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Market take

Weekly video_20241101

Nicholas Fawcett

Opening frame: What’s driving markets? Market take

Camera frame

The Federal Reserve is set to cut interest rates again this week. We don’t think the central bank will cut as much as markets expect given we see the labor market remaining solid and wage pressures firm.

Title slide: Structural forces playing out now

1: Wage growth easing but still high

We think markets are viewing structural changes through a short-term cyclical lens, driving volatility and sharp price swings.

Much of inflation’s recent fall is due to the unwind of pandemic-era supply shocks and a temporary boost in the U.S. labor supply due to immigration. That’s why U.S. wage growth has slowed, even if last week’s labor data showed it remains high historically.

2: Longer-term inflation pressures

But we see powerful structural forces that could keep inflation sticky longer term, like persistent budget deficits no matter who wins the U.S. election.

Longer term, population aging means the economy will not be able to grow as fast without bolstering inflation.

3: Europe vs. the U.S.

Market pricing of rate cuts by the European Central Bank is more in line with our view than in the U.S.

The ECB has tightened policy more than the Fed, even against a weaker growth backdrop. That gives the ECB more room to cut rates than the Fed.

Outro: Here’s our Market take

This is not a typical business cycle. We don’t think the Fed can cut as much as markets expect because of sticky inflation.

We prefer European fixed income and are overweight UK gilts as they better reflect our policy expectations.

Closing frame: Read details: blackrock.com/weekly-commentary

Market take

Weekly video_20241101

Nicholas Fawcett

Opening frame: What’s driving markets? Market take

Camera frame

The Federal Reserve is set to cut interest rates again this week. We don’t think the central bank will cut as much as markets expect given we see the labor market remaining solid and wage pressures firm.

Title slide: Structural forces playing out now

1: Wage growth easing but still high

We think markets are viewing structural changes through a short-term cyclical lens, driving volatility and sharp price swings.

Much of inflation’s recent fall is due to the unwind of pandemic-era supply shocks and a temporary boost in the U.S. labor supply due to immigration. That’s why U.S. wage growth has slowed, even if last week’s labor data showed it remains high historically.

2: Longer-term inflation pressures

But we see powerful structural forces that could keep inflation sticky longer term, like persistent budget deficits no matter who wins the U.S. election.

Longer term, population aging means the economy will not be able to grow as fast without bolstering inflation.

3: Europe vs. the U.S.

Market pricing of rate cuts by the European Central Bank is more in line with our view than in the U.S.

The ECB has tightened policy more than the Fed, even against a weaker growth backdrop. That gives the ECB more room to cut rates than the Fed.

Outro: Here’s our Market take

This is not a typical business cycle. We don’t think the Fed can cut as much as markets expect because of sticky inflation.

We prefer European fixed income and are overweight UK gilts as they better reflect our policy expectations.

Closing frame: Read details: blackrock.com/weekly-commentary

Opening

This is Mark Peterson with the October 2024 Student of the Market update.

Slide 2, 00:06

This month, a handful of things on stocks. We'll mix in the election as always, talk a little volatility as well, hit on valuations. Then we'll touch on money market funds and yields, where they're headed. And the fact that often it takes a while for those dollars to come off the sidelines. And finish up with some things on alternatives, stock and bond correlations leading to those alternatives, and something on private equity at the end.

Slide 3, 00:35

So, let's begin with what we touched on last month. Third best start to an election year for US stocks going back to 1928. So, 25 different elections, up over 22% in US stocks begin the year. Really pretty remarkable. You have to go back to 1936 to find a year in which we had such a good start to the year. And generally, that momentum carries through. We hit that last month. But just wanted to pull up the historical average of what happens in the last three months in election years. You can see October usually pretty sluggish. Starting to see a little bit of that now. But November and December, once you get to the election thereafter, the market seems to perform pretty favorably.

