October 2025 Market Update: Knockin' on Leverage's Door

Knockin’ on Leverage’s Door is a reference to "Knockin' on Heaven's Door", a song Bob Dylan wrote in 1973 for the movie Pat Garrett and Billy the Kid. Recent generations likely associate the song’s cover with musicians Eric Clapton and the band Guns N’ Roses. The song’s lyrics depict a frontier lawman, Slim Pickens, who has been shot and is near death. Slim Pickens is on his way to the afterlife and maybe heaven awaits him.

Stock market investors have been enjoying a slice of heaven. Since April 8, one week after the April 1 Liberation Day tariffs were announced by the Trump Administration, the U.S. stock market has marched steadily higher, with the S&P 500 index rising 32% by the end of September. Non-U.S. stocks have enjoyed an upward surge of a similar magnitude.

Where has the relentless buying power come from? The data says the continued upward surge has been driven by investors Knockin’ on Leverage’s Door. In other words, investors have increased their buying power by adding lots of financial leverage, i.e., buying stocks on margin.

From our perspective, the spike in stock prices driven by leverage is concerning in light of equity market valuations sitting at or above prior historical peaks. An economic, financial or geopolitical shock could ignite a cascade of margin calls, generating a large drawdown in the stock market. For investors, the afterlife of a margin call spiral is often akin to knockin’ on hell’s door.

1. Global equities had a strong September, led by emerging markets.

2. Since April 8, the U.S. stock market has marched steadily higher, with the S&P 500 index rising 32% by the end of September.

Non-U.S. stocks have enjoyed an upward surge of a similar magnitude.

3. Margin loan balances rose 24.6% in just four months from April to August.

Source: FINRA

Margin loan balances are up an outstanding 67% since October 2023.

4. U.S. equity market valuations are near all-time highs.

Source: https://am.jpmorgan.com/us/en/asset-management/institutional/insights/market-insights/guide-to-the-markets/guide-to-the-markets-slides-us/equities/gtm-forwardpe/

5. The performance leaders remain an unlikely duo, namely Artificial Intelligence linked stocks and gold.

Artificial Intelligence is equated with innovation and productivity while gold is an unproductive asset unlike its sibling commodities, copper and silver.

NVDA is the ticker for shares of NVIDIA Corp, the semiconductor company whose GPU chips have come to dominate the AI landscape.

6. In mid September, the Federal Reserve announced a quarter point cut to the Federal Funds Rate to a range of 4.00% to 4.25%.

It had been nine months since the Fed reduced its policy rate. While the U.S. inflation rate hovers near 3%, a full percentage point above the Fed’s 2% target, and the U.S. unemployment rate remains quite low at 4.3%, the Fed is clearly concerned about the lagged negative impact of tariffs on economic activity.

The Fed’s rate decision reflects a risk management mindset in contrast to the YOLO (you only live once) investor mentality of reaching for returns via financial leverage. Alarmingly, investors speculating via increased leverage seem to believe the Fed not only has their backs, but has the tools to proactively save them from their folly.

Can AI invent something as valuable as AI?

THIS WEEK’S NOBEL PRIZE IN ECONOMICS

This week’s Nobel Prize in Economics went to three academics - Mokyr, Aghion, Howitt - for studying Innovation as the central feature of sustained economic growth.

Readers of this blog should not be surprised by this finding as we have written extensively about Innovation in the context of investing - for example: “Where Does Alpha Come From”, “Investment Process vs Innovation”, “Two Centuries of Creativity”. It’s also just a very intuitive finding.

Interestingly, one of the three Nobel Prize winners, Peter Howitt, was one of my professors during my undergraduate studies at Brown University. Our economics department was well known for studying models of long-run economic growth.

The department chair and my thesis advisor, Oded Galor, developed the first model to explain the shift from centuries of Malthusian stagnation (pre-1800) to modern, innovation-driven growth. He recently published a fascinating book “The Journey of Humanity” with many of his findings.

For curious readers, here is my 2004 honors thesis, written under the supervision of Professor Galor, exploring a related question—why life expectancy has risen so dramatically over the past two centuries. Yes, readers will recognize that’s where my passion for “Everything Long Run” was born.

[As a side note, today’s popular quest for Longevity might benefit from revisiting a hypothesis I proposed in my thesis: humanity’s life expectancy increased so dramatically in the late 19th and early 20th centuries not only because of scientific breakthroughs, but also because longer lifespans offered evolutionary advantages. If we are to extend human life even further, there may need to emerge new evolutionary pressures or contexts that favor or enable longer-living humans—perhaps even allowing us to “download” the knowledge required for scientific innovations that would enable survival over extended lifetimes.

For example, if our planet becomes inhabitable, multi-century space flights to seed life on distant planets could make long-lived humans evolutionarily advantageous—or some other context might provide a similar benefit to living, say, 300 years.]

During that senior-year thesis experience, I felt for the first time the electrifying freedom of being allowed to invent something entirely new within an established field like economics. Up until that point, economics had been a strictly textbook-driven discipline—an experience I later brought to Wall Street, developing a “not by the textbook” quant model that outperformed the market for many years.

In fact, our elective seminar with Professor Galor had no textbook at all. On the chalkboard, he would draw a single chart: first a long horizontal line, then a sharp kink upward around 1800 into a diagonal line. He’d label it as log-scale GDP per capita, then look pensively at our small class of ten and ask one question:

“What unified model can explain this entire history of human growth, not just the subperiods?”

That kind of powerful, clear question is the root of innovation. After months in the library, a researcher trying to answer it would inevitably experience those “aha moments” that feel like a light bulb turning on inside. These moments feel biologically real—both exciting and relaxing at once. (Anecdotally, My Oura ring even shows green relaxation dots during these times, as if the pressure to discover something new is released, even as heart rate rises from excitement.)

This is the process where, out of a gazillion possibilities and permutations, your mind attracts one intuitive idea—and your body instantly recognizes its value. Innovation isn’t just about novelty; it’s about value. People who work creatively, from scientists to artists, often describe this feeling.

