Historically speaking, September is typically the worst month in a calendar year – with the last two weeks being the most volatile. On average, most Septembers tend to trend negative with some months down over 10% (like in 2022), many months slightly negative, and a few months slightly positive. Apparently this year was an anomaly year with a slightly positive return; except what “worked” in the first half of the year (the Mag 7 trend) failed to propel the US markets higher in Q3.
In reviewing the data it appeared a rally across multiple sectors of the economy trended higher; most likely in sympathy to the FED’s 0.50% rate cut decision. Coupling the FED rate cut with the fear that the labor market was deteriorating too fast, the US equity market’s irrational exuberance, post August’s flash crash, began to price in excess rate cuts through the end of the year (much like it did in November 2023). Of course that sentiment was short lived as the September Job’s Report came in stronger than expected leading analysts to reduce rate cut expectations.
Fast forward to the end of the quarter and it feels like September’s performance is akin to trying to predict the path of a hurricane. Financial models upon financial models can be run, based on multiple data sets and decades of economic theory, and yet a slight wobble in one direction, or another, can lead to the creation of even more financial models. However, unlike a hurricane’s path of destruction, economic destruction can be masked for quite some time… until the last straw breaks and the deterioration is felt in home values and equity portfolios.
This brings me to the September’s update and what I am calling “The Tale Of Two US Economies”.
Quick anecdote…. I was never a huge Dickens fan growing up. I always thought “old books” (i.e. Death of a Salesman, To Kill A Mockingbird, or A Tale of Two Cities) didn’t apply to modern day, and I couldn’t relate. Of course with age comes reflection; which I would like to think also brings wisdom and patience.
Earlier this year I read the Dickens classic again and found some parallels in the moral of the story – things are not always as they seem – to the world we live in today. While I hope we do not find ourselves in a revolution after next month’s elections I do believe there are two economies that exist within the US economy. One that I have been saying can barely make ends meet, and the other that is living off the wealth effect created by a dozen stocks and a rapid rise in home values.
This is where I want to start this month’s Market Update. In particular I plan to paint a picture of the two economies and why I remain concerned about the overall direction of the US economy; while at the same time looking for opportunities in value based areas along with non-US based markets.
Summary Analysis:
Last month was one for the books as what worked in the first half of 2024 did not do much in Q3 2024. That said, when the market “flash crashed” in August due to the Yen carry trade debacle (which continues to be reinstated as the Yen weakens against the dollar) we were able to pick up some positions that we have been waiting awhile to invest in at reasonable valuations.
Then in anticipation of market volatility over the following weeks ahead of the election we took profits in many positions across all investment strategies by reducing equity allocations. While exciting to see a plan come together it was even more exciting to see one of our positions “rocket” higher nearly 125% from the start of the quarter. During Q3 rocket company met some launch milestones, successfully test fired a new rocket (another product to compete with SpaceX’s monopoly) and received some analyst upgrades. This increase added 1% to 2% to the aggregate portfolio – depending on the investment allocation.
Turning toward fixed income we saw additional bond market volatility with the 10 year Treasury dropping from 4.48% to a low of 3.62% before bouncing up to 3.74% to close out Q3. As noted in prior Market Updates, this type of bond volatility is quite uncommon and was directly related to two events: 1) the August Job’s report 2) the long awaited first FED rate cut. Since our fixed income portfolio is heavily weighted to the shorter end of the curve (targeting 5% – 5.5% APY) we experienced an approximate 0.50% price increase in our largest position, while maintaining our target APY.
Looking ahead, our research continues to show slowing economic growth in the US economy with declining consumer spending in cyclical goods, declining corporate revenues and earnings, and continued heightened political uncertainty as the election nears. Couple those data points with a ~10% increase in oil and gasoline prices over the last month due to ongoing Middle East issues and fears that a “red” or “blue” sweep in the White House and Congress could lead to major debt/deficit problems… and we remain steadfast in our view that the US economy is operating on borrowed time.
Detailed Analysis:
To say things do not appear as they seem would be an understatement in my opinion. While I might sound like a broken record pointing to concerns related to delinquencies in consumer credit and CRE, a rising unemployment rate due to hiring rates near multi year low, 50% of households making more than $100k (which is approximately 67% of America) live paycheck to paycheck, recession warnings flashing, and a number of other data points… the facts remain true. If you have significant resources, or an income in excess of $200k, then you are in a much better financial position as compared to the rest of America.
