Investment Management - Second Quarter 2024

July 24, 2024
Woman using AI, West Financial

Compute Rules Everything Around Me

Investment professionals attempt to summarize what factors are currently driving financial markets. Usually, the narrative covers a few major influences, sometimes ignoring smaller cross currents that have material impact. Occasionally, investors are handed an environment that is easier to navigate, due to powerful forces that dominate across equity and fixed income assets. These narratives are powerful enough to conquer investors’ imaginations, and single-handedly influence the direction of economic growth, and of course financial assets.

Artificial intelligence (“AI”) is one of these narratives, and rightfully so. We are likely in the first inning of understanding how AI, and all its potential, will impact almost every industry across the globe. Unfortunately, these mega waves never occur in a linear fashion. To borrow a term from Former Chairman of the Federal Reserve, Alan Greenspan, “irrational exuberance”i may occur in the short-term as hype and expectations outpace reality. About thirty years ago, investors fell victim to similar hype over the potential of the internet, which created massive wealth but also left some investors devastated.

The early stage of AI spending has benefitted only a limited number of companies. These mega-capitalization stocks are in the S&P 500 index, which ended the second quarter with a total return of 4.28%, and over 15% during the first half of 2024. Other indices that lack the exposure underperformed in the second quarter. Specifically, the S&P 400 Mid Cap and S&P 600 Small Cap indices returned -3.45% and -3.11%, respectively. International indices also finished the quarter slightly lower, with the MSCI EAFE index falling -0.42.

Performanceii for various indices for the three-month (not annualized), one-year, three-year, and five-year periods appears below:

 

Bond Indices

DatesICE BofA 1-5 Yr.ICE BofA 1-10 Yr.ICE BofA 1-12 Yr. Muni
3/31/24 - 6/30/241.03%0.83%-0.20%
6/30/23 - 6/30/246.20%6.15%2.61%
6/30/21 - 6/30/240.32%-0.76%-0.32%
6/30/19 - 6/30/241.80%1.54%1.01%

 

Equity Indices

DatesDow Jones Ind. Avg.NASDAQ CompositeS&P 500 (Large)S&P 400 (Medium)S&P 600 (Small)MSCI EAFE (Int'l)
3/31/24 - 6/30/24-1.27%8.47%4.28%-3.45%-3.11%-0.42%
6/30/23 - 6/30/2416.02%29.61%24.56%13.57%8.66%11.54%
6/30/21 - 6/30/246.42%7.78%10.01%4.47%-0.26%2.89%
6/30/19 - 6/30/2410.33%18.21%15.05%10.27%8.06%6.46%

 

The immediate beneficiaries of the first wave include those companies building the infrastructure for AI, specifically members of the semiconductor supply chain, cloud providers (hyperscalers), and those associated with the physical construction of facilities. The effects will vary across industries, though they could potentially lay the groundwork for greater economic growth, improved worker productivity, and higher corporate operating margins. Overall, fundamentals support current stock valuations, though it’s focused on only a small number of stocks.

While the group of stocks, dubbed the Magnificent 7, are spending massively on capital expenditures and research, they are using free cash flow from operations and not relying on debt. Since consumption and services tend to dominate economic growth in the U.S., the economy is less sensitive to higher interest rates. Industries that are dependent on financing purchases are interest rate sensitive, and therefore have not enjoyed similar appreciation of their stock prices. Broader growth would increase the resilience of the current economic expansion.

Another dominant narrative is the direction of interest rates. Several members of the Federal Reserve believe the fed funds rate is too restrictive, given the deceleration of inflation since peaking in 2022. However, the Fed’s preferred measure of inflation, the Bureau of Economic Analysis’s Personal Consumption Expenditures Price Index, rose 2.6%iii year-over-year in May, and remains above the Fed’s 2% target. The deceleration stalled earlier in 2024, supporting the Fed’s decision to hold rates steady until they have “greater confidence” of inflation approaching their target. According to Chicago Mercantile Exchange’s FedWatch Tool, consensus expectations are currently for two 25 basis point cuts to the fed funds rate before the end of the year.iv

With inflation seemingly under control, the Fed’s second mandate of full employment has become of equal importance to price stability.v Though the employment situation remains strong, there are signals of modest deceleration in supplementary employment measures. The number of job openings in the private sector have been declining, and wage growth has cooled. This additional slack of the employment situation has been the goal of tightening monetary policy. Still there are early indications that stability is now key. Broadly speaking, households remain in strong financial shape, net worth is at an all-time high while debt service costs remain low. However, consumption growth is decelerating as low-income consumers have exhausted their resources while unemployment claims and loan delinquencies have recently trended higher.