If innovation requires the body to feel the creative moment, can AI—without a body—ever truly innovate?

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Can AI truly innovate?

Now, back to the question in the title of this blog. Today’s AI is an extremely powerful machine trained on historical probabilities. It excels at tasks like summarizing writing—rearranging words and concepts in the most likely patterns.

But can AI truly innovate on its own, without human involvement?
Isn’t something truly new defined by having a historical probability of zero?

Humor is a great example. Can AI create a genuinely fresh and funny joke? A good joke, by definition, isn’t stale—it’s surprising, relevant, and releases tension in ways only humans can fully experience. So far findings (and experience) suggest that AI struggles with humor.

Can AI come up with The One research question, and discover The Insight that is both new and valuable?

Advocates of AI will say yes. And maybe, someday, it will be possible when AI is trained not just on data but on human intuition and the biochemistry of the “aha moment.” There are times when it feels like AI is already there, so precisely capturing the nuances of my intent. But soon those moments fade like mirages—projections of true intelligence.

For me, anything genuinely new, artistic, creative, and “aha-worthy” still happens inside the human body and not inside the machine. Then we bring those ideas into AI for refinement, expansion, and execution.

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The shadow of innovation

One important “shadow” aspect of innovation that Professor Howitt studies is creative destruction—the process by which the new replaces the old, often causing the latter to vanish. This evolutionary mechanism has propelled growth and human progress.

Yet many thought leaders today worry that AI could eventually extend this process to humanity itself.

It seems to me that if AI ever truly takes over the innovation mantle from humans—and without any human input begins producing breakthroughs as valuable as AI itself, the Internet, antibiotics, the steam engine, the Beatles, or the Mona Lisa—then we might indeed become the displaced, evolutionarily extinct branch of biology.

Until that day, let’s continue creating and innovating—but also building into every innovation design the support mechanisms for those negatively affected by such innovation: the displaced, the disrupted, the destroyed.

Because someday, that could be us.

And if AI has been trained on designs that include compassion and support for those replaced, maybe it will learn to keep the humans around.

Would love to hear from readers - comment to this blog’s related post on LinkedIn or X.
Have you experienced real innovation or true creativity from AI?

Sep 2025: Market Update: Some Like it Hot

Some Like It Hot. I am not referring to the acclaimed 1959 comedy crime film starring Marilyn Monroe, Jack Lemmon and Tony Curtis. I am referring to the Trump Administration policy for the U.S. economy.

Inflation is hovering between a 2.5% and 3.5% rate based on the dashboard of inflation measures from the Federal Reserve Bank of Atlanta. The current U.S. unemployment rate of 4.3% is still near the low of this economic cycle. The Atlanta Fed GDPNow metric is currently sitting at a 3.1% a rate. All else equal, this trifecta of data points would not call for easy fiscal policy and easy monetary policy. And yet here we are.

U.S. fiscal policy is expansionary, with the fiscal deficit running above 6% of GDP, a level normally associated with recessions. As for monetary policy, the Trump Administration is pressuring the FOMC to run a looser monetary policy, despite the aforementioned inflation, labor market and economic growth data, no crisis in credit markets and the banking sector and no large price declines in most real estate markets.

While I have no policy insight and no crystal ball, it is possible the combination of easy fiscal policy and the pressure for easier monetary policy is an implicit acknowledgement by the Trump Administration that negative second round impacts of their tariff policies are on the horizon. The immediate impact of the increase in tariffs in the U.S. was an increase in price for traded goods and some modest demand destruction. The upcoming second round impact may be more onerous, in the form of beggar-thy-neighbor policies that are likely to result in a decline in global economic activity and less liquidity within financial markets. Since the U.S. dollar is the world’s reserve currency, the antidote may have to be easier U.S. monetary policy. Time will tell.

1. Despite the imposition of tariffs in April, measures of inflation are generally below the level of last year, though the rate of change year-over-year of the Consumer Price Index has been ticking up since May.

Source: Federal Reserve Bank of Atlanta

Source: Federal Reserve Bank of Atlanta

2. The unemployment rate remains near this cycle’s low.

3. Projections of third quarter economic growth have been moving higher, not lower.

4. The concern lies with the current composition of GDP growth. It is low quality.

Both consumption growth and investment growth remain weak compared to recent history. GDP growth is being driven by the high level of fiscal spending and the decline in imports, neither of which are sustainable and don’t create a virtuous cycle of higher incomes and higher productivity.

Source: Washington Monthly, based on initial estimate of 2q2025 GDP

https://washingtonmonthly.com/2025/08/04/the-u-s-economy-is-stumbling/

5. Global equity market investors remain unconcerned about tariff impacts and other global economic challenges.

Equity markets had another strong month in August. Year to date, non-U.S. equity markets continue to outperform the U.S. equity market, a reversal of the trend over the last fifteen years.

August 2025 Market Update: No Easing Up

At its July meeting, the Federal Open Market Committee (FOMC) once again decided not to change the Federal Funds Rate target. Despite no easing of monetary policy in the U.S., there has been no easing up of the global equity market rally.

1. Global equity markets have been on a tear since their April 8, 2025 trough, which was driven by the Trump Administration’s tariff proposal on the so-called “Liberation Day”.

In the U.S., high beta stocks have led the rebound, followed by pure growth stocks. Low volatility stocks have been the laggards. It has been a “risk-on” rally, not a gradual, climb the wall of worry rally.

2. Year-to-date, non-U.S. equity markets continue to significantly outperform U.S. equites, in a reversal of the prior multi-year trend.

More than half of the non-U.S. equity market outperformance can be directly attributed to the currency impact of a weaker U.S. Dollar.

3. Credit spreads in the high yield bond market also reflect the “risk-on” sentiment as they are hovering below 3%, not far from their lowest level in the last decade.

4. The rate of inflation, excluding food and energy, appears to be settling below 3%, but still above its pre-pandemic trend.

5. Second quarter earnings for S&P 500 companies have been buoyed by extremely strong earnings reports from largest companies within the communication services and information technology sectors.

90% of S&P 500 companies have reported earnings as of August 8.

