |
| Managed Futures | Credit Suisse Mgd Futures Liquid | (-0.04) | 0.86 |
| Global REITs | FTSE EPRA Nareit Developed NR | (-2.43) | (-3.70) |
| Global Infrastructures | S&P Global Infrastructure | 2.67 | 4.04 |
| Gold | S&P GSCI Precious Metal | 6.00 | 13.48 |
| MLPs | Alerian MLP | 3.35 | 17.71 |
| Emerging Markets Bonds | Bloomberg EM USD Sovereign | 0.10 | 1.38 |
| US High Yield Bonds | Bloomberg US Corporate High Yield | 1.09 | 2.58 |
| Floating Rate Loans | Credit Suisse Leveraged Loan | 1.87 | 4.44 |
| Long Bonds | Bloomberg US Long Corporate | (-1.74) | (-3.39) |
Emerging Markets (+5%) and Gold (+6%) added significant value in the second quarter whereas Mid Cap stocks (-3.35%) and Global REITs (-2.43%) undermined performance. All diversifying equity asset classes posted positive returns year to date. However, MLPs (+17.71%) was the only asset class to outperform the S&P 500.
Among diversifying fixed income asset classes, Floating Rate and High Yield bonds added significant value in the second quarter, whereas Long bonds underperformed on a relative basis.
We expect the Federal Reserve to continue to exercise caution in managing the economy to a “soft landing”, i.e., taming inflation without triggering a recession. Sticky inflation and uncertainty around interest rate cut(s) may continue to cause volatility in the markets. Ongoing geopolitical concerns along with the upcoming presidential election may add to the uncertainty. We plan to help you meet your long-term financial goals in all environments and encourage you to stay the course.
Sincerely,
David B. Smith, CFA
Managing Director and Chief Investment Officer
