May 2024 Market Update

Market Update Summary

U.S. Growth on Positive Trajectory

The economic outlook this month is optimistic with growth prospects continuing in positive territory in the U.S., along with improving global economic prospects, according to our leadership team at City National Rochdale. More than likely, the Federal Reserve’s rate hiking cycle is finished and policy headwinds for the market will moderate. Generally, the U.S. has a solid economic foundation, and the probability of a recession is low. We expect a moderate slowdown of GDP growth in 2024 and 2025.

Consumers continue to be resilient with job and wage growth supporting continued consumer spending. We anticipate improvements in corporate profits, inflation, credit conditions and the housing market. One key risk we continue to watch is geopolitical events.

 

Elections around the globe are under scrutiny for their potential impact on the market. One particular area we’re monitoring as an outcome of the U.S. election in November is the possibility of new tariffs that could have both direct and indirect economic effects. If new tariffs are imposed, there’s a strong probability of higher consumer prices, lower consumption and lower real incomes. Higher net trade is a possibility, too, although retaliatory tariffs could lower export volumes. Overall, a new tariff environment could be trouble for continued U.S. economic growth. There would be additional pressure on business sentiment and global supply chains.

 

Election results in the U.S. will have major implications for the possible extension or expiration of the Tax and Jobs Act tax cuts that are scheduled to end in 2025. Beyond the impact on consumers, tax decisions will also impact the deficit. The U.S. deficit is already skyrocketing. If the tax credits are extended, this could create a significant increase in the deficit over time. Higher deficit growth would likely put upward pressure on interest rates.

While there are negative implications of higher interest rates, there could also be an opportunity to invest in municipal bonds for higher returns.

 

Election results are also likely to impact Treasuries, with a projected issuance of over $3 trillion by 2029. The share of foreign purchases of Treasuries has dropped significantly down to 33%, but domestic buyers have picked up the slack and represent 48% of buyers. However, domestic investors tend to be more price sensitive, which means rate volatility is likely here to stay.

 

As part of our continuous monitoring of global markets, we anticipate that many global central banks are likely to ease their tightening policies before we see the first Fed rate cut in the U.S. Some central banks in emerging markets have already begun rate cuts. These cuts could stimulate the economies in those markets, which could increase returns on non-U.S. investments. However, we’re still waiting for more clarity around stable growth, currency stability and geopolitical issues before increasing our exposure to overseas investments.

 

Consumer consumption continues to be the driving force of GDP in the U.S. and is up 23.8% since the end of the pandemic-related recession. Spending is anticipated to moderate because wage growth is slowing, hiring is slowing, and because household savings are being depleted. In addition, higher interest rates will take their toll. Overall, this will help balance the income and spending relationship to be in line with long-term trends.

 

Inflation continues to moderate but is still too high for the Fed. The Consumer Price Index (CPI) is 3.4% year-over-year and the Fed’s target is 2.0%. Core CPI is 3.6%. The main drivers of inflation now are housing costs and auto insurance. Auto insurance rates have risen by 23% year-over-year, in part because of higher costs for labor and materials for repairs. In addition, claims dropped dramatically during the pandemic because fewer people were driving, followed by a period of higher claims once people returned to the roads.

 

Yields on the 10-Year Treasury have increased 4.1% year-to-date since the beginning of 2024. We believe our higher for longer thesis continues to play out, which should keep demand in check. Forward issuance and potential price fluctuations may challenge prices, but open entry points.  Rates in the 4.1% to 4.6% range offer fair value. We anticipate the Fed to begin easing sometime in the second half of the year, so this is a good time to put money into Treasuries. The continued volatility may be challenging but can also offer opportunities.

 

Higher income from corporate bonds is a great benefit for investors, but a secondary benefit is that the additional income provides a cushion for portfolios to offset market volatility. Scenario analysis supports the extension of duration on potential forward return outcomes. The higher for longer thesis and potential for future rate cuts provide a good risk-reward balance.

 

Much of 2023’s market gains were attributed to the “Magnificent Seven” tech stocks, but their market share peaked during the second quarter of 2024. During that quarter, tech stocks represented an estimated 31% of the market gains, while the rest of the market represented 10% of gains. That is expected to flip during the third quarter of 2024, when tech stock estimated earnings will likely be 19% of the market compared to 32% for other stocks. Estimates for the fourth quarter of 2024 show a similar trend, which bodes well for the CNR portfolio.

 

In addition to individual stock choices, we focus on sector positioning for long-term performance. We evaluate the quality, financial strength and competitive market position of various sectors. The investment team is currently overweight on industrial infrastructure and energy investments, along with the financial sector, which has more oversight and now includes the growing digital payments business that was formerly considered part of the tech sector. We are underweight on technology other than semiconductor manufacturing and AI. In addition, we avoid the commodities sector because of its volatility.

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