July 2025 Market Update: To Ease or Not to Ease

The Federal Reserve faces a dilemma, to ease or not to ease.

The U.S. economy is running hot as evidenced by the rate of real economic growth, the inflation rate, and the historically high level of fiscal spending. The U.S. equity market and the U.S. high yield bond market continue to generate exceptional returns. Easier monetary policy could provide fuel for higher inflation, U.S. dollar depreciation and increased asset market speculation, and lead to a damaging unwind of excesses in the future.

On the other hand, U.S. bankruptcy filings have been rising at a rapid rate and credit card delinquency rates are at their highest level since 2012. The negative impact of tariffs on economic activity also looms on the horizon. Easier monetary policy may be appropriate if looming economic weakness in the private sector is being masked by the high level of government spending.

1. Global equity markets have been on a tear since their April 8, 2025 trough, which was driven by the Trump Administration’s tariff proposal on the so-called “Liberation Day”.

Year-to-date, non-U.S. equity markets continue to significantly outperform U.S. equites, in a reversal of the prior multi-year trend.

2. In the U.S., momentum and quality free-cash-flow generation factors continue to drive exceptionally strong equity market returns.

Momentum and quality free-cash-flow generation have consistently been the top performing factors for the last fifteen years. The trailing twelve months were the same as it ever was.

Source: S&P Dow Jones Indices, as of June 30, 2025

3. Credit spreads in the high yield bond market are hovering at their lowest level post the 2008 Global Financial Crisis.

4. The rate of inflation, excluding food and energy, appears to be settling below 3%, but still above its pre-pandemic trend.

5. Real economic growth remains solid. In first quarter of 2025, real economic growth decreased at a 0.5% annualized rate, dragged down by increased imports and reduced government spending.

6. Fiscal spending is likely to reaccelerate with the signing of the reconciliation bill by President Trump. As a result, the federal deficit will continue to trend at its highest level since the World War II period.

7. U.S. business and non-business bankruptcies increased 13% year-over-year in March and continue to trend upwards from the 2022 lows.

Source: www.uscourts.gov

8. Credit card delinquencies are increasing at the highest rate since 2012.

9. The optimal outcome, though not the most likely, is a productivity boom, raising the growth rate of real GDP, lowering inflation, and putting downward pressure on long-term interest rates. Such an outcome will make the Fed’s current dilemma go away.

June 2025 Market Update: Policy Dilemma

1. Global equity markets continued to rebound in May as it became apparent the proposed “Liberation Day” tariffs would be reduced and implementation delayed.

Year-to-date, non-U.S. equity markets continue to significantly outperform U.S. equites, in a reversal of the prior multi-year trend.

2. The rate of inflation, excluding food and energy, appears to be settling below 3% after having plateaued near 3.25% for several months.

The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) continues to decline.

3. The Federal Reserve is facing a policy dilemma, and not just due to the uncertainty about tariffs. The Fed may be trapped when an economic downturn occurs.

Since year-end 2023, long term interest rates have risen, despite

• inflation declining by 1.1%, as measured by the year-over-year change in CPI excluding food and energy. and

• the Federal Reserve cutting the Federal Fund Rate target by 1.0%.

The ten-year U.S. Treasury note yield has risen 52 bps and the thirty-year U.S. Treasury bond yield has risen 89 bps.

The real growth rate of GDP (economic activity) has not risen, but has plateaued around 2.5%.

The federal deficit is running at its highest level since the World War II period. Given the federal debt to GDP ratio, the current federal deficit level is unsustainable, unless it is going to help generate a productivity boom.

Federal Debt to GDP has risen above 100%.

The optimal outcome is a productivity boom, raising the growth rate of real GDP, lowering inflation, and putting downward pressure on long-term interest rates.

However, if an economic downturn occurs before a productivity boom, then the ratio of federal deficit will increase from its historically high post-WWII level and federal debt to GDP will rise even further.

The Fed would have to consider whether its typical policy response of lowering the Federal Funds Rate would lead to a dangerous combination of higher long-term inflation expectations, higher long-term interest rates, higher U.S. government funding costs, and U.S. dollar depreciation.

May 2025 Market Update: Tariff Turmoil

1. Global equity markets declined sharply in early April in response to the surprisingly high tariffs announced by U.S. President Donald Trump. Equity markets rebounded, led by non-U.S. developed markets, when it became apparent the proposed tariffs would be reduced and implementation delayed.

Year-to-date, non-U.S. equity markets continue to significantly outperform U.S. equites, in a reversal of the prior multi-year trend.

2. All that glitters is not gold, but gold has performed exceptionally well year-to-date as the U.S. Dollar has depreciated versus other currencies.

3. The rate of inflation, excluding food and energy, dipped below 3% after having plateaued around 3.25% for several months.

The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) continues to decline.

4. Corporate earnings reports looked solid but companies have yet to face the impact of tariffs.

For the first quarter of 2025, S&P 500 companies have reported year-over-year earnings growth of 12.9%, driven by strong margin expansion and revenues increasing 4.9% (with 96% of companies having reported).

The challenge for companies will be maintaining earnings growth, when profit margins are near all-time highs as a percentage of GDP and revenues and profit margins face the headwinds of tariffs and potentially reduced government spending.

April 2025 Market Update: Volatility and De-Leveraging

1. The U.S. equity market sold off in March. The catalyst was the surprise announcement by the Trump Administration of 25% tariffs on Mexico and Canada. Tariffs have negative implications for global economic growth, goods prices, and corporate profit margins.

2. The global equity markets cracked in early April when the Trump Administration surprised again by announcing tariffs on almost every nation, with some nations facing very high tariffs.

3. The reduction in leverage was a contributing factor to the sell-off.

Hedge funds increased financial leverage by approximately 100% over a two-year period. Margin loans in brokerage accounts rose 47% over a fifteen-month period. Rapid rises in financial leverage are often followed by a rapid deleveraging if an event triggers risky asset price declines, a sharp rise in volatility spikes, and an increase in asset correlations.