For example, when we extrapolate the strain that middle to low income households are experiencing we see bankruptcies climbing at staggering year over year rates. “Compared to prior years, the growth in 2024 bankruptcy filings is stark. Chapter 7 filings have increased by approximately 44.77% year-over-year, with Chapter 13 filings growing by 21.62%. This contrasts sharply with the relatively stable filing rates seen between 2021 and 2022, signaling a sharper economic downturn in 2024. Chapter 11 filings, used by businesses, have also seen a notable rise of 19.35% this year, likely reflecting increased business insolvencies due to challenging economic conditions. The filing numbers across all chapters show a clear upward trend, underscoring growing financial instability” according to Bankruptcy Watch. If that wasn’t enough this group has seen child care costs outpacing inflation and auto/home insurance premiums increasing at staggering year over year rates.
To put this into perspective, let’s assume a household makes $100,000 and then let’s deduct common expenses that most households of three people (two adults and one child) would pay.
+ $100,000 (two family household)
– $22,000 (approximate FED & State Taxes)
= $78,000 (free cash flow)
– $10,000 (child care)
– $24,000 (rent/mortgage)
– $8,400 (two used car payments)
– $2,400 (fuel for both cars)
– $2,400 (utilities like gas and electric)
– $8,400 (groceries)
– $3,600 (cell phones and internet)
– $2,400 (auto insurance)
– $2,000 (homeowner’s insurance but could be $500 for renters)
– $6,000 (a heavily subsidized group health insurance plan)
= $69,600 in total essential expenses
Add in annual variable expenses like:
– $3,000 for entertainment (~$60 per week for 3 people)
– $2,000 for travel/staycation
– $2,000 for out-of-pocket health care costs
– $1,500 a year for new clothes for the entire household
– $1,000 for car repairs
– $1,000 for personal care (like hair cuts for 3 people)
– $1,000 for personal property taxes in some states (for two cars)
– $500 for a couple streaming services
– Then assume they do not have a pet or other third party to support
= $12,000 not accounted for…
If you think this is an extreme example I assure you the only items that MAY have some element of “fluff” would be childcare and rent/mortgage. Although I would argue when my kids were toddlers we paid over $1,000 per month in child care (per child) and when they reached adolescence the cost dropped to about $500 per month (per child). And in terms of housing costs today, Apartments.com states the average rent in America is over $18,000 per year for a 700 square foot apartment. Furthermore, these households are not saving any money toward future emergencies, saving for a house, college, or even retirement.
Now imagine a single parent household making less per year? Or a dual income household with two or more young children? These families are forced to live beyond their means which is why credit card debt has reached all-time highs, delinquencies and charge-offs are reaching multi-year highs, and consumer spending is continuing to drop (which directly affects the sales/profits of hundreds of companies).
So, knowing this… how does the other half of the US economy live?
Simply put, pretty well.
While this group has many of the same expenses they are not confined by the constraints mentioned above. They have disposable income to do more, pay off credit cards, travel more, gift to family/friends/charities, or even save toward their future. This is an important point so I want to focus on it.
Over the last 20 years of working with clients in personal finance it is all too common to see people spend more as their incomes increase. Under the assumption their percentage of savings (as it relates to their income) remains the same then net spending increases marginally. In other words, if a household’s income increased from $200k to $250k, and they saved 20% into various accounts before and after the income adjustment, then the household’s net spending increased by the pay increase minus taxes and savings – or about $28k.
For both groups $28k would go along way toward improving a household’s standard of living. For example, both groups could allocate more to discretionary spending like entertainment, or toward funding goals like education, or even toward moving into a larger home. The point being… the “Have’s” are afforded more options while the “Have Not’s” are living like Oliver from Dickens’ Oliver Twist… asking “May I have some more (income) please?!”
I say all this to say… the wealth effect the second group has continued to experience, from their home and/or portfolio value increasing, continues to fuel some amount of consumer spending.
But at some point the bag of money turns up empty, and it’ll be a sad day for those who find themselves left holding the empty bag… just ask the thousands upon thousands of people in the Southeast who are trying to put their lives back together after two horrible hurricanes took everything from them. Their “wealth effect” related to home values… is gone. Those insurance premiums on homes and cars… aren’t going down. Replacing their cherished items… could be potential pipe dream if they didn’t copiously document what they owned and how much those items were purchased for.
Bottom line, we will continue to keep a cautious outlook while also looking for opportunities in areas undervalued – both domestically and overseas.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. You cannot invest directly in an index. Asset allocation is no guarantee of risk reduction. Past performance is no guarantee of future results.
