Commentary from the Investment Committee of Coral Gables Trust
Q3 2024 – The Wait Is Over
The summer months presented the market with challenges as August’s disappointing economic data evoked fears of slowing growth and the greater potential for recession. However, as the quarter progressed, economic data and some key earnings reports displayed a more resilient economy than originally feared, resulting in the market recovering from the August lows and back to challenging the all-time high set in July. The Dow Jones Average led the pack with a quarterly return of +8.21%, followed by the S&P 500 at +5.75% and finally, the technology-heavy NASDAQ at +2.57%. While the strength of the equity market this year can be largely attributed to the Technology sector and the Artificial Intelligence trend, the recent rebound has unleashed a change of leadership. Since the August 5th low, the market’s recovery has been relatively broad with 90% of the constituents in the S&P 500 increasing in price. Of which, 45% of the stocks in the index are up by at least 10% and 70% of them having increased by at least 5%. The chart below illustrates how the equal-weight S&P 500 has performed against the broader S&P 500 this year.
Source: LSEG
Looking deeper within market capitalization, investors are welcoming the resurgence of small- cap equities and value equities. This rotation commenced alongside the cooler inflation report in July which prompted the Federal Reserve to shift their focus to the labor market and begin the long-awaited easing of interest rates. Historically, small-cap equities tend to outperform in an environment of falling interest rates and easing monetary policy. However, time will tell if the rotation experienced in the third quarter marks the beginning of a new upward trend.
Economic Developments: Signs Of Slowing in The Labor Market
The third quarter’s employment situation showcased a cooling labor market with job gains well below consensus and the unemployment rate increasing to 4.20%. Furthermore, the Bureau of Labor Statistics announced a downward revision to payrolls of 818,000, which means that total job growth between March 2023 and March 2024 now stands at 2,082,000; thus, decreasing the average monthly job gains for the period to 173,000. The economy is entering a critical window since the labor market needs to produce an average of 180,000 jobs per month to keep up with population growth. While these revisions place the labor market slightly below trend, it does not mean that a recession is inevitable. In other words, the labor market needs to hold up before the effects of rate cuts and easier financial conditions can provide a cushion for growth. GDP growth remains healthy with second quarter growth of 3.00% and the Atlanta Federal Reserve’s GDP model is forecasting third quarter annualized growth of 3.10%. The question remains whether the Federal Reserve rate cuts will be enough to produce a soft landing in time before the labor market softens further.
Federal Reserve: Recalibration & Supersized Interest Rate Cut
The Federal Reserve started an easing cycle by lowering the policy rate by 0.50% or 50 bps to a range of 4.75% to 5.00% and set the stage for several more cuts later this year. While the size of the initial rate cut exceeded expectations, Chair Powell made it clear that the 50 bps increments are not the new pace for the cycle. The committee left the door open to future 50 bps moves and is prepared to adjust the pace of the easing cycle as warranted by data. Chair Powell emphasized that the slowdown in job growth was the key factor behind the decision to kick off the easing cycle with a larger-than-normal rate cut of 50 bps, rather than the traditional 25 bps. The projections indicate 50 bps of cuts by year-end and gradual cuts over the course of 2025 and 2026.
Fixed Income Markets: Time to Transition from Cash to Bonds?
With the Federal Reserve cutting interest rates and the economic outlook pointing toward slower but healthy growth, what does this mean for bonds? When a rate cutting cycle begins, history shows cash underperforms traditional fixed income investments and the focus should be on higher quality bonds located in the 3-7 maturity range. After being inverted over the past two years, the yield curve is finally normalizing. As such, rates are falling faster at the shorter end compared to the longer end. The caveat being as interest rates fall, so will the hefty cash yields that investors have been accustomed to. The chart below outlines the significant improvement of yields in the credit markets since 2022.