4. High valuation multiples made the U.S. equity market especially vulnerable.

The U.S. equity market started the year with high absolute valuation multiples, near the historic highs of the Internet Bubble of 2000. On a relative basis, U.S. equities also exhibited the largest historical valuation gap to emerging markets equities and non-developed markets equities.

March 2025 Market Update: Gold Shines through the Fog

1. U.S. equity markets stumbled in February. Non-U.S. developed equity markets continued to outperform, generating a year-to-date return near 8%.

2. All that glitters is not gold, but gold’s performance has shined the brightest.

3. The inflation rate appears to have plateaued around 1% above its pre-pandemic levels.

The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) has dipped but is still running at a 3.5% annual rate. We anticipate a further moderation in owners’ equivalent rent.

4. While the moderation in owners’ equivalent rent will put downward pressure on the inflation rate, tariffs are likely to exert upward pressure on the inflation rate. The combination of a slowdown in government spending due to DOGE initiatives and the impact of tariffs, including disrupting business planning, will put downward pressure on economic growth. Continued market volatility and profit margin pressures are likely the only certainties.

As of March 20, 2025, S&P 500 companies have reported year-over-year earnings growth of 18.3%, driven by strong margin expansion and revenues increasing 5.4%. According to FactSet, analysts are forecasting 11% earnings growth for calendar year 2025.

The challenge for companies will be maintaining earnings growth, when profit margins are near all-time highs as a percentage of GDP and revenues and profit margins face the headwinds of tariffs, inflation, and reduced government spending.

February 2025 Market Update: Golden Start to the Year

1. Global equity markets began the year on strong footing.

2. Gold remains a stalwart performer. Since the U.S. stock market trough at the end of October 2023, gold is the only major asset class that has kept pace with the S&P 500 Index.

3. Inflation is a risk to U.S. equity market valuation multiples. The rate of inflation has plateaued above 3%. Any uptick in inflation will likely be a headwind for U.S. profit margins.

The “core” inflation rate (CPI excluding food and energy) remains over 1% above pre-pandemic levels. Second waves of inflationary pressure are also not uncommon throughout history. The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) has dipped but is still running above a 3.5% annual rate. We anticipate a further moderation in owners’ equivalent rent. To the extend a moderation in rents does not occur, the Federal Reserve will likely delay accommodative monetary policy.

4. Thus far in fourth quarter 2024 earnings season, S&P 500 companies have reported strong earnings growth, on the back of profit margin expansion. With 77% of S&P 500 companies have reported, earnings have increases 16.9% and revenues have increased 5.9% year-over-year, according to FactSet.

Source: FactSet

Source: FactSet

January 2025 Market Update: No Year-End Rally

1. “Heavy is the head that wears the crown.”

In November, U.S. small cap equities looked to be the biggest winner of the U.S. election. By the end of December, U.S. large cap equities were back wearing the crown they have worn for over a decade.

2. While there was no Santa Claus rally into year end, U.S. equity investors had much to be thankful for in 2024 given double digit returns, led by U.S. large cap equities, which generated a return of almost 25%.

Stocks with strong price momentum, mostly growth stocks, led the way with a return of 46%. Consistent dividend payers were the laggard with a return of 7%.

Source: S&P Dow Jones Indices

3. The valuation gap between U.S. large cap equities and non-U.S. equities is the widest ever.

A sizeable valuation gap is justified as long as U.S. equities can generate much higher earnings growth with less earnings volatility than non-U.S. equity markets.

4. Inflation is a risk to U.S. equity market valuation multiples. The rate of inflation has plateaued above 3%. Any uptick in inflation will likely be a headwind for U.S. profit margins.

The “core” inflation rate (CPI excluding food and energy) remains over 1% above pre-pandemic levels. Second waves of inflationary pressure are also not uncommon throughout history. The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) has dipped but is still running near a 4% annual rate.

5. A downturn in the rate of economic growth in the U.S. is a risk to both corporate earnings growth and U.S. equity market multiples. Predicting economic growth, especially predicting recessions, is difficult.

One of the proverbial canaries in the coal mine for economic growth and corporate earnings growth is credit spreads. Currently, U.S. high yield corporate credit spreads remain below their long-term average and have not exhibited any signs of an upward surge typically associated with recessionary environments.

6. Another possibility that leads to a compression of the valuation multiple gap between U.S. equities and non-U.S. equities is a sustained improvement in earnings growth, i.e., an improvement in fundamentals, for non-U.S. companies.

China has been dealing with the impact of overinvestment, especially in real estate, as its population has begun to rapidly age. Many local governments are facing declining tax revenues as the real estate sector contracts. China’s banking system may also need a federal government backstop. Europe has been dealing low productivity due to high energy prices driven by poor energy policy, stifling regulation, aging populations, and immigration policies that didn’t provide low-cost labor but have consumed government resources. Both China and Europe have been slow to address the structural issues facing their economies. Neither benefit from easy access to low-cost energy and a large, innovative technology sector, two factors that buttress the U.S. economy/

However, if China and Europe can “stop the bleeding” and demonstrate some semblance of sustained improvement in fundamentals, then the “value” represented by China and Europe will not be a “value trap”. Less bad fundamentals would likely translate into China and Europe equity markets outperforming the U.S. equity markets.

December 2024 Market Update: Small Stands Tall

1. Investors crowned U.S. small cap equities as the biggest winner of the U.S. election.

U.S. small cap stocks rallied almost 11% in November on the back of the results of the U.S. election. U.S. large cap stocks had a strong month too, surging almost 6%.

2. The outperformance on U.S. large cap equities over the last decade, especially over the trailing three and half years, is striking.

The U.S. economy has delivered stronger economic growth than most other countries and U.S. companies, especially  information technology companies, have delivered stronger earnings than their foreign counterparts. However, U.S. equity market valuations have risen sharply while non-U.S. developed markets and emerging markets valuation have declined, in anticipation of current economic and corporate earnings trends being permanent. Some retracing in valuations is likely in the next few years, favoring non-U.S. equities.