Slide 4, 01:17

Moving ahead, I wanted to update the slide. We've run this in the past, just looking at geopolitical events historically and what happened to the market a little bit before and after those famous geopolitical events. Seems like we've had a bunch here lately, so we updated the chart. You can see historically going back to really World War II. Generally, the market holds in there pretty well. You have some periods here like the first one from the top, Germany invading Poland and starting World War II. We're three years later. Stocks were lower. Probably not a huge surprise there. Of course, following that, you can see in the next one, Pearl Harbor attack. Just picking up a couple years there. All of a sudden, you get towards the end of World War II, and the market reacted very favorably. You go down the list. Generally, stocks were higher three years later. I think the first one was the only negative there. So, the resiliency of the market is pretty astounding historically, and obviously been better lately with some of these recent events with the market being able to power through. Not in every case, but more often than not, the market shows that resiliency.

Slide 5, 02:30

We mentioned volatility, one of our favorite topics. We love talking about 2% trading day. So, just any day the market's up 2% or more or down 2% or worse, we check that off. And we've had a couple here recently, but still very low volatility given all the challenges we've faced both here in the West politically and geopolitically across the globe. We've had four so far this year, which is pretty low. You can see the pace we had back in 2020. We had 44. Of course, that was the pandemic. And the shutdowns or we had 72 back in 2008. You can see all the election years going back to 1928 and this volatility story is either an all-in or all-out phenomenon either volatility is an issue and you're seeing it all over the market or it's not at all. And this year falls into the really not at all camp. You can see that 140 back in 1932 is astounding. There's only about 250 trading days in the year. And when you start to look and line up what happens in these years when we have volatility in the election year, it isn't that the election is creating this volatility. It's all about the economy. And you can see we added recessions in these election years. And really every one of these periods where you had a lot of volatility, you had economic challenges. And the market tried to digest those economic challenges, created the volatility. So, I think that's just an easy way to connect volatility for investors. The market's trying to figure out where the economy's headed. If you have a lot of volatility, the market's really unsure. And then, the final piece on the right side is, when you have very little volatility, it tends to be really good for market performance. You can see, and this is just election years, it's actually even better for all years, but just in election years when you have very low volatility, stocks average 15%. When you have 10 or fewer of these 2% trading days, where if you have more than 10, all of a sudden, returns start to get real challenged. You're down to 4.7%, well below average for US stocks when the market's trying to figure out where the economy's headed. You get these 2% days popping up all the time.

Slide 6, 04:50

Good questions on valuations in the market. Certainly, we've had a nice run in stocks. Valuations aren't cheap. You can see here's the S&P trailing 12-month earnings. 27 range here roughly and you can see it's not as high as we've been in other periods including bubble or even early 2021. But I think one thing to understand about valuations, they tend to be a real poor predictor in the short term, better in the longer term. And you can see some of the recent periods that we've had here up top, where you've had some high valuation, but still had pretty good returns, one, three years later. The exception, of course, is the tech bubble. You ran right into the lost decade there, where you had really high valuations in stocks, leading into a really slow and sluggish period the next decade for stocks. And then, on the bottom, I thought it was interesting, lower valuations actually tend to be a really good predictor. And maybe this is just the nature of the market here recently. If you can buy stocks cheap, the returns are tremendous. Look at the table at the bottom, really no exception. They all look fairly similar, right? The lower the valuation, the better the return on the other side. Especially following the global financial crisis probably no surprise. But look at some of those others. In 2011, 2018, some pretty nice returns on the other side when you can buy stocks at low prices, no surprise.

Slide 7, 06:19

Money funds, certainly at record level assets, about $6.4 trillion in money funds. And of course, we got the first Federal Reserve rate cut, 50 basis points down to right between 4.75% and 5% on the effective funds rate. And you can see historically, especially some of the recent cutting cycles for the Federal Reserve, rates came down very consistently, very dramatically. Granted, some of these periods had very sharp recessions, very deep recessions, whether it was the COVID shutdown or the global financial crisis. You can see what happened in '07 and '08. Rates just collapsed. Even 2001, the Fed was very aggressive, lowering rates. Maybe this time around, it doesn't look like that if we don't get that recession, which is a nice scenario that we've talked about for portfolios. But maybe it looks something a little bit more like '95, where you get a couple of cuts and then it settles in and maybe economy rebounds from there. But I thought that was interesting to understand that history, all these periods a little bit of a different story. They all have their own narrative, but I think good to understand. And then on the right side, something we've talked a lot of about is, even though money funds have done great, all these bond categories have actually done better since the start of 2023, which is really, you can see on the chart on the left, that's right about when money market yields started to get back to what we consider a very attractive level. Look at, out of the top 15 largest bond categories, 13 of the 15 have outpaced money market funds, some of these by a very healthy margin. Certainly, some of the categories here well-represented in portfolios for advisors. So certainly, that looks good for folks who've been in a diversified portfolio above cash, even on the fixed income side.