Source: Bloomberg Index Services Ltd, as of 8/30/2024
In the last forty years, bonds have delivered nearly double the annual return and have outperformed cash in 98% of rolling 5-year periods prior to 2022. With the Federal Reserve cutting interest rates, the window to extend duration is closing. Notably, extending a portfolio’s duration before rates decline causes the market value of the underlying bonds to appreciate, which is a critical function of the total return component. In other words, investors need duration to benefit from falling rates. The fixed income market, on aggregate, posted a strong third quarter with longer maturities leading the charge in September. The Bloomberg Barclays Aggregate Bond index posted a quarter return of +5.30% and finally turned positive for the year with a return of +4.70%. Foreign bonds are still underperforming their domestic counterparts but entered positive territory for the year with a +2.04% return.
International Markets: Rotation & Broadening
Despite the overseas turmoil surrounding the geopolitical developments and the abrupt unwind of the yen carry trade, international developed equities outperformed US equities in the third quarter. International equities are beginning to benefit from market breadth and broadening away from the handful of U.S. Artificial Intelligence stocks that have led the overall market. These equities remain favorably valued and are quite attractive due to their improved earnings growth and outlook. In contrast to the U.S. market’s heavy exposure to growth and technology, international markets are comprised of more value-oriented sectors such as financials, materials, industrials, and energy.
In Japan, the Nikkei weathered the early August meltdown, bouncing back around 20% after falling 12.40% in a single day. For years, investors have taken advantage of ultra-low interest rates in Japan to finance investments in riskier assets, known as the carry trade. However, investors began to unwind their positions as the spread between the two countries narrowed (the Bank of Japan increasing interest rates and the Federal Reserve on a campaign to reduce them). Current data suggests that approximately 90% of the carry trade has unwou+nd. The chart below illustrates the unusually tight correlation between the selloffs in the NASDAQ and USD/JPY in August, sparking suspicions of investors having used cheap borrowing rates to fund the purchase of US technology stocks.
Source: Bloomberg, Goldman Sachs Global Investment Research
In China, the economy expanded 4.70% in the second quarter, slowing from the 5.30% in the first quarter. While the economy remains generally strong, it is showing signs of weakness. To regain consumer confidence and redirect the trajectory of the economy back towards President’s Xi’s 5.00% target, the Chinese political establishment announced stimulus measures in the form of monetary and fiscal easing to bolster asset prices. Market participants swiftly welcomed these developments, which led to Chinese equities experiencing their largest weekly gain in nearly sixteen years. The global macroenvironment may be witnessing a coordinated policy stimulus similar to the timeframe of 2015-2016, which could lead to the international market outperforming their domestic counterparts. The MSCI ACWI ex-US index returned +6.50%, the MSCI EAFE index returned +7.20%, and the MSCI Emerging Markets returned +7.68% for the third quarter of 2024.
Thoughts on Asset Allocation
Markets have continued their strong performance on the back of healthy earnings growth and expectations of a more favorable interest rate environment. We believe large cap stocks will continue to perform well, but we are recommending investors consider increasing their exposure to small and mid-caps as the changing interest rate environment is expected to boost profits for more rate and growth-sensitive companies. As allocators of our client’s capital, we diversify beyond mega-cap growth to achieve more consistent longer-term performance. We continue to advise our clients on the need to take a long-term approach to their portfolio that aligns with their financial goals. The Investment Committee will soon begin active discussions regarding portfolio positioning for the new year. We are confident that our present investment managers are well positioned to benefit from market breadth and broadening. Listed below is a subset of our equity and fixed-income managers that performed exceptionally well during the year against their benchmarks.
*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns.
We look forward to speaking with each of you about our investment philosophy and strategies and your portfolio’s performance.
For additional information, please contact Mason Williams, Chief Investment Officer, at 786-497-1214, or Michael Unger, Vice President/Investment Officer, at 786-292-0310.