 

Chart on the left: Source: U.S. Bureau of Labor Statistics, Labor Force Participation Rate retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/LNU01300060, July 23, 2024. The series comes from the 'Current Population Survey (Household Survey)'
Rate of labor force participation for ages 55 years and over on the right scale ranging from 38.0% to 41.0% and ages 25-54 years on the left scale ranging from 79.5% to 84.0%, time periods on horizontal axis every 2 years beginning with 2008 through 2024. The rate of participation is U.S. Data as of June of the following years: Right scale: 2008 is 39.0; 2010 is 40.0; 2012 is 40.3; 2014 is 39.7; 2016 is 39.8; 2018 is 39.9; 2020 is 38.8; 2022 is 38.4; and 2024 is 38.0. Left scale: 2008 is 82.9; 2010 is 81.9; 2012 is 81.3; 2014 is 80.8; 2016 is 81.0; 2018 is 81.8; 2020 is 81.2; 2022 is 82.1; and 2024 is 83.5. 
Chart on the right: U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/ICSA, July 23, 2024. An initial claim is a claim filed by an unemployed individual after a separation from an employer. The claim requests a determination of basic eligibility for the Unemployment Insurance program. Frequency is weekly, ending Saturday.
Initial jobless claims on the left axis ranging from 175,000 to 400,000, time periods on the horizontal axis are for years 2021 through 2024. The jobless claim on June 26, 2021 is 372,000; on June 25, 2022 is 213,000; on July 1, 2023 is 248,000; and on June 29, 2024 is 239,000.

 

At West Financial, our focus is on durable portfolio construction, through diversification across asset classes and rebalancing opportunistically. Several tactical decisions in equities, to overweight growth stocks relative to value stocks, along with a substantial underweight to international equities relative to our benchmark, have been successful. Eventually, every trend has an ending, though timing the exact pivot point is extremely difficult. Rebalancing involves taking profits on winners, even extremely successful investments, while reinvesting opportunistically in other industries, or asset classes.

For fixed income allocations, the days of T-bills earning over 5% coupons with no duration risk will come to an end in the not-too-distant future. As short-term rates are generally the first to fall when rates are cut, we believe it is a good time to lock in these higher long-term yields. High quality corporate and municipal bonds continue to look attractive in this environment as “income” has returned to fixed income.

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We are delighted to announce the following well-deserved promotions in June. Kirstie Martinez has been named as our chief operating officer. Since joining West Financial Services in 1998, Kirstie has done an outstanding job for her clients and colleagues. She will continue to serve as a relationship manager, in addition to her new COO duties. We are very excited to see her in this new role. We also are excited for Abigail Just, formerly our senior portfolio manager, as she transitioned to the director of portfolio management. Brendan Lyons also joins the team as associate portfolio manager, from his prior role as research analyst. Lastly, we are pleased to announce the promotion of Maya Gentry to senior client service associate. Congratulations to all!

Also in June, we welcomed back Jessica Staton.  Jessica recently returned to the D.C. Metro area and is rejoining us as our director of operations. Please help us give her a warm welcome.

If you missed our webinars on Social Security and Medicare earlier this year, the recordings are available on the Events page of our website. Please save the date for an event we are hosting on Thursday, October 3rd, with Michael Townsend, Vice President, Office of Legislative and Regulatory Affairs for Charles Schwab. During this exclusive webinar, Michael will share his insights on the upcoming presidential election as well as the regulatory environment that will shape the economic and market landscape for years to come. Invitations to this event will be sent in September for this entertaining and informative discussion.

We have included our annual Privacy Notice to your report, stating our policy on the confidentiality of client information. If you wish to opt out of sharing information, other than that which is required by law, please complete the form and mail it to West Financial or the Sandy Spring Bank address provided on the form. If you prefer, you may also opt-out by calling the number listed on the Privacy Notice.

Follow us on LinkedIn or go to www.westfinancial.com to view our recent blog post. Thank you for your continued confidence in West Financial, and please do not hesitate to refer friends, family, or co-workers who you feel may benefit from our services.

  

President, Brian L. Mackin, CFP(r)Glenn Robinson CFA, Chief Investment Officer

Brian L. Mackin, CFP®

Glenn Robinson, CFA

President
Chief Investment Officer

ihttps://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm

ii Each of the S&P 500 Index, the S&P 400 Index, the S&P 600 Index, the MSCI EAFE Index, the ICE BofA 1-5 Year Index, the ICE BofA 1-10 Year Index, the ICE BofA 1-12 Year Municipal Bond Index, the Dow Jones Industrial Average, and the NASDAQ Composite (each, an “Index”) is an unmanaged index of securities that is used as a general measure of market performance. The performance of an Index is not reflective of the performance of any specific investment. Each Index comparison is provided for informational purposes only and should not be used as the basis for making an investment decision. Further, the performance of your account and each Index may not be comparable. There may be significant differences between the characteristics of your account and each Index, including, but not limited to, risk profile, liquidity, volatility and asset comparison. The performance shown for each Index reflects no adjustment for client additions or withdrawals, and no deduction for fees or expenses. Accordingly, comparisons against the Index may be of limited use. Investments cannot be made directly into an Index.

iiihttps://www.bea.gov/data/personal-consumption-expenditures-price-index

ivhttps://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html?redirect=/trading/interest-rates/countdown-to-fomc.html

v https://www.federalreserve.gov/monetarypolicy/fomcminutes20240612.htm

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This information is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Certain information contained herein was derived from third party sources as indicated. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. We have not and will not independently verify this information. Where such sources include opinions and projections, such opinions and projections should be ascribed only to the applicable third party source and not to WFS.

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