October 9, 2024
3Q24 Highlights
Risk assets roared back to life in 3Q24, driven by stunning declines in interest rates across the yield curve. The 2Y Treasury yield declined 113 bps to 3.62% while the 10Y Treasury yield declined 65 bps to 3.74%. The subsequent curve steepening (10Y-2Y) resulted in the first positive yield differential since June `22 (as shown in the chart below).
The primary catalyst for interest rates declining was the FED beginning its long-awaited easing cycle on September 18, 2024. This first cut since 2020 of 50 bps was also at the higher end of market expectations. Positive sentiment coming into the FED announcement got further extended with economic data in following weeks showing the economy softening but still holding in and inflation declining.
The implications of a positive rate (10Y-2Y) differential are significant. Primarily, it allows for normal pricing of credit and removes the distortions that an inverted yield curve brings. Secondarily, risk taking gets more rational with rates aligned to the appropriate time horizons. Businesses and consumers should now have more reliable and durable rate structures to make investment/purchase decisions that will be less prone to defaults, changes, or cancellations.
Market Snapshot
Apart from the interest rate action mentioned above, other notable moves included Volatility Index (VIX) for stocks rising sharply due to the apparent reversal of carry trade positions in early August. More specifically, Japanese equities sold off while Yen (JPY) appreciated as strengthening expectations of lower US rates caused panicked deleveraging.
Natgas and crude oil divergence was another notable action as was the divergence in Bitcoin and Gold. While continued instability in middle east and lower rates expectations boosted Gold, Natgas maintained its uptrend on solid fundamental backdrop. Curiously, the middle east situation could not support crude oil as concerns of softening demand globally and increased OPEC supply prospects offset the instability catalyst.
Performance Review
All OppoQuest strategies materially outperformed their respective benchmarks this quarter with MODERATE and CONSERVATIVE strategies outperforming for four consecutive quarters now and the GROWTH strategy outperforming in three of the last four.
Significant positive contributors to the strategies’ performance were:
· Artificial Intelligence (AI) levered Palantir (PLTR) whose AI platform (AIP) seems to be received very well by enterprise customers
· Energy infrastructure play GE Vernova (GEV) on reporting strong numbers and getting recognized as a turnaround story with multiple upside drivers
· Payment processing firm PayPal (PYPL) which finally seems to have gotten its act together and executed on cost discipline and growth initiatives
· Chinese internet names as represented by Krane Shares China Internet ETF (KWEB) which got bid on hopes of monetary and fiscal stimulus from China
Outlook
Our positive outlook on risk assets had already tempered a bit by quarter-end given the strong gains that accrued year-to-date and the rapid moves in the interest rate markets. However, the escalation of hostilities in the middle east post-quarter has increased our caution substantially.
For the past 18-24 months, the most important catalyst for risk assets like stocks has been the expectation of lower inflation and consequently, lower interest rates. Both those catalysts have not only occurred but, arguably, have played out to a large extent. Inflation as measured by CPI has gone from 9.1% in June of 2022 to an estimated 2.5% for October 2024. For reference, the FED’s target is around 2%.
The 10Y interest rate meanwhile, has declined from a high of 5% in October 2023 to 4% currently after having touched 3.5% in September 2024. If inflation does get to the expected 2% level by next year, the 10Y rate should also get into the low 3s. While that best case scenario for risk assets does provide for some more upside, we hesitate to baseline best case scenarios given our risk-conscious approach.
The biggest risk, as mentioned earlier, is the escalating war in the middle east. Iran’s 180 missiles attack on Israel on October 1 is almost certainly going to elicit a strong response from Israel. How, when, and where Israel decides to retaliate will have huge geopolitical implications. Although oil prices have moved from high-60s to mid-70s post-quarter, we think probabilities are rising for a major oil price dislocation. Such a development would stoke inflation and likely cause significant risk aversion. Our inclination, therefore, is to focus on selling stocks into the current strength of equity market and add to the ~ 20% cash/fixed income allocation we have already built across our strategies.
For OppoQuest
PARESH JAIN
Managing Member & Portfolio Manager
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