Slide 8, 08:15

And one thing that I thought was interesting, just staring at the money market flows and assets over the years, is you get these periods of time where you get a big buildup in cash assets, 6.4 trillion, as I mentioned, record high in money market fund assets. So, you can see over the years, you've had pretty distinctive peaks here in assets, whether it was 2003, 2009, even during the pandemic in 2020, you had some buildup in cash and cash on the sidelines. And generally, it took a little bit of time for those dollars to come out. You can actually see that the first Fed rate cut, there's roughly anywhere between nine months and two years of a lag time between when money market assets actually peaked and when the Feds started lowering short-term rates. So, it can take a while for folks to actually come off those sidelines. You can see that actually when money markets peaked, the yield on these money funds were pretty darn low at that point in time. Granted, some of these periods, there was more than a lot of concern about the market. Certainly, 2003 had stocks down three years in a row from 2000, 2001, 2002, or 2009 global financial crisis, the pandemic, 2020. Certainly, concern and fear at a high at that point. So, maybe it's a little bit different this time. We don't see the immediate rush out of cash. Maybe rates stay a little bit higher for longer. So, and maybe assets hang around. But I think we saw on the previous chart, probably not a bad time to start talking to folks about putting money the work in a portfolio, whether it's stocks and bonds. Even though certainly, rates have come down a hair here, we still think bonds make a lot of sense in the back half of 2024, into 2025 or diversified portfolio. We've touched on that in the past as well. Just the benefits above cash, pretty undeniable over time.

Slide 9, 10:15

Correlation with stocks and bonds still tracking last three years at historic levels, 0.7, highest that we've seen historically. It hasn't budged too much here in recent months. But I thought it was interesting on the right side, just to look at what's been the lowest correlated categories to stocks over the last three years. And they're all alternative type categories. You have systematic trend, which shows very low correlation. The challenge is you don't see much return. Equity market neutral actually looks great. You can see zero correlation to stocks over the last three years. 8.2% average annual return over the last three years. That's just the average for the category. Obviously, a lot better strategies in the top quartile of that category. And then, commodities, I thought it was shocking that commodities was next up on the list as far as fund categories with the lowest correlation to stocks. It was that big of a jump to commodities. So, low correlation to [inaudible] equity market neutrals one of those few categories did a nice job delivering correlation, but also delivering some returns along with that.

Slide 10, 11:25

And finally, just want to throw one in private equity. Noticed private markets face get tons of attention. Just look what happens when the Fed starts lowering rates the last couple cycles. What's happened to private equity? And I think this tells a good story. It's certainly not all sunshine here. You have periods like 2008 in the global financial crisis where there's no place to hide, right? Stocks were down, small caps were down, private equity was down as well. But some of these other periods held up much better. More recently, 2019, even in 2020. I thought that was interesting for folks who are starting to dabble in that space. Certainly, something that we think can add to a portfolio. The access that we have here today is the best that we've had in my 30 years in the industry. Something that I think we can all build on and really evolve portfolios to a better place.

Slide 11, 12:16

So, that does it for us for our October 2024 Student of the Market Update. As always, you can find us if you Google BlackRock Student of the Market. You can find us out there and hopefully, you can find the spot to add comments and questions. If you have suggestions for content as well, some of the best ideas come from folks across the country and certainly want to answer those for everyone out there. So, with that, we'll talk to you next month on BlackRock's Student of the Market Update. Thank you.

Student of the Market: October 2024

BlackRock’s Student of the Market provides monthly insights on current and historical market trends. Share these key insights with your clients now.

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