Let's Start with a Quick Recap of our May Commentary
In our May portfolio update video, we discussed the potential for a market pullback due to the Fed's stance on rate cuts and possible negative economic data. The latest jobs numbers show a softening labor market, and concerns have been growing over the past week that high interest rates may have slowed the economy too much.
You can revisit the 2 minute, 57 second video here: Portfolio Update: Risk Reduction Near All-Time Highs
Understanding Risk Off vs. Risk On Assets
We want to take a moment to explain what we mean by ‘risk on’ and ‘risk off’ assets. Risk-on assets tend to perform well when the market is healthy and trending upwards. Risk-off assets, on the other hand, are more resilient and hold up better in periods of volatility.
Portfolio Preparation
We began hedging the portfolios last December as market expectations and economic data were not aligning. Coming into 2024, the market expectation was 6-7 rate cuts by June, which we felt was overly aggressive given the economic data. As such, we decided to reduce overall portfolio risk by adding capital preservation and hedged equity sleeves to the model portfolios.
As the year progressed, economic data progressively became softer while markets have continued to rise. Jobs data was showing cracks, credit card and auto loan delinquencies were showing rapid increases, and the return difference between the Magnificent 7 (the nickname for the largest tech companies in the world) and the rest of the S&P 500 was at one of its highest points in recent stock market history. Even with the mounting negative economic data, the market continued to expect the first rate cut in June. We continued to take note that market expectations and reality were not aligned. We further expanded our capital preservation and hedged equity weightings in late April and again in late May.
Being proactive in advance of this current market volatility limits our need to be overly reactive at this time. Over the last 3 weeks, the market has fallen more than 8%. While we understand it can be uncomfortable to watch the market (and more importantly, your portfolio) moving lower, we want to point out that your portfolio has been positioned for this recent move since late May.
As an example, we have included the adjustments we made to our 80/20 Tactical Model below. Notice how we have expanded the purple (hedged equity) and the yellow (capital preservation). If we continue to see lower market prices, this will provide us the opportunity to move back into the blue (core model positions) at lower levels.
Potential for a Weakening Consumer
I also want to take this opportunity to share something else we are watching closely.
Notice the chart below1, which shows the personal savings rate that skyrocketed during the COVID pandemic. When we were limited in terms of travel and dining options, the savings quickly accrued. Now look at the blue mountain that depicts cumulative excess savings – it is being consumed at a consistent pace ever since the COVID restrictions were lifted. In the quarters ahead, the entirety of the excess savings will likely be depleted.
This is a concern for us. As the excess savings dissipates, we are keeping a skeptical eye on the US consumer. We have been closely monitoring early debt delinquencies. See this chart2:
The blue line shows an increase in auto loan delinquencies, and the grey line shows rising credit card delinquencies. As the excess savings mountain of cash gets depleted, we expect that these delinquency rates could climb further.
Looking to the Future
Volatility can be worrisome, but it is prudent to remember that it is part of the normal business cycle. We remain optimistic about the long-term future of global markets. The Fed is likely to begin rate cuts in September or November, setting the stage for the next market cycle. In the meantime, your portfolio is positioned to mitigate some of this volatility while providing dry powder to redeploy when opportunities arise.
We are closely monitoring the markets and your portfolio. Thank you for trusting us to manage your investments.
Sources:
- Guide to the Markets – U.S. Data are as of August 2, 2024. BEA, Federal Reserve, J.P. Morgan Asset Management. (Top right) From March 2020 to August 2021, consumers amassed a peak $2.3 trillion in excess savings relative to the pre-pandemic trend. Since August 2021, consumers have drawn down on those excess savings, with the remaining reflected in the chart annotation.
Guide to the Markets – U.S. Data are as of August 2, 2024. FactSet, FRB, J.P. Morgan Asset Management, BEA