At the time of this writing the U.S. presidential election is upon us.  It remains close.  Super close.  We are reminded that the 2016 election was decided by ~78,000 voters in three states, 0.06% of the electorate.  2020 was even closer, ~66,000 votes.  How tight will it be this November?  We’ll leave the handicapping to our partner, Dan Clifton, and his ace team in Washington but from 30,000 feet, an unbiased observer could argue the economic data – while on a knife’s edge – leans slightly in the VP’s favor, while the polls – if only recently – have broken toward the former President.  Less than a week to go.  A lifetime in politics…

Against this backdrop we remain bullish on the equity market though mindful that leadership continues to evolve.  As Strategas’ Chris Verrone and Todd Sohn have highlighted, excluding Utilities – carrying the thematic torch for the “Industrial Power Renaissance” – sector leadership in both trend and momentum remains decidedly cyclical.  (Could this be the market making-up its mind on the Election?)  Economic data, however, far from falling off a cliff, remains mixed… Manufacturing is the latest sector to show some (small) cracks; U.S. industrial production fell -0.3% in September.  But summer softness in the labor market and the concomitant ebb in consumption appeared to rebound last month; retail sales perked up +.04% M/M in September.  Earnings for CY’24 continue to come in less-than-expected, pulling estimates for the S&P down below $240 from ~$245 in 1H’24, in-line with our ~$241 estimate.  With little revision to CY’25 Street estimates, year ahead growth expectations have mathematically increased and remain at roughly +15% Y/Y.  (Though this will moderate as earnings season wraps up.)  We will watch top-line results in 4Q’24 and 1Q’25 closely to see if operators can follow through on the Street’s lofty expectations.  (Consensus lamps CY’25 earnings at ~$275; Strategas is lower, at ~$265.) 

Strategas, FactSet

If corporates do deliver, the market may achieve the margin expansion necessary to substantiate the current valuation backdrop; if they can’t follow through, Index performance will more likely become selectively cyclical and perhaps adopt a more late-cycle leadership composition.  We remain thematically bullish on “Cash Flow Aristocrats” in our Macro Thematic Opportunities portfolio as a hedge on increased economic volatility and the knock-on effect for corporate fundamentals. 

Note from the road: Recent travels to visit with clients in Miami revealed far greater concern about a second inflation wave given the current policy backdrop than what we hear from investors we meet with in other parts of the country.  More often the feedback is “out of sight, out of mind.”  Investors with more experience in Latin American markets would posit it’s not a question of “if,” rather a question of “when.”  Despite the urge to see inflation and the volatility of inflation expectations as in abeyance, we continue to watch oscillations in Rissmiller’s Wave: In a study of historical inflation data, across 24 developed economies, Strategas’ chief economist Don Rissmiller found 62 instances in which the annual rate of inflation peaked above 6%.  In all but eight episodes (87%) price surges evidenced in multiple waves.  We are in the basing period; one sufficient to convince policymakers that inflation and inflation expectations are anchored.

Source: Strategas, Bureau of Labor Statistics, Macrobond

From 30,000 Feet Down:  The investing environment continues to be heavily influenced by macro considerations.  Case in point, “De-Globalization” maintains, by our lights and as reflected in our Macro Thematic Opportunities portfolio, considerable thematic momentum.  A broad theme with many interesting and cross-cutting currents – ranging from: Trade Relations & Supply Chains, Natural Resource Procurement & Energy Security; and, Defense Alliances; to, Technology Alignment & IP Sharing; and, Populism – De-Globalization illustrates the utility of both incorporating macro and arbitraging time horizons in portfolio construction. This is a frequent topic of discussion with both institutional managers and wealth advisors. 

My colleague Tom Tzitzouris and I spend a considerable amount of time each year with clients examining and (sometimes) tweaking secular capital market assumptions.  This exercise provides the long form scaffolding that can inform everything from which investment strategies to seed or products to develop in the institutional channel to broad asset allocation decisions and tax planning in the wealth advisory channel, e.g., are Alternatives and Hard Assets taking share, is Fixed Income entering a secular bear market, what impact will private equity and credit have on public equity returns?  From this vantage point, you’ll also see the proliferation of all the wonderful conclusions from Kondratiev-length datasets[1], average risk-adjusted returns[2] and the formational arguments on the power of passive[3].  

Within our own and clients’ secular framework (and client analytical outcomes often vary, producing empirically divergent starting points) our team focuses on analyzing the long-term, economic and policy trends which inform the cyclical (and super-cyclical) investment environment.  Historical analogues are instructive, e.g., observing inflation through the prism of the 1970s U.S. paradigm and other developed economy episodes of unanchored prices (Rissmiller’s Wave) or the fraying – and fracture – of long-held geo-political operating conventions (De-Globalization).

From here the analytical template starts to address the “macro is important but how do I implement it within my portfolio?” question.  For us, the simpler the approach the better.  The building blocks of risk asset prices are earnings and interest rates with due consideration for transient, or unsustainable, political shifts.  Are valuations too high, what about the cost of capital?  How will the next run at the debt ceiling play out?  Our approach has generally been to draw thematic conclusions, identifying event-driven and episodic catalysts (for entry and exit) and to take measure of not just the investible characteristics but also of relative strength and momentum.  The latter informs tactical thematic rotation[4], our equity and fixed income sector views and, with backmatter of this monthly report, tactical risk-adjusted asset allocation, i.e., overweight domestic shares, lengthen bond duration.

Macro matters down to the most granular application.  Is it always the final arbiter?  No.  But the advantage of leveraging our Technical & Markets research team to assess the near and short-term tone of markets and their underlying constituents allows us the flexibility to confirm higher altitude conclusions or take opportunistic departures from our intermediate and longer-term investment theses.

Positioning for Year-End:  With the equity market continuing to press at all-time highs, there was a certain sense that had the Fed eased just -25bps both the bond and equity market would have been disappointed. Historical analogues are not kind to the market when the Fed starts to cut: In the 8 easing cycles that preceded this one, stocks fell an average of -23.3% over ~210 trading days from the first cut. Perhaps the circumstances are different this time? The Fed appears intent on engineering a soft landing for the economy and with inflation in an acceptable range (for the time being) policymakers’ attentions have turned to softness in the labor market. With the Election looming and the market adjusting from “bad news is good news” to “bad news is bad news” a spike in near-term volatility is likely; in the intermediate term, however, we believe investors should be careful about becoming too bearish. As Chris Verrone and Todd Sohn have highlighted, the composition of market leadership has shifted. We would recommend a more defensively cyclical equity allocation as opposed to the pursuit of ever-increasing growth cyclical exposure that defined performance for the past several years.  We remain overweight Equities in our tactical allocation portfolios with a preference for Industrials, Staples and, Utilities over Technology, Communication and, Discretionary shares. 

Nicholas Bohnsack