4Q2024 Investor Letter

Investors & Friends,

Here in this first week in October, the velocity of news from home and abroad kicked up several gears as flooding decimated parts of Appalachia, the escalating conflict in the Middle East threatened to further draw in regional and international players, and a historic strike of the Longshoremen’s union shut down ports up and down the eastern seaboard (by the time this went to print a tentative agreement was announced to stop the strike). All things that have the potential to reignite inflation just weeks before the US election.

Speaking of inflation however, after nearly three years of gains, US grocery prices had the largest single month drop in the past ten years in August and the Fed’s preferred measure of inflation, the PCE index, is nearly at their 2% target.

As inflation readings drop across the board and the Federal Reserve begins their easing cycle, a typically weak month of September saw another gain for the headline US equity indices, marking the 5th positive month in a row and the 10th positive out of the last 11. In fact, since August, pretty much everything has been up.

And strength like this has tended to beget more strength in bull markets past. When the S&P 500 is up in 8 of the first 9 months of the year going back to 1950, the 4th quarter was higher every time by an average and median of more than 6%.

Recent GDP numbers suggest that we are still in an expansion:

And an important piece of news from the Commerce Department last week flew under radar. The below excerpt from a First Trust Briefing:

“Like it does once every year, last week the Commerce Department went back and revised its GDP figures for the past several years.?And while the top line revisions to Real GDP were small, there was a larger revision to corporate profits.

Real GDP was revised up 1.3% for the second quarter of 2024, which means the annualized growth rate since the start of 2020 was about 0.3 percentage points faster than previously estimated: 2.3% per year rather than 2.0%.

And the statistician’s also said profits were underestimated.?The government now thinks its comprehensive national measure of pre-tax corporate profits is 11.5% higher than previously thought, mostly due to profits at domestic non-financial companies (such as manufacturers, retailers, transportation & warehousing, etc.).?Meanwhile, after-tax profits were revised up 13.3%.”

This is a big revision in the after-tax profits of US companies and helps to justify some of the returns in the equity markets we have been seeing. It is also a big deal because history has shown that the economic context in which rate cuts start is hugely important for how equity markets perform once they are underway. In the context of an expansion rate cuts have been quite positive. In the context of a recession, it is quite negative. So, an upwards revision that indicates the economy is stronger than previously thought puts more acorns on the right-hand side of the scale below.?

With that in mind, let’s look forward in the context of expansion, because despite the noise on a day-to-day basis, stocks tend to follow earnings. The chart below is from Yardeni Research and you may remember Ed Yardeni from our predictions letter at the beginning of the year. He was the analyst most right in 2023 and had one of the highest targets for 2024 which so far looks prescient.?If you take their 2026 year-end S&P 500 earnings estimate of $325 /share and you put a 20x P/E multiple on it, that gets you to an S&P value of 6,500 by the end of 2026, about 13.5% higher than today's 5,724. A not so unreasonable target for the optimistic scenario.?

One potential source of liquidity to fuel both the equity markets and consumer spending over the next 12-18 months is the now nearly $7T (trillion!) socked away in money market funds. As rates begin to come down, the attractiveness of saving in these funds will decrease and some of that money will likely find its way to equity markets, and the housing market, and the bottom lines of business income statements. We can see that for much of the 2010’s, money market assets hovered around a stable $3T, so there is plenty of excess now that could be on the move as compared to pre-pandemic levels.

Additionally, in aggregate, US household balance sheets are nearly at their strongest going back at least forty years. Note how much leverage was in the system in the 2000 – 2008 period as compared to now when liabilities are essentially fully funded with available liquid assets.

In our next letter, we will assess the results of the 2024 US election season and what that means for policy moving forward, but one thing I want to highlight before the election is the rise of Gen Z as a potential electoral force. In 2016, there were essentially no Gen Z voters. Now there are more than 40 million of them, more than enough to swing the balance of power. The question is, will they show up to the polls?

Along the same theme of demographics, a major source of angst we will have to deal with in the coming years is the decidedly negative aging trends present in much of the developed world. At the turn of the century, there were more than 6.5 active workers for every 1 retired worker. Just 25 years later, there are now only 4 active workers for every 1 retired worker and this trend will continue.

Many folks are worried about the potential for artificial intelligence to disrupt the workforce and steal jobs (Exhibit A: Longshoremen's strike), while I will argue that drastic productivity increases from AI are an absolute necessity to sustain our economy because we are going to run out of workers.

Turn on the news and you will find no shortage of reasons to be pessimistic. But consider this:

Stock prices at all-time highs

Gold prices at all-time highs

Home equity at all-time highs

Bond & cash yields at 4-5%

Unemployment rate at 4.1%

Inflation rate at 2.5%

This is about as good as it gets and it surely won't last forever.

And despite having far from perfect choices when we go to the polls next month, I want you to remember how unusual it is in the span of human civilization the act of voting is and how privileged we are to get the opportunity to do it. For all their faults (and there are many), the twin engines of democracy and capitalism have nonetheless powered the world forward. Let’s all stay engaged in the process and play our small parts in keeping the ship moving over the horizon.

In Wealth,

Zachary S. Mineur, CFA

Chief Investment Officer?

Independence Square Advisors

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