Do you remember the old riddle, “If a tree fell in the woods, and no one was there to hear it, does it still make a sound?” Well, today in 2024, we have a version of that question that similarly begs the question, “if limbs were falling from a branch high above, would you have the presence of mind to know it, look up, and get out of the way?”
Although this missive is tabbed as a 3rd quarter expository, it strikes home more as a 2025 conundrum because contained in the current data is a cause and effect that we believe is clearly being overlooked. Let’s begin with the fact that the stock market averages are trading at record highs. How, then, does one reconcile the enormous psychological and financial gap that exists between those who report that they are “comfortable” with their financial situation and those who are desperately falling behind? Why are corporations acquiring new companies in their portfolios but downsizing nearly 25 percent of the workforce? How are record earnings propelling equity expectations when high interest rates are decimating the bottom line? To be sure, most of the globe’s economic news is positive even when measured against highly grossed up expectations. But the symmetries are way out of balance. Is anyone looking up at the falling limbs?
Further, the contentiousness of the 2024 Presidential discourse worries us. Markets count on a cohesiveness and continuity of economic principles but current deviations from the norm would account for indecisiveness and fear permeating the electorate. Clearly, in that kind of environment, fiscal (political) judgement regarding policies and initiatives is stultified. The potential for voters simply to give up is a possibility and strengthens the vocal minority who say the whole system is “rigged” or “unfair”. The attitude has become that no one or nothing makes a difference which exacerbates even further the apathy that citizens and businesses feel about following the rules or being good citizens. In more ways than one, “downsizing” is becoming a way of life far too often.
And yet, the cornerstone of our optimism is that it all works out in the end...usually. While we allow for the pull and push of political debate a majority of people support isolationism, closing borders, and law enforcement under the guise of altruism.
It cannot be ignored, however, that the landscape has dramatically changed. In normal times conciliation is a fact of life. The risk premiums have expanded like no other time we can recall. The unknown outcome of the election in November will exact a higher cost in terms of volatility and strife than many might predict, possibly resulting in further erosion of confidence and optimism.
Markets
We are therefore raising our projected volatility in the financial markets for the balance of the year and into next. It is our suspicion that inflation will not budge, perhaps moving higher in certain core goods, which limits room for bond and equity appreciation. Unless political leaders can accommodate one another private consumption might sit on the sidelines for several years hence. Consumer confidence is weak right now and affecting spending habits that once were robust immediately after the covid pandemic. On the other hand, low confidence helps to limit an upsurge in inflation. We clearly observe that we are on the cusp of major spending changes in the next few years. The pesky issue of interest rate direction, while not something the average person obsesses about daily, does affect decisions about future capital expenditures. Consumers are the engine of economic capacity and inventory growth. Budget and spending inertia could impact political and household goal-setting for years to come.
Much of this turmoil is politically induced, and not definitionally economic in the truest sense. The first half of this year was, in fact, quite successful economically. Businesses have reemerged from a two year pandemic hiatus, employment and wealth building were both on record pace, and the markets, as noted earlier, are breaking all time highs. The impact of both the medical and economic response to the Covid virus has been successful and is raising the bar even higher for predictions about the economy. All the while, we watch out for the “limbs” above us…just in case.
The success of the markets is also its curse. Higher interest rates continue to be the sticking point in our projections. Based upon current earnings forecasts, and the impact of higher borrowing expenses, our valuation models indicate the possibility of a rough Summer ahead. This “seasonal rotation” should be completed before the end of year, mostly influenced by the elections in November. We would not be surprised to see a contraction of ten percent on the Dow and S&P which would bring the numbers closer to fair valuation. Therefore, we are advising our clients about near-term caution in the equity markets. We do not see the question as one about “up or down”, but rather one of timing. Can the elections lead to a constructive debate about priorities and policies that allow for sequential cycling of sector allocations? Without strict expectations and direction the consequences of undisciplined investing become more penal and more meandering. In this observer’s opinion the likelihood of those issues being resolved in a convivial fashion are not good.
One must consider that as recently as two years ago the financial markets were in a tailspin. Valuations were so low that issuing a “buy” recommendation was easy stuff. However, the valuation expansion in stocks right now makes the confluence of fundamental and technical analysis all the more important. It may take several more weeks…or months…of consolidation and capitulation to bear this out but we see significant recalibrations that are necessary to find equilibrium and opportunity in a marketplace that is so extended.
For example, energy (oil) stocks are highly overvalued based upon events in the Middle East, Ukraine, and elsewhere, and influenced by surging post-pandemic pent-up demand for travel. If demand were to wane so too would valuations of Energy stocks. We prefer, instead, to value these and other commodity equities based upon supply and the generational depletion of natural resources, as well as shifting demographics and expectations about climate and the globe. One might also include other commodities in that evaluation such as water, food, gold, and copper.
Further, our third quarter equity recommended list over-weights Tech stocks and Utilities, clearly a sign that while investors are interested in capital gains, they are more concerned about preservation of wealth during tumultuous times.
Hidden in this message about supply and demand is a not so subtle contrarian view about retail stocks. As mentioned earlier, high interest rates and a diminishing appetite by consumers to part with discretionary funds is going to have a negative impact upon earnings in this sector for the balance of this year. Brick and mortar stores, as well as dining establishments, are having a difficult time bringing in traffic, thus their shares are suffering also. Juxtapose their inertia against the enormous expansion in infrastructure projects worldwide (roads, bridges, rail, etc.) which I believe will boost capitalization of industrials during the same period. Of course, we continue to have one eye on the future by focusing on socially responsible objectives such as agriculture (food insecurity), technology, housing, water access, and renewable energy sources.
We are also proponents of modest exposure to short term and intermediate interest-bearing time deposits to maintain balance and defensive allocations within high net worth portfolios.
Conclusion
Our work has always been predicated upon the use of quantitative modifiers to enhance portfolio valuation through the use of information systems that create greater efficiency in portfolio diversification decisions. But because so much of the current data is skewed by emotion and fear, rather than data and integers, it becomes more difficult to engender the shared citizenship required objectively to analyze the macro and micro data. The rebuke of, and inability to accept common sense is the most vexing issue of our time, both financially and politically, and muddies the overlay of any market strategy worth its salt.
At no time in the last 3 years have we been more conflicted by the lack of purpose and direction in macro events which form the basis for our asset allocation decision making. This equivocation stems from the harsh rhetoric in our political debate; war poverty and immigration/migration worldwide; and uncertainty about the future. The most important questions for investors in the coming quarter revolve around how the current environment of fundamentals meld with the psychological climate of mistrust which permeate the discussion. The agenda, such as it is, is disjointed at best and poses severe roadblocks to our current quarter expectations. We caution again to look up and listen for the sound of limbs falling….
Suggested Balanced Account Asset Allocation Q3, 2024
Equities: 48%
Fixed Income: 40%
Cash: 12%
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