Monthly CIO Update | August 2024

MARKET WRAP

US equities were mostly higher in July despite heightened volatility in the second half of the month driven by economic, election and earnings uncertainties (Dow Jones +4.41%, S&P +1.13%, Nasdaq -0.75%). The market concentration we highlighted in June began to abate in July as a mid-month tech sell-off saw most of the Magnificent 7 stocks pulling back sharply before paring declines into month-end. The rotation out of mega-caps contributed to a broadening in performance breadth, with the equal-weighted S&P500 outperforming the official index by 333bps and the Russell 2000 (+10.10%) outperforming the Nasdaq by the widest margin in over 20 years.

Despite some high-profile misses (i.e., INTC), companies reporting Q2 earnings have broadly beat analyst estimates. With 75% of S&P500 having reported Q2 earnings, the blended y/y earnings growth rate for S&P companies is 11.5% vs. 8.9% estimated at the end of June. Interest rate sensitive sectors including Real Estate (+7.24%), Utilities (+6.82%) and Financials (+6.40%) notched the best monthly performance while Communication Services (+0.15%) and Technology (-3.28%) were hit the hardest amidst the sell-off.

Recent economic data indicated further cooling in the US economy, with headline CPI declining for the first time in two years (-0.1% m/m) along with a long-anticipated easing in shelter inflation. Treasuries were broadly firmer against this backdrop with the 2Y yield closing the month at its lowest level since February. The rally at the front end of the yield curve contributed to further steepening, with the 10Y-2Y spread normalizing to least inverted level since January (-20bps).

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INVESTMENT OUTLOOK

EQUITIES: The AI theme came under scrutiny in July, with high-profile investors raising concerns about the sustainability of Big Tech’s huge upfront AI capex budgets and their ability to translate these investments into a reasonable ROI. Given the degree of performance concentration observed amongst Mag 7 stocks throughout 1H24, some rotation out of growth/tech and into value/small-caps was warranted. However, we see opportunities in oversold technology stocks and believe a reversal in the medium-term is likely. We expect continued turbulence in equity markets through Q3 behind uncertainty around the U.S. presidential election, recession worries and potential conflict escalations abroad.

MACRO: Inflation has continued to trend downwards over the last three months and the latest employment data points towards a labor market that is cooling more abruptly than expected. This has exacerbated recession concerns and triggered a significant shift in rate cut expectations. The market implied probability of a 50bps cut by September jumped as high as 85% following the latest jobs report (up from less than 15% just a week prior), with an additional 75bps of cuts expected by year-end. In the July Fed meeting, Chair Powell signaled willingness to cut rates as soon as September, “if the labor market were to weaken unexpectedly or inflation were to fall more quickly than anticipated”; however, we do not anticipate that the data will support the aggressive policy path currently priced into markets. We read the combination of recent economic data (a soft CPI print and weakening labor market coupled with robust Q2 GDP growth and expanding ISM services PMI) as indicators of a cooling of the economy rather than an outright recession. Against that backdrop our base case remains unchanged, forecasting a 25bps cut in September and one additional cut by year-end.

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CHART OF THE MONTH

Much has been made of the recent unwinding of the “yen carry trade”. The Bank of Japan (BOJ) had held interest rates in negative territory from 2016 until earlier this year when they implemented their first rate hike in over 15 years. The BOJ’s July hike and hawkish shift caught traders offsides who were short the Yen and long international currencies and equities. This along with the recent rotation out of tech, the acceleration of Fed rate cuts and a sharp decline in the USD/JPY exchange rate precipitated a swift sell-off as traders attempted to raise cash to repay Yen-denominated debt. However, the carry trade is inherently leveraged and the full impact of the unwind may take months to unfold.

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