Q2 Market Commentary: A Look Back & Ahead
MODERNIST’S ASSET CLASS INVESTING PORTFOLIOS ARE STRATEGICALLY INVESTED WITH A FOCUS ON LONG-TERM PERFORMANCE OBJECTIVES. PORTFOLIO ALLOCATIONS AND INVESTMENTS ARE NOT ADJUSTED IN RESPONSE TO MARKET NEWS OR ECONOMIC EVENTS; HOWEVER, OUR INVESTMENT COMMITTEE EVALUATES AND REPORTS ON MARKET AND ECONOMIC CONDITIONS TO PROVIDE OUR INVESTORS WITH PERSPECTIVE AND TO PUT PORTFOLIO PERFORMANCE IN PROPER CONTEXT.
As evidence-based investors, we use an approach fueled by data with over 50 years of research, rooted in diversification and tax conscious investment options. Time has proven the value of investing. While these quarterly market reviews are helpful for staying informed, we also love to remind our clients and community: focus on what you can control, remember the big picture, and stick to your plan.
market snapshot:
The big story continues to be NVIDIA. Having grown by over 150% this year, the chipmaker now comprises nearly 6% of the S&P 500, and helped the index surpass 40% of global market cap. (20) While the AI story has boosted mega-cap stocks, higher interest costs are weighing on small firms with more debt.
Bond markets continue to be particularly volatile by historical standards. The data-dependent Fed has bond traders closely watching economic releases, leading to larger price fluctuations around announcement times.
inflation eases, recession risk falls
Main Takeaway
Although risks remain, the economy has successfully navigated the path toward lower inflation without triggering a recession. Fiscal spending and the expectation that the Federal Reserve will cut interest rates have buoyed the American economy. Rates will likely stay higher for longer than anticipated at the start of the year, which continues to squeeze certain sectors. Inflation continues to stabilize in developed countries, and the likelihood of a global recession has declined.
Top Risks
Although fiscal policies have boosted economic growth, policymakers seem unwilling to navigate back toward a balanced budget. With interest expenses continuing to grow, the debt-to-GDP ratio in the U.S. is on an unsustainable path. Consumer spending is weakening among younger and lower income households. Commercial real estate debt refinancing threatens to undermine regional banks, while a trend toward domestic production threatens higher inflation.
Sources of Stability
Globally, inflation has subsided and the threat of a recession over the next 12 months is on par with a “normal” economy. Other central banks, such as Canada and Europe, have started to reduce their target interest rates. The Fed has indicated its next move will likely be a rate cut, giving businesses and consumers more confidence to spend. Interest rates for businesses, measured by credit spreads, have fallen since the Fed's change in messaging.
KEY ECONOMIC INDICATORS: AREAS TO WATCH
Economic Growth
Despite rates remaining higher than anticipated at the beginning of the year, the U.S. economy continues to expand with GDP growth estimated to be 1.5% for the second quarter. (1) The services sector is still expanding, and after a short blip of expansion in manufacturing, we're seeing continued contraction. The U.S. is expected to account for over 26% of global GDP this year, the highest in nearly 20 years. (2)
Inflation Trajectory
Inflation is falling slower and will likely exceed the Fed's 2% target this year. Cyclical forces, such as the transition to green energy, a focus on U.S. manufacturing and high fiscal spending, are helping to keep inflation above the target rate. (3) Increases in auto insurance stand out as particularly painful for consumers, increasing more than 20% over the last 12 months. (4) Expect inflation to be more volatile as the government continues its deficit spending. (5)
Monetary Policy
The impact of a higher federal funds rate has worked through the economy significantly slower than in prior tightening cycles. (6) This is partially due to less rate sensitivity in the broader economy through fixed-rate mortgages and less manufacturing, but the Fed has also made its job harder by taking a more optimistic tone in December 2023, giving consumers and businesses more confidence to spend rather than save. (7) Markets are currently pricing in two rate cuts in 2024, with an 80% chance of easing as early as September. (8)
Fiscal Policy
In the U.S., spending continues to exceed revenues. Expect a deficit of 7% this year. (9) On the positive side, JPMorgan estimates that the primary deficit, which excludes interest expense, will be relatively stable over the next year or two at 3% of GDP. (10) However, with nearly $9 trillion of debt maturing over the next year, expect higher interest expenses to persist and to put more pressure on the fiscal budget. (11)
Commercial Real Estate
With nearly $1 trillion of commercial real estate that needs to be refinanced this year, much of it at higher rates, we continue to watch the commercial real estate market for signs of distress. (12) Despite headlines around office vacancies, other areas of commercial real estate look resilient, such as warehouses and data centers. (13) Strain in commercial real estate loans will likely spill over to regional banks and, more slowly, to local municipalities through lower appraisals and lower tax receipts. (14)
Consumer Lending
Despite broadly positive economic news, some American consumers continue to feel the pinch. The percentage of consumers starting to miss payments on their credit card or auto loans is in the high single digits. (15) Although the total credit card utilization rate, the amount borrowed as a percent of what individuals could borrow, is steady at roughly 23%, an analysis by the Fed found that 18% of borrowers are using more than 90% of their credit, which is especially concentrated among lower income and younger individuals. (16)
Global Economy
Globally, central bankers are beginning the process of rate cuts. Canada was the first to cut in early June, followed by the European Central Bank. The Bank of England maintained its policy rate in early June, but economists expect it to start cutting rates in August. Consensus estimates for a global recession in 2024 have declined significantly, now sitting at merely 30% or less for the U.S., U.K., Canada, and Europe. (17)
China
The Chinese government made headlines earlier this year by advocating for new productive forces. Although vague, the overarching desire is to further establish the Chinese nation as a leading innovator in existing industries and a leader in emerging technologies. Internal policies and entrepreneurs’ distrust of the government will likely hinder these ambitions. This year, Mexico overtook China as the No. 1 source of imports to the U.S. (19)
Thanks to our reliance on long-term evidence-based investing principals, we know that short term data is too noisy to determine our investing choices. Yet, we always like to offer our review of markets because we believe this information should be accessible to all!
