Takeaways: Putting 2024 in Perspective

• The first half boom stalled out over worries about inflation, debt levels, and the possibility that the Fed will keep rates high for too long. 
• The one bullish narrative centered around AI, specifically one company that seems to be capturing most of the spoils: Nvidia.  Those who owned the S&P 500 benefitted as this stock lifted the index to a 3.92% return ahead of the -0.92% return to the S&P 500 equal-weighted index. International, fixed income, and commodity indices ended with modest gains.
• As investors, the big questions are:  is valuation outmoded, i.e. does expensive beget more expensive?  Also, time frames matter: will AI benefits to the economy manifest before or after the next recession?  Lastly, we can’t ignore the mountain of debt about to reprice at higher interest rates facing real estate and most importantly, the US government.

At the conclusion of the first half of 2024, risk markets wavered between the promise of applied artificial intelligence (AI), set against economic headwinds of inflation, higher interest rates and debt worries across the economy; particularly in real estate and, surprisingly, at the US Treasury. 

As a result, we saw a tale of two markets: half of the return to the S&P 500 this year comes from just five stocks with Nvidia accounting for over half of that. The thesis behind Nvidia is that the artificial intelligence boom will be a major boost to corporate performance. However, the question remains whether the spoils will accrue to this one outstanding company.

Beyond domestic equities, investors profited from diversifiers. For example, gold, silver, and base metals like copper have positioned commodities as our biggest outperformer and of course, there are laggards—those that aren’t giving us as much diversification as we would like.  We are focused on whether these remain unique as asset classes, which, like pistons in an engine can rise when others fall creating a positive net result. 

The graph below shows us how sectors take turns rotating towards the top. 

In today’s market, one remarkable trend is the low cost of portfolio insurance against a market crash.  I believe this “portfolio insurance” is facing stiff price competition from a surprising actor, the Fed.  Simply stated, there is a belief that the Federal Reserve will bail out market participants if there is a major drop.  Why buy insurance when the government—being the ultimate risk manager—gives it to us for free?  At my Harvard Business School reunion in 2010 one of my finance professors told me that one of the lessons of the financial crisis is that you should always buy insurance when it's cheap or free.  Accordingly, we are evaluating whether to add this insurance.  This would respect the message conveyed by the other 495 stocks; that there is a tremendous risk of a recession and repression caused by the inflation that's still out there. Still?  Didn’t the inflation data last quarter show almost no growth?  Yes, however while the growth has attenuated, let us not forget that the level of prices in the American economy stand at 20% above the levels when Biden was elected. A significant increase in expenses is on many minds and we will find out if this is a big enough issue to affect the election.  Whatever the case, post-election, the mandate to keep prices low will ease leading to less support and greater challenges for investors.

You may see the question of indebtedness becoming another headwind for the US economy.  To give you a feel for the debt problem, consider this: US public debt—meaning, on behalf of all citizens at the governmental level—has quintupled in the past 15 years.  The total debt amassed exploded starting with the 2008 Global Financial Crisis (GFC) followed by Covid-19 relief spending.

The risk of not addressing this issue is that interest rates could spike due to forces beyond our control. Bill Clinton’s chief strategist James Carville famously said, “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”  Historically, bond vigilantism has resulted in economic shocks that can lead to political turmoil and a drastically lower standard of living.

The tale of this year is really the first quarter as this was a quarter to forget with most assets showing milquetoast performance. 

Enter your text here...