Michael Zeuner (01:20.171)
Hi everyone, this is Michael Zeuner, one of the managing partners at WE Family Offices. Thanks for listening to the Wealth Enterprise briefing. I’m joined again today by Sam Sudame, our global head of macro, and we’re going to take a step back and look at the world through the lens of our global investment committee, which just finished our cycle of meetings for the third quarter, and talk with Sam a little bit about the committee’s outlook.where we see things going forward and what the implications might be for portfolios. So welcome back, Sam. Thanks for joining us.
sam (01:54.446)
Thank you, Michael. So maybe I will just start by doing a quick recap of the third quarter, which just recently completed. So the best word to summarize the economy is resilient. And we saw a reflationary environment assert itself in the third quarter. You know, economic momentum globally picked up based on powerful CapEx spending. And that really caused government bond yields around the world to rise.
You know, reaching multi-decade highs on the back of strong demand for capital. And as a result of that, bonds really struggled. the Barclays aggregate bond index was down 350 basis points. It was one of the most difficult quarters we’ve had in about four years. We saw the 10-year US Treasury rates rise over 115 basis points as the Fed raised rates in September. But then, you know.
Despite the strong earnings growth, many equity markets were mixed in the third quarter and pulled back, particularly in September, as yields really started to rise. So overall, the SP 500 and NASDAQ had decent quarters of about 2% each, leading to double-digit year-to-date returns. But the higher yields caused a narrowing of breadth and weighed on the SP equal weight.
Mid caps and small caps, which all had negative quarters. And then developed international equities were up nearly 1% of the third quarter. It was really led by Japan. Japan was up 2% in the quarter and up about 30% for the year. And then emerging markets, on the whole were down about 1%, largely because South Korea was down about 20%.
After the government regulators tamped down on leverage vehicles, but South Korea is still up 87% for the year. But in the quarter, we also saw Hong Kong do really well. So that was up 7%, Taiwan was up 4%. But overall, we saw strong earnings growth. US earnings growth at the beginning of the quarter came in around 50%, which was just absolutely stellar. And then commodities.
sam (04:16.269)
Commodities were very strong in the quarter, up 16%. You know, commodities do tend to perform well in a reflationary growth environment. But one of the major causes that oil was up significantly, rising twenty dollars a barrel to ninety dollars on the back of continued global geopolitical risk. So, you know, although geopolitical risk started in the first quarter, it continued to go through the quarter.
It started the quarter off fairly well, but then kept rising through the quarter and really started to play out a lot more in September. So overall, you know, the third quarter was a slog. So I am looking forward to the fourth quarter.
Michael Zeuner (04:56.632)
So when you say you’re looking forward to the fourth quarter, Sam, let’s talk about maybe what’s underneath that because there’s a lot of discussion, and we certainly had it in our macro committee about the risks that are out there stemming from increased inflation, rising interest rates, geopolitical risk, oil. you know, and yet you and I have talked about this on several podcasts over the last month or two.
as we say it, the underlying economic conditions and the fundamentals still look very healthy. So talk to us a little bit more about why you are looking forward to the fourth quarter, even in the context of the elevated risk environment.
sam (05:33.996)
Sure. So, you know, economic growth, I think, should continue to be supported by a powerful investment capex cycle. So the reflationary environment should continue, which is supportive of risk assets. But when we look at equities, you know, US equities, we continue to think you know, equ US equity should be in a slightly overweight position based on the building blocks of return. So earnings growth continues to be really strong.
So we expect US earnings growth to in the third quarter to come in around 25%, which is outstanding. Valuations have become much more attractive. Forward PE multiples have come down four turns this year, down from 23 times at the beginning of the quarter, down to 19 times. Liquidity is neutral but supportive.
It’s interesting that sentiment is negative, but for future returns, that’s actually a good thing. But the key reason why, I mean, these are the same things we said in the third quarter, but the third quarter didn’t pan out as well. And that’s because going forward in the fourth quarter, I think interest rates will start to settle down. So what happens with interest rates when they start to spike, that is when stocks start to pull back.
It becomes a tug of war between multiple decompression and earnings growth. In the third quarter, it was actually multiple decompression that largely won out because yields spiked. And this happened after Chairman Warsh’s very hawkish speech in August at Jackson Hole. From there, they took a a hawkish posture at the September FOMC meeting. But we now realize that they do mean business.
On fighting inflation. And rates have already moved up in response to it. So as a result, if rates start to settle down, you know, the tug of war starts to get pulled in the direction of earnings growth, which is why I think we’ll have a better quarter for US equities. Once those rates settle down, I think equal weight mid-caps and small caps should start to do better.
sam (07:54.474)
As that equity rally resumes its broadening out. But overall, we still recommend being balanced in growth versus style, cap sizes, and cyclical versus defensives for US equities.
Michael Zeuner (08:10.071)
Okay, so so many of the same themes playing out, but your view is that interest rates should start to settle down, albeit at an elevated rate, but the spike should settle down, and therefore the earnings engine should come back into play and hopefully drive capital markets higher as a result.
sam (08:36.353)
And you know, one of the main reasons is when we look at what should interest rates be, given the fundamentals of economic growth and inflation, we’re pretty close to being around that fair value for the 10-year. It has moved quite a bit. In fact, it’s moved quite a bit in the last two weeks. So when we look at it around that 530 rate that we’re seeing today, that’s pretty
Pretty close to being fair value, which is why I think the rates market would settle down.
Michael Zeuner (09:07.416)
Okay. And you know, as we talked about last last podcast, right, short term rates is one thing, right, which the Fed is setting in an effort to really manage inflation and employment. medium term rates are really the tenure is really about economic growth and and forward looking.
And then the long end of the curve is about all of those things plus the the term premium and people’s view of the long-term health of the economy. But you’re really when you look at the the sort of projection of rates, you’re looking at the 10 year and thinking, okay, we’re we’re at equilibrium on the 10 year.
sam (09:45.56)
Yes, because the tenure also underpins a lot of the equity market as well. So when we also when we look at core bonds, the Barclays Aggregate Bond Index, you know, that duration is around six to seven. So the tenure is a pretty good estimate that we can use for that market as well. So it’s a pretty handy tool, is to look at the 10-year rate. But when that starts to settle down, I think you know there won’t be as much pressure in the bond market.
But we continue to recommend that short to intermediate duration, you know, in that belly of the curve, as we’ve talked about on several of the of our podcasts.
Michael Zeuner (10:23.819)
Okay. And Sam, before we close, just take that analysis and your outlook to real assets and and inflation sensitive assets. Do you still see the same trend continuing that we’ve seen all year?
sam (10:38.039)
Definitely. So, you know, we continue to be or recommend an overweight in infrastructure and commodities. You know, infrastructure still has a massive of tailwinds behind it, terms of power generation and building out of data centers. And there’s also that strong appetite for industrial commodities. I think one thing that changes a little bit for the fourth quarter is agricultural commodities should benefit
More as we go through the quarter, as El Nino becomes more prominent. But we continue to be neutral on real estate. You know, valuations appear to have largely bottomed and prices are starting to recover. But higher rates still do remain a headwind and pressure cap rates. But overall, still like real assets quite a bit.
Michael Zeuner (11:30.879)
Okay. Well, Sam, I think you’ve been very clear in terms of your outlook. Let’s see how things play out as we get into the fourth quarter. We’ll revisit accordingly. Thanks, Sam.
sam (11:41.645)
Thank you, Michael.