3. Both financial markets and the Federal Reserve have become concerned the rate of inflation has plateaued above 3% and will not revert to its pre-pandemic trend of 2% anytime soon without a recession.

The “core” inflation rate (CPI excluding food and energy) remains over 1% above pre-pandemic levels. Second waves of inflationary pressure are also not uncommon throughout history. The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) is running a hair below a 4% annual rate.

4. The dust has settled regarding U.S. government elections and while there is still some fog clouding the picture of investment implications, there are a few clear takeaways.

First, tariffs and the threat of tariffs will be used by the incoming Trump Administration as a negotiating tool, especially when dealing with China and its mercantilist tendencies. Donald Trump has been singing the same tariff tune for four decades, starting in the 1980s with his concerns about the Japan export engine that at the time was dominating world trade in goods.

Second, the Trump Administration will lighten the regulatory burden facing U.S. businesses, especially small business.

Third, energy policy will shift to an increased focus on natural gas and nuclear energy for power generation relative to wind and solar.

November 2024 Market Update: U.S. Large Cap Equities Remain Preeminent

1. The U.S. equity market continues to outperform.

In October, the U.S. equity market, as proxied by the S&P 500 Index, declined near 1% but still outperformed non-U.S. markets. The multi-year trend of U.S. outperformance remains intact.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), EFA (iShares MSCI EAFE ETF in purple), and EEM (iShares MSCI Emerging Markets ETF in orange).

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), EFA (iShares MSCI EAFE ETF in purple), and MCHI (iShares MSCI China ETF in red).

2. By the end of October, the ten-year U.S. Treasury yield had risen 64 bps post the Federal Reserve cutting the Federal Funds Rate target by 50 bps.

The optimistic interpretation is the Federal Reserve has not only facilitated a soft landing but has given a boost to economic growth. If the ten-year yield continues to rise it will be a concerning sign that the bond market is losing faith in the Fed’s inflation fighting credentials.

Source: treasury.gov, Two Centuries Investments

3. Inflation continues to moderate, but we need to observe an extended period of low inflation to be certain the inflation genie is back in the bottle.

The “core” inflation rate (CPI excluding food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels. Second waves of inflationary pressure are also not uncommon throughout history. The Atlanta Federal Reserve Bank’s measure of “sticky price” inflation (think rent, insurance and medical care) is still running at a 4% annual rate.

4. As we write this update, the dust has settled regarding U.S. government elections but there is still plenty of fog clouding the picture of investment implications. We will provide more insights in next month’s update.

Thus far, through November 15, financial markets have crowned U.S. equities as the winner.

October 2024 Market Update: To Ease or Not To Ease

1. China’s equity market surged in late September with the announcement of monetary and fiscal stimulus.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), EFA (iShares MSCI EAFE ETF in purple), EEM (iShares MSCI Emerging Markets ETF in orange), and MCHI (iShares MSCI China ETF in dotted red).

China’s stock market rose over 20% in September.

The People’s Bank of China (PBOC) eased monetary policy and the fiscal authorities announced new spending initiatives with the objectives of boosting the economy and supporting the stock market.

• Lowered the benchmark seven-day reverse repo rate from 1.7 % to 1.5%.

• Lowered the one-year medium-term lending facility loan rate to some financial institutions 2.3% to 2.0%.

• Aimed to reduce existing mortgage rates by 0.5%.

• Reduced the Required Reserve Ratio applicable to banks by 0.5%.

• Established a 500 billion yuan (US$70.9 billion) facility to allow security houses, fund-management firms and insurance companies to tap liquidity when purchasing stocks.

• Established a lending facility of 300 billion yuan, with an interest rate of 1.75% to incentivize banks to support listed companies’ stock buy-backs and purchases.

• Reduced down payment ratio on second-home purchases from 25% to 15%.

Over the last fifteen years, China’s economy has slowed from a 10% growth rate in 2009 to a growth rate of less than 5% currently. The slowdown raises concerns about sustaining employment and social unrest.

China did an amazing job of marshaling labor and physical capital to create the second largest economy in the world and significantly boost the living standards of its citizens. However, China has struggled to expand its services sector, boost domestic consumption and increase total factor productivity via innovation.

Public equity shareholders have suffered. Productivity gains did not accrue to shareholders. The magnitude of underperformance of China’s equity market to the U.S. equity market is astounding.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), EFA (iShares MSCI EAFE ETF in purple), and MCHI (iShares MSCI China ETF in red).

Monetary easing, amplified by fiscal stimulus, is the “easy” first step. For China to sustainably boost economic activity, boost the stock market, and support the real estate market, China will need to consider rebalancing its economy and altering many regulations and incentives.

2. On September 18th, the Federal Reserve lowered the target for the federal funds rate by 50 basis points, to a range of 4.75% to 5.00%, despite inflation rate still exceeding the Fed’s 2% target, solid employment data, and mixed signals about economic activity.

While the Federal Reserve beat the PBOC to the monetary easing punch bowl, the Fed’s less aggressive easing and bullish sentiment towards U.S. equities produced a more muted bounce for U.S. equities.

Interestingly, the ten-year Treasury yield rose 15 basis points in the days subsequent to the Fed’s announcement and finished the month only 10 basis points lower than it started the month.

The optimistic interpretation is the Fed is facilitating a soft landing and giving a boost to future economic growth. If the ten-year yield continues to rise it will be a concerning sign that the bond market is losing faith in the Fed’s inflation fighting credentials.

3. The European Central Bank will likely cut rates in October as inflation has moderated and the real economic growth rate hovers around a miniscule 0.6%.

Source: Eurostat

Eurozone inflation dipped below 2% for the first time since mid-2021.

4. The BOJ (Bank of Japan) faces a dilemma with the PBOC, the Fed and the ECB in easing mode.

Source: Japan Government Statistics

The BOJ raised its policy rate 20 basis points in March and 15 basis points in July. Its current rate of 0.25% reflects Japan’s unique situation, namely a few decades of no inflation and a post-pandemic bounce in inflationary pressure that was muted compared to the spikes in the U.S. and Europe.