RESOURCES
Quarterly Report: Q3 2024
Q3 2024 – The Wait Is Over
The summer months presented the market with challenges as August’s disappointing economic data evoked fears of slowing growth and the greater potential for recession. However, as the quarter progressed, economic data and some key earnings reports displayed a more resilient economy than originally feared, resulting in the market recovering from the August lows and back to challenging the all-time high set in July. The Dow Jones Average led the pack with a quarterly return of +8.21%, followed by the S&P 500 at +5.75% and finally, the technology-heavy NASDAQ at +2.57%. While the strength of the equity market this year can be largely attributed to the Technology sector and the Artificial Intelligence trend, the recent rebound has unleashed a change of leadership. Since the August 5th low, the market’s recovery has been relatively broad with 90% of the constituents in the S&P 500 increasing in price. Of which, 45% of the stocks in the index are up by at least 10% and 70% of them having increased by at least 5%. The chart below illustrates how the equal-weight S&P 500 has performed against the broader S&P 500 this year.
Source: LSEG
Looking deeper within market capitalization, investors are welcoming the resurgence of small- cap equities and value equities. This rotation commenced alongside the cooler inflation report in July which prompted the Federal Reserve to shift their focus to the labor market and begin the long-awaited easing of interest rates. Historically, small-cap equities tend to outperform in an environment of falling interest rates and easing monetary policy. However, time will tell if the rotation experienced in the third quarter marks the beginning of a new upward trend.
Economic Developments: Signs Of Slowing in The Labor Market
The third quarter’s employment situation showcased a cooling labor market with job gains well below consensus and the unemployment rate increasing to 4.20%. Furthermore, the Bureau of Labor Statistics announced a downward revision to payrolls of 818,000, which means that total job growth between March 2023 and March 2024 now stands at 2,082,000; thus, decreasing the average monthly job gains for the period to 173,000. The economy is entering a critical window since the labor market needs to produce an average of 180,000 jobs per month to keep up with population growth. While these revisions place the labor market slightly below trend, it does not mean that a recession is inevitable. In other words, the labor market needs to hold up before the effects of rate cuts and easier financial conditions can provide a cushion for growth. GDP growth remains healthy with second quarter growth of 3.00% and the Atlanta Federal Reserve’s GDP model is forecasting third quarter annualized growth of 3.10%. The question remains whether the Federal Reserve rate cuts will be enough to produce a soft landing in time before the labor market softens further.
Federal Reserve: Recalibration & Supersized Interest Rate Cut
The Federal Reserve started an easing cycle by lowering the policy rate by 0.50% or 50 bps to a range of 4.75% to 5.00% and set the stage for several more cuts later this year. While the size of the initial rate cut exceeded expectations, Chair Powell made it clear that the 50 bps increments are not the new pace for the cycle. The committee left the door open to future 50 bps moves and is prepared to adjust the pace of the easing cycle as warranted by data. Chair Powell emphasized that the slowdown in job growth was the key factor behind the decision to kick off the easing cycle with a larger-than-normal rate cut of 50 bps, rather than the traditional 25 bps. The projections indicate 50 bps of cuts by year-end and gradual cuts over the course of 2025 and 2026.
Fixed Income Markets: Time to Transition from Cash to Bonds?
With the Federal Reserve cutting interest rates and the economic outlook pointing toward slower but healthy growth, what does this mean for bonds? When a rate cutting cycle begins, history shows cash underperforms traditional fixed income investments and the focus should be on higher quality bonds located in the 3-7 maturity range. After being inverted over the past two years, the yield curve is finally normalizing. As such, rates are falling faster at the shorter end compared to the longer end. The caveat being as interest rates fall, so will the hefty cash yields that investors have been accustomed to. The chart below outlines the significant improvement of yields in the credit markets since 2022.
