New municipal bond issuance has continued the strong pace that has been in place all year. According to figures from The Bond Buyer, primary issuance was $49.2 billion in August, representing a 25% increase from last year. This figure is the highest
new issue volume on record for the month of August. Even in the face of strong supply, persistent demand caused municipal yields to drop by more than U.S. Treasuries last quarter. However, both the taxable and municipal fixed income markets
continue to offer higher income relative to the past fifteen years and we maintain our favorable view.
The S&P 500 Index generated a solid gain last quarter driven by strong earnings growth and the Federal Reserve’s rate cut. However, there was a notable change in leadership as Value and Small/Mid Cap stocks led the market higher. In
terms of sectors, interest rate sensitive stocks tended to outperform given the falling rates with strong performance in the real estate and utilities segments. The Federal Reserve’s reduction in interest rates is positive for equities,
but so is the return of earnings growth. Corporate profits have increased significantly year-to-date, after modest gains in 2023. During this bull market, stocks of the largest companies in the artificial intelligence ecosystem have generated
much higher rates of profit growth than the rest of the equity universe. However, in the second half of the year we are expecting an increase in earnings for the stocks outside of the artificial intelligence segment. This gradual normalization
of growth rates should serve as a positive driver of equity prices along with the ongoing economic expansion. A sustained period of earnings growth is critically important given today’s high valuations. As of the end of the third quarter,
the market was trading at more than 21 times the expected earnings for the coming year. At this level, stocks are trading well above their long-term average of 16 times earnings. While there is a chance of a melt-up in equity prices fueled
by an overly ambitious series of rate cuts by the Federal Reserve, valuations should function as a headwind for the equity market. This suggests growth in corporate profits should be the driver of stock prices and unusually large gains for
the equity indexes are less likely in the coming year.
Foreign stocks generated strong gains last quarter fueled by rising levels of government stimulus and a decline in the U.S. dollar. In fact, stocks in both the developed and emerging markets outperformed the S&P 500 Index. In the developed
markets, the decline in the U.S. dollar was a significant driver of the strong performance and the gains were broadly based. In the emerging markets, stocks in China performed particularly well after the government implemented a stimulus program.
The economic expansion outside the U.S. has been uneven with weakness in China, soft conditions in Europe, and an improving environment in Japan. While economic growth has not been robust, we anticipate modest improvement in the outlook as
many governments and central banks are beginning to provide stimulus measures. In addition, the ongoing expansion in the U.S. should help to provide support and valuations on foreign stocks remain attractive. We are encouraged by these factors,
but mindful that many foreign economies continue to be hampered by low rates of growth, and we maintain a balanced view.
Commodity
Commodities provided mixed performance last quarter with energy and agricultural prices falling while precious metals increased. A slowing global economy has served as a backdrop for a decline in inflation and a moderation in many commodity
prices. In addition, plentiful supplies of oil are keeping energy prices contained despite significant geopolitical risks. Gold has bucked the trend and continues to rise given persistent increases in government debt and falling interest
rates. The short-term outlook for commodities is mixed given the soft backdrop in the global economy. However, we are maintaining our positive long-term view. Commodity prices, as a group, have declined significantly from their highs.
In addition, many governments and central banks around the world are providing stimulus measures to support higher rates of growth. That should help the global economy gradually improve, placing upward pressure on demand. Commodities also
remain a good hedge against geopolitical risks and the associated supply shortages that can accompany them.
Potential opportunities & risks
Opportunities
The emergence of artificial intelligence and other innovative technologies—The convergence of cloud computing, significant increases in computing power, and the advent of the smartphone have created a connected world
in which new technologies change the way we live. This convergence has created investment opportunities centered around long-term themes such as the growth of artificial intelligence, Big Data, quantum technologies, and cloud computing.
A productivity boom—According to some estimates, technology was pulled forward two to three years during the pandemic. That development coupled with a persistent shortage of labor is leading companies to invest in new
technologies with the goal of boosting productivity, automating processes, and adapting to today’s constrained labor markets.
The evolution of finance—Technological advancements are disrupting traditional methods of banking, finance, and transfers of cash. We are experiencing a global shift from paper currency to electronic payments fueled
by the popularity of credit and debit cards, as well as the emergence of cryptocurrencies. Online payment systems facilitating money transfers, e-commerce, and electronic bill paying services are also experiencing strong demand. This shift
is still in its early stages and is expected to have a long runway as it is occurring across both the developed and developing economies. In the coming years, blockchain technology may become a significant disruptor in the finance industry
with opportunities for new entrants while creating risks for the firms that currently dominate this space.
Expansion of robotics—Recent technological breakthroughs are taking advantage of 5G communications, sensors, and artificial intelligence providing for an expansion of robotics in healthcare, restaurants, construction,
and other industries. Some estimates project total global robotics spending will jump from $40 billion in 2023 to $260 billion in 2030.
Personalized healthcare—Advancements in technology support tailoring treatments to each patient, streamlining the drug discovery process, providing continuous data analysis in real time, and improved clinical trials
through digitization. Investment opportunities across the healthcare spectrum will be enhanced as artificial intelligence and machine learning increasingly result in better healthcare experiences.
Risks
Rising Government Debt—Sovereign debt levels were rising prior to the outbreak of COVID-19. However, in the wake of the virus, they have increased significantly. In the U.S., government debt outstanding has increased
60 percent since the end of 2019 and that trend shows no sign of reversing course with persistent budget deficits. While the short-term implications of higher debt levels are manageable, the long-term impact may be substantial as rising
interest costs burden taxpayers.
Geopolitical risks—Conflicts in many parts of the world have escalated or have near-term catalysts that may result in a change in dynamics. We are closely monitoring the wars in Ukraine and the Middle East along with
the relationship between the West and China.
Inflation—Given the unparalleled amount of fiscal and monetary stimulus in previous years, persistent federal budget deficits coupled with high government debt, the wars in Ukraine and the Middle East, reduced investment
in production capacity for some commodities, the trend towards deglobalization, and a shortage of labor, there is a risk that inflation may eventually return to an upward trend and remain above the average of the last thirty years.
Deglobalization/Protectionism—Rising geopolitical tensions across many parts of the world have resulted in a reversal of the globalization trend we have enjoyed since the fall of the Berlin Wall. A renewed priority to
secure access to commodities and other vital product inputs, along with a race to establish global dominance in certain technologies, have led to a reversal of the free trade movement. We expect this development to be coupled with a sustained
increase in geopolitical tensions, upward pressure on inflation, a rising cost structure for some industries, and the potential for moderation in the rate of economic growth.
Political risk and increasing government regulation—Our historical studies show that the average stock market return over presidential terms is similar regardless of which party holds the Presidential office. However,
elections can generate risks for specific industries if they become the target of a candidate’s proposed legislation. For example, some of the leading technology companies are facing increased scrutiny as their business success has
resulted in dominant market positions.
Cybersecurity—Cybersecurity remains a significant issue as evidenced by persistent attacks on governments, businesses, and individuals worldwide.
Originally posted on October 28, 2024
Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable. However, Badgley Phelps cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Badgley Phelps does not provide tax, legal, or accounting advice, and nothing contained in these materials should be taken as such.