The BOJ was the last major central bank to raise its policy rate to fight inflation. Its tightening of monetary policy in July with the threat of more to come was the likely catalyst for the global equity market volatility in early August.

The challenge for the BOJ is the inflation rate in Japan has halted its decline and started rising again. The most likely course for the BOJ is to sit on the sidelines for now. It is unlikely BOJ is unlikely to raise its policy rate any time soon with synchronized monetary easing occurring in the other major economic blocs.

5. In the U.S., inflationary pressures also continued to ease.

In the U.S., the headline inflation rate has plateaued over 1% above pre-pandemic levels. In the last five months it has started to creep down.

The “core” inflation rate (excludes food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels.

6. U.S. high yield credit spreads remain well below levels that signal a brewing recession.

High yield credit spreads were a hair above 3% at the end of September.

September 2024 Market Update: Rotation or Recession?

1. Global equity markets sold off in early August but recovered by month end.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), EFA (iShares MSCI EAFE ETF in purple), EEM (iShares MSCI Emerging Markets ETF in orange), and EWJ (iShares MSCI Japan ETF in dotted red).

The primary impetus for the rapid sell-off in global equities seemed to be fears of a Japan Yen carry trade unwind after comments by the Bank of Japan (BOJ) about more increases in its policy rate. The BOJ raised its policy rate to 0.25% on July 31. When the BOJ walked back its hawkish comments, equity markets began to recover. 

The incident highlights the current high sensitivity of risky asset prices to reductions in financial leverage by levered investors.

2. Below the surface, dividend payers outperformed for second month in a row. Low volatility stocks led the way in August. These occurrences point to a market rotation away from risk and toward more stable stocks, especially those that are interest rate sensitive.

Source: S&P Dow Jones Indices

Source: S&P Dow Jones Indices

Momentum and growth stocks, especially the so-called Magnificent Seven mega cap stocks, have delivered historically strong performance since mid-2023. The question is whether recent equity market activity marks a broadening of performance and a catch-up by the lagging sectors and factors or proverbial canary in the coal mine, Equity market performance in the first several days of September, after the bout of volatility in early August, hints at burgeoning equity market weakness after a surge in stock prices over the last 22 months.

Source: S&P Dow Jones Indices

3. The good news is the behavior of high yield credit spreads. After jumping 90 basis points from their July lows, high yield spreads reversed course, declining once again to well below their long-term average.

High yield credit spreads were trending downward over the last year until the bout of volatility in early August.

High yield credit spreads remain well below levels that signal a brewing recession or financial crisis.

4. Markets are now pricing in several federal funds rate cuts by the Federal Reserve. Since May month end, the two-year Treasury yield has declined by 100 basis points.

5. Inflationary pressures are starting to ease. Inflation remains a headwind for investors seeking high real returns (real return = nominal return - rate of inflation).

In the U.S., the headline inflation rate had plateaued over 1% above pre-pandemic levels. In the last three months it has started to creep down.

The “core” inflation rate (excludes food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels.

Due to sticky inflation, the FOMC has kept the effective federal funds rate at 5.33% for the past year.

We discussed the inflation challenge in more detail in April’s market update.

https://www.twocenturies.com/blog/2024/4/13/april-2024-market-update-will-the-real-fed-funds-rate-please-stand-up

6. While inflationary pressures are easing, economic growth is also slowing down. The recent earnings reports from the dollar stores point to economic challenges facing lower income consumers.

This chart shows the performance of various consumer related stocks in August 2024.

WMT (Walmart Inc. in orange), COST (Costco Wholesale Corp. in yellow), ROST (Ross Stores, Inc. in green), TJX (The TJX Companies, Inc. in red), MSCI Emerging Markets ETF in orange), DLTR (Dollar Tree, Inc. in purple) and DG (Dollar General Corporation in blue).

In August, both Dollar General and Dollar Tree reported disappointing revenue growth and forecast weak volume growth going forward. While the stock prices of other consumer related stocks (consumer staples and off price) benefited from the market rotation, the dollar store stocks were crushed by pull back in purchases by lower income consumers. If a recession is brewing, the lower income consumer will likely be a canary in the proverbial coal mine.

August 2024 Market Update: uh-Moh

1. U.S. small cap stocks rocketed higher in July. Year-to-date, U.S. large cap stocks continue to outperform.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

2. Below the surface, investors rotated away from momentum and growth stocks, which were the big winners over the last twelve months. Dividend payers and value stocks outperformed.

Source: S&P Dow Jones Indices

Source: S&P Dow Jones Indices

The question is whether the market rotation away from momentum and growth stocks, especially the so-called Magnificent Seven mega cap stocks, represents a broadening of market strength or is the proverbial canary in the coal mine. Equity market performance in the first several days of August hints at burgeoning equity market weakness after a twenty-one month surge in stock prices.

3. Gold continues to glitter, with no loss of price momentum.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in blue), GLD (SPDR Gold Trust in yellow), DXY (U.S. Dollar Index in green), and IEF (iShares 7-10 Year Treasury Bond ETF in purple).

Gold typically underperforms in periods of U.S. Dollar strength, when inflation is declining, and when long-term interest rates are rising. All three circumstances have occurred this year and yet gold has outperformed. The reason is clear. Strong demand for gold has emanated from the east, with The Central Bank of the People's Republic of China being the biggest buyer.

4. Inflationary pressures are starting to ease. Inflation remains a headwind for investors seeking high real returns (real return = nominal return - rate of inflation).

In the U.S., the headline inflation rate had plateaued over 1% above pre-pandemic levels. In the last three months it has started to creep down.

The “core” inflation rate (excludes food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels.

Due to sticky inflation, the FOMC has kept the effective federal funds rate at 5.33% for the past year.

We discussed the inflation challenge in more detail in April’s market update.

https://www.twocenturies.com/blog/2024/4/13/april-2024-market-update-will-the-real-fed-funds-rate-please-stand-up

5. Despite sticky inflation and no rate cuts by the FOMC, U.S. financial conditions remain loose and U.S. credit markets remain sanguine.