Source: Bloomberg Index Services Ltd, as of 8/30/2024
In the last forty years, bonds have delivered nearly double the annual return and have outperformed cash in 98% of rolling 5-year periods prior to 2022. With the Federal Reserve cutting interest rates, the window to extend duration is closing. Notably, extending a portfolio’s duration before rates decline causes the market value of the underlying bonds to appreciate, which is a critical function of the total return component. In other words, investors need duration to benefit from falling rates. The fixed income market, on aggregate, posted a strong third quarter with longer maturities leading the charge in September. The Bloomberg Barclays Aggregate Bond index posted a quarter return of +5.30% and finally turned positive for the year with a return of +4.70%. Foreign bonds are still underperforming their domestic counterparts but entered positive territory for the year with a +2.04% return.
International Markets: Rotation & Broadening
Despite the overseas turmoil surrounding the geopolitical developments and the abrupt unwind of the yen carry trade, international developed equities outperformed US equities in the third quarter. International equities are beginning to benefit from market breadth and broadening away from the handful of U.S. Artificial Intelligence stocks that have led the overall market. These equities remain favorably valued and are quite attractive due to their improved earnings growth and outlook. In contrast to the U.S. market’s heavy exposure to growth and technology, international markets are comprised of more value-oriented sectors such as financials, materials, industrials, and energy.
In Japan, the Nikkei weathered the early August meltdown, bouncing back around 20% after falling 12.40% in a single day. For years, investors have taken advantage of ultra-low interest rates in Japan to finance investments in riskier assets, known as the carry trade. However, investors began to unwind their positions as the spread between the two countries narrowed (the Bank of Japan increasing interest rates and the Federal Reserve on a campaign to reduce them). Current data suggests that approximately 90% of the carry trade has unwou+nd. The chart below illustrates the unusually tight correlation between the selloffs in the NASDAQ and USD/JPY in August, sparking suspicions of investors having used cheap borrowing rates to fund the purchase of US technology stocks.
Source: Bloomberg, Goldman Sachs Global Investment Research
In China, the economy expanded 4.70% in the second quarter, slowing from the 5.30% in the first quarter. While the economy remains generally strong, it is showing signs of weakness. To regain consumer confidence and redirect the trajectory of the economy back towards President’s Xi’s 5.00% target, the Chinese political establishment announced stimulus measures in the form of monetary and fiscal easing to bolster asset prices. Market participants swiftly welcomed these developments, which led to Chinese equities experiencing their largest weekly gain in nearly sixteen years. The global macroenvironment may be witnessing a coordinated policy stimulus similar to the timeframe of 2015-2016, which could lead to the international market outperforming their domestic counterparts. The MSCI ACWI ex-US index returned +6.50%, the MSCI EAFE index returned +7.20%, and the MSCI Emerging Markets returned +7.68% for the third quarter of 2024.
Thoughts on Asset Allocation
Markets have continued their strong performance on the back of healthy earnings growth and expectations of a more favorable interest rate environment. We believe large cap stocks will continue to perform well, but we are recommending investors consider increasing their exposure to small and mid-caps as the changing interest rate environment is expected to boost profits for more rate and growth-sensitive companies. As allocators of our client’s capital, we diversify beyond mega-cap growth to achieve more consistent longer-term performance. We continue to advise our clients on the need to take a long-term approach to their portfolio that aligns with their financial goals. The Investment Committee will soon begin active discussions regarding portfolio positioning for the new year. We are confident that our present investment managers are well positioned to benefit from market breadth and broadening. Listed below is a subset of our equity and fixed-income managers that performed exceptionally well during the year against their benchmarks.
*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns.
We look forward to speaking with each of you about our investment philosophy and strategies and your portfolio’s performance.
For additional information, please contact Mason Williams, Chief Investment Officer, at 786-497-1214, or Michael Unger, Vice President/Investment Officer, at 786-292-0310.
Index of Commentary
Q4 2024
Q3 2024
Q2 2024
Q1 2024
For additional information, please contact:
Mason Williams
Managing Director
Chief Investment Officer
Michael J. Unger, CFP®
Vice President
Investment Officer