Monthly Market Pulse: August

Macro Views

China Growth

A shorter-than-expected reopening impulse and weakness in exports, housing, and consumption have contributed to a meaningful slowdown. We expect policy loosening to be lighter than in past easing cycles given China’s low growth target of “around 5%” and emphasis on “high quality growth.” Still, easing has accelerated, and we expect further accommodation to focus on fiscal, monetary, housing, and consumption base, supporting GIR’s 5.4% FY GDP growth forecast. Read More

DM Growth

GIR has lowered their US recession probability from 25% to 20%, as cooler wage growth informs their conviction that inflation can fall without a recession. Internationally, we believe the Euro area and UK are on similar paths as the US but at different points: the Euro area has further work to do in taming wage growth; the UK even more so. Read More

Monetary Policy

We believe the Fed has finished its hiking campaign, though risks are skewed to the upside if markets become too exuberant. In our view, the threshold for rate cuts is high given resilient US growth and thus we expect gradual cuts no earlier than 2Q 2024. Read More

Inflation

Some speculate that deglobalization and a green transition may structurally increase prices. Certainly, if these trends come in the form of taxes, we think costs would be passed to consumers. However, if they come in the form of subsidies, we think prices would instead deflate. For example, the US CHIPS Act and Inflation Reduction Act offer domestic producers large subsidies, which should offset production costs and in turn, lower consumer costs. Read More

Market Views

US Earnings

We highlight four themes to focus on during this earnings season: 1) margins, which GIR expects to bottom this quarter, 2) financials, which may provide clarity on the economic impact of bank stress, 3) AI risks and opportunities, and 4) the state of the consumer. GIR continues to forecast full-year S&P 500 EPS of $224. Read More

DM Rates

US Treasury yields have likely peaked; however, we believe risks skew to the upside. Cooling inflation in the US has fueled excessive market optimism in monetary easing and without labor market deterioration, the Fed may hold rates higher for longer. In the UK, high rates are a result of sticky inflation, and may prove to be even more durable than the LDI-related Gilt sell-off in Q3 2022, in our view. In the Euro area, an uncertain activity outlook and a hawkish tilt from the ECB may spawn a higher policy path than is priced in. Read More

We continue to expect the US dollar to depreciate in the long term, however, its descent may be bumpy. Even if the July hike was its last, the FOMC may not be able to pivot until it is confident that prices are stable. Furthermore, sharp dollar depreciation requires currency appreciation prospects elsewhere, which remain to be seen. For example, growth remains subdued in the Euro area, inflation may have peaked in the UK, and monetary easing continues to be deployed in China. Read More

Active Management

Concentration limits have driven underweight positions in top performing companies among mutual fund managers this year. As a result, only 31% of US large-cap funds have outperformed their benchmarks year-to-date. Despite this, we maintain our preference for an active approach and believe relative performance will improve as returns broaden among index constituents. Read More

Staying the Course

Full valuations in US equity markets may make the grass appear greener in other asset classes, specifically with cash now yielding over 5%. Although defensive tactical shifts may provide short-term outperformance, they have a tendency to become strategic allocations if they’re not closely monitored. Investments in cash funded from equity capital have historically not proven to be a successful strategy for longer-term capital appreciation, even when equities are expensive and cash yields attractive.

THE PRICE WE PAY

US equities may feel a bit pricey with the S&P 500’s cyclically adjusted price-to-earnings (CAPE) multiple in the top quintile since 1950. Fortunately for investors, prices aren’t always the primary determinate of performance, especially as time horizons shorten. For example, valuations historically have explained only 15% of deviations in S&P 500 returns over a two-year time horizon. The price of an investment is a factor worth considering, but we don’t believe it is the only one.

RESISTING TEMPTATION

Abandoning strategic equity allocations may be most tempting at the end of central bank tightening cycles when cash yields reach their most attractive levels. Historically however, exiting the equity market to invest in cash at these inflection points has not provided durable capital appreciation in the longer term. Investors may need to exercise discipline in maintaining target equity weights to achieve long-term return targets.

“WHAT” OVER “WHEN”

Top-ticking an expensive market is a fear of many investors, though we believe what you invest in can often be more important than when. The difference in ending portfolio values between perfectly timed annual S&P 500 contributions and the worst-timed contributions is ~$300k. Meanwhile, the difference between the worst-timed contributions and holding cash is ~$600k. We believe this larger opportunity cost underscores the appeal of strategic equity weights.

Top Section Notes: As of June 30, 2023. “CAPE” refers to cyclically adjusted price/earnings. Middle Section Notes: As of July 21, 2023. Bottom Section notes: As of July 21, 2023. “Perfect timing” is a strategy in which $12,000 is invested into the S&P 500 at its lowest closing value each year. “Worst timing” is a strategy in which $12,000 is invested into the S&P 500 at its highest closing value each year. “Cash” is a strategy in which $12,000 is invested into three-month US Treasury bills at the start of each year. Please see additional disclosures at the end of this document. Past performance does not guarantee future results, which may vary.

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