Over the last few months, the Chicago Fed’s National Financial Conditions Index has been signaling looser financial conditions, suggesting monetary policy is not restrictive despite 525 basis points of federal funds rate increases over the last two years.

6. Corporate earnings are on pace to increase almost 11% year-over-year in the second quarter, the best growth rate since 4q 2021.

July 2024 Market Update: Momo in the Driver's Seat

1. U.S. large cap stocks continue to outperform year-to-date.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

2. Stocks with strong 12-month price momentum (the momo factor) have been standpoint performers in 2024.

Source: S&P Dow Jones Indices

Source: S&P Dow Jones Indices

Year-to-date within the S&P 500 Index universe, the momentum factor (orange bars in the charts above) has returned almost 34% year-to-date and outperformed the index by almost 19%.

Over the last 12 months, the momentum factor has returned 57.9%, crushing the S&P 500 Index return of 24.6%.  S&P Dow Jones Indices noted this magnitude of outperformance last occurred in August 2000 at the end of the dot-com boom.

3. In a surprise, gold has been the other outperforming asset class.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), GLD (SPDR Gold Trust in yellow), DXY (U.S. Dollar Index in green), JNK (SPDR Bloomberg High Yield Bond ETF in orange), IEF (iShares 7-10 Year Treasury Bond ETF in blue), and TLT (iShares 20+ Year Treasury Bond ETF in red).

Gold typically underperforms in periods of U.S. Dollar strength, when inflation is declining, and when long-term interest rates are rising. All three circumstances have occurred this year and yet gold has outperformed. The reason is clear. Strong demand for gold has emanated from the east, with The Central Bank of the People's Republic of China being the biggest buyer.

4. Inflationary pressures are starting to ease. Inflation remains a headwind for investors seeking high real returns (real return = nominal return - rate of inflation).

In the U.S., the headline inflation rate had plateaued over 1% above pre-pandemic levels. In the last three months it has started to creep down.

The “core” inflation rate (excludes food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels.

Due to sticky inflation, the FOMC has kept the effective federal funds rate at 5.33% for the past year.

We discussed the inflation challenge in more detail in April’s market update.

https://www.twocenturies.com/blog/2024/4/13/april-2024-market-update-will-the-real-fed-funds-rate-please-stand-up

5. Despite sticky inflation and no rate cuts by the FOMC, U.S. financial conditions remain loose and U.S. credit markets remain sanguine.

Over the last few months, the Chicago Fed’s National Financial Conditions Index has been signaling looser financial conditions, suggesting monetary policy is not restrictive despite 525 basis points of federal funds rate increases over the last two years.

At month end June 2024. high yield bond spreads remained subdued and had settled almost 200 basis points below the long-term average and well below recent peaks.

June 2024 Market Update:April Showers Bring May Flowers

1. Global equity markets rebounded in May after a weak April.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

2. Equity investors have enjoyed strong returns year-to-date.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

3. Bond investors haven’t fared as well due to the increase in interest rates at intermediate and long maturities.

Source: www.treasury.gov, Two Centuries Investments

4. Sticky inflation, in the face of high public debt and high fiscal deficits in the developed world, remains a big headwind for investors seeking high real returns (real return = nominal return - rate of inflation).

In the U.S., the headline inflation rate has plateaued over 1% above pre-pandemic levels.

The “core” inflation rate (excludes food and energy) has continued to creep down but also remains over 1% above pre-pandemic levels.

Due to sticky inflation, the FOMC has kept the effective federal funds rate at 5.33% for the past year.

We discussed the inflation challenge in more detail in April’s market update.

https://www.twocenturies.com/blog/2024/4/13/april-2024-market-update-will-the-real-fed-funds-rate-please-stand-up

5. Despite sticky inflation and no rate cuts by the FOMC, U.S. financial conditions remain loose and U.S. credit markets remain sanguine.

Over the last few months, the Chicago Fed’s National Financial Conditions Index has been signaling looser financial conditions, suggesting monetary policy is not restrictive despite 525 basis points of federal funds rate increases over the last two years.

At month end May 2024. high yield bond spreads remained subdued and had settled almost 200 basis points below the long-term average and well below recent peaks.

May 2024 Market Update: Markets of Confusion

1. In April, the multi-month rally in global equity markets stalled.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

2. Over the last two months, gold has shined brightly relative to other asset classes.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), IWM (iShares Russell 2000 ETF in grey), GLD (SPDR Gold Trust in yellow), TLT (iShares 20+ Year Treasury Bond ETF in red) and DXY (U.S. Dollar Index in green).

The strong performance of gold over the last two months is surprisingly given both the increase in U.S. Treasury yields of between 40 and 45 basis points at the 5-year, 10-year, and 30-year maturities, and the increase in the U.S. dollar versus other currencies. Gold almost always underperforms when U.S. Treasury yields increase and the U.S. dollar appreciates.

The PBoC, China’s central bank, and Chinese citizens have been big buyers of gold. The buying points to a possible devaluation of the Chinese yuan and also highlights the PBoC’s aversion to increasing its holdings of U.S. Treasury securities.

3. The Japanese Yen has certainly lost it lustre and its decline versus the U.S. Dollar has recently accelerated.

The acceleration in yen weakness poses a dilemma for the Japanese government.

Inflation, while low compares to other developed market countries, remains high by Japanese standards. Currency weakness reinforces domestic inflationary pressures.

On the other hand, raising interest rates to combat currency weakness means a higher interest expense for government debt. Among developed market countries, Japan already has the highest public debt as a percentage of GDP. In addition, the BOJ, Japan’s central bank, owns more than 40% of the debt. Finally, asset markets have used the low interest rates in Japan as a cheap funding source for carry trades. Any rapid rise in short term interest rates could reverberate across global asset markets.

A potential short term solution, namely the BOJ selling central bank reserves of U.S. Treasury securities to support the yen, would like force the U.S. Federal Reserve to adjust it quantitative tightening strategy.

4. Sticky inflation, in the face of high public debt and high fiscal deficits in the developed world, remains a big headwind for investors seeking high real returns (real return = nominal return - rate of inflation).

In the U.S., the headline inflation rate has plateaued over 1% above pre-pandemic levels.

The “core” inflation rate (excludes food and energy) remains 2% above pre-pandemic levels.

The improvement (downtrend) in the rate of inflation has stalled over the last several months. As a result, the FOMC has sat on the sidelines and the effective federal funds rate has sat at 5.33% for the past year.

We discussed the inflation challenge in more detail in last month’s update

https://www.twocenturies.com/blog/2024/4/13/april-2024-market-update-will-the-real-fed-funds-rate-please-stand-up

5. Despite sticky inflation, currency market turmoil, and a gold market warning sign, U.S. financial conditions remain loose and U.S. credit markets remain sanguine.

Over the last few months, the Chicago Fed’s National Financial Conditions Index has been signaling looser financial conditions, suggesting monetary policy is not restrictive despite 525 basis points of federal funds rate increases over the last two years.

At month end April 2024. high yield bond spreads remained subdued and had settled over 1.5% below long-term averages and well below recent peaks.

6. Overall, second quarter corporate earnings reports have been solid, albeit not signaling future earnings growth consistent with the elevated valuations for U.S. equities.

With 80% of S&P 500 companies having reported earnings, year-over-year revenue growth has averaged 4.1% and earnings growth has averaged 5.0%.

April 2024 Market Update: Will the Real Fed Funds Rate Please Stand Up

1. In March, global equity markets rose sharply for the second consecutive month.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), and IWM (iShares Russell 2000 ETF in grey).

Since the end of October 2023, U.S. stocks have sizzled. Emerging markets have been dragged down by China.

This chart shows the performance of SPY (SPDR S&P 500 Index ETF in purple), EFA (iShares MSCI EAFE ETF in blue), EEM (iShares MSCI Emerging Markets ETF in orange), IWM (iShares Russell 2000 ETF in grey), and MCHI (iShares MSCI China ETF in red).

2. Will the real federal funds rate please stand up? Inflation remains the most important story for markets. Increased uncertainty over the FOMC’s reaction function adds a new element.

(reader note: real federal funds rate = effective federal funds rate – inflation rate

The headline inflation rate has dropped to about 1% above pre-pandemic levels.

The “core” inflation rate (excludes food and energy) remains 2% above pre-pandemic levels.

The improvement (downtrend) in the rate of inflation has stalled over the last several months. As a result, the FOMC has sat on the sidelines and the effective federal funds rate has sat at 5.33% for the last eight months.

What gives?

From a supply perspective, labor force and energy supply have been the big constraints.

• Ongoing skills mismatches have led to high wage growth in certain industries, e.g., pilots and machine workers.

• Higher energy and electricity costs are a result of years of underinvestment in oil exploration and production and nuclear energy generation.

On the margin, other constraints have limited supply, in particular:

• Underinvestment in infrastructure.

• Increasing regulation in various industries.

• Incoherent immigration policy.

• Geopolitical frictions.

From a demand perspective, there have been two “surprises”.

• The “long and variable lag” of monetary policy tightening in reducing economic demand has been quite long versus historical precedent and not as impactful as projected.

  • Many large corporations extended debt maturities when interest rates were low pre-2022.

  • Since the U.S. housing market is largely financed with 15-year and 30-year fixed rate mortgages, most existing homeowners have not faced re-financing risk.

  • Many household and business had significant cash holdings or built-up cash holdings during the pandemic and have benefitted from higher interest income.

• The U.S. federal government has engaged in an unprecedented spending spree over the last several years, which has boosted demand but has not boosted supply.

The deflationary forces of globalization, competition and technology innovation have yet to win out. Maybe they will.

In the meantime, what is the Federal Reserve (FOMC) to do?

The FOMC has three official mandates, namely maintain full employment, keep prices stable, and serve as lender of last resort in a crisis. The FOMC has also operated as if it has a fourth mandate, namely support risky asset prices. Over the last four decades, the Fed has not had to worry about price stability. Globalization was a strong deflationary force.

Now it faces the challenge of balancing its mandates.

• Maintaining full employment is particularly important in an election year.

• After a strong rally, U.S. large cap equity valuation multiples appear to be factoring in federal funds rate cuts.

• Many banks are facing the prospect of credit losses on commercial real estate loans (mostly offices in urban centers) and credit losses on leveraged loans as the rise in short term interest rates starts to bite. On the other hand, financial conditions remain loose, according to the Chicago Fed’s National Financial Conditions Index.

• Inflation, especially services inflation, has proven sticky. Wage growth in the services sectors is still hovering around a 5% annual growth rate. The Atlanta Fed's sticky-price consumer price index (CPI), a weighted basket of items that change price relatively slowly was up 4.4% on a year-over-year basis in February.

Investors keep changing their expectation for rate cuts. In October, investors were pricing in three rate cuts (using the upper end of current federal funds rate range of 5.25% to 5.50%). By January, they were pricing in seven rate cuts. By the end of March, they are back to pricing in three rate cuts.

The options market has detected the lack of a clear signal about near term FOMC policy actions.

In the Federal Reserve’s December 2023 note “Elevated Option-Implied Interest Rate Volatility and Downside Risks to Economic Activity”, author Cisil Sarisoy commented on the rise in uncertainty about short term interest rates.

“Measures of uncertainty about U.S. short maturity interest rates derived from options have risen sharply since October 2021, reaching their highest levels in more than a decade. This note first uses survey-based measures of economic uncertainty to argue that this increase in option-implied measures likely reflect higher uncertainty about inflation, the associated monetary policy response, and the perceived resulting downside risks to economic activity. It further shows that increases in implied volatility over the past twenty years have generally been associated with lower future economic activity and larger downside risks.”

3. Credit markets will likely be the canary in the coal mine, as the typically are, if a sustained economic contraction, is forthcoming and large federal funds rate cuts are on the horizon.

At month end March 2024. high yield bond spreads remained subdued and had settled around 1.5% below long-term averages and well below recent peaks.

U.S. leveraged loan default rates also remained subdued, per data from PitchBook | LCD.