4th Quarter 2024 CIO Commentary

The Hard Part

This quarter, we aim to address a topic that will likely elicit a range of opinions: the fiscal trajectory of the United States, the impact of the newly formed Department of Government Efficiency (DOGE) on that trajectory, and their implications for the markets. Driven by our concern over the nation’s unsustainable fiscal path, we are committed to offering a hopeful and constructive perspective, with the goal of providing a balanced and thoughtful analysis.

This is an excerpt from a longer commentary. Please Download the PDF to read the entire 4th Quarter 2024 CIO Commentary.

3rd Quarter 2024 CIO Commentary

Not So Fast, My Friend

Lee Corso was born in 1935 in Cicero, Illinois, the son of immigrant parents. After a long career playing and then coaching college football, he was hired by ESPN in 1987 as an analyst for its Saturday “College Game Day” program where he has been a fixture ever since. Lee Corso may have seen more college football than any person alive. At the end of the show each week, analysts predict which team will win different games. When it’s Lee’s turn to make a pick, and he disagrees with someone ahead of him, he will often say, “Not so fast, my friend,” and then explain why the other team will win the game. He isn’t always right, but he always has good reasons and is usually worth watching and listening to.

As we observe markets today, the persistent climb through the end of August is beginning to give us that “Not so fast, my friend” sense. Make no mistake, we have been bullish for quite some time, even up to and including last quarter’s letter. What is changing for us is the level of the market versus our perception of the increasing level of uncertainty. Markets do not like uncertainty. This is why we often see them make most of their election year gains in the fourth quarter, particularly when the incumbent party wins. The uncertainty of the outcome constrains the markets. Investors are not sure if the stocks to own are the ones that would likely benefit from one party’s proposed policies. Until the outcome of the presidential race becomes more apparent, investors often sit on the sidelines. Once clarity returns, markets usually benefit. It is also worth noting that, seasonally, the October–December period is the strongest of the year.

This is an excerpt from a longer commentary. Please Download the PDF to read the entire 3rd Quarter 2024 CIO Commentary.

2nd Quarter 2024 CIO Commentary

The Times, They Are About to Change

Every quarter for nearly nine years we have sent this CIO Commentary with the goal of sharing our view of what is happening in the global capital markets and how we are incorporating that information into the portfolios we manage for you. We will do a little of that this quarter before sharing with you some comments from Jensen Huang, Co-Founder and CEO of NVIDIA. Mr. Huang’s company makes the fastest and most sought-after graphics processing units (GPUs) in the world. These chips are in high demand to run artificial intelligence (AI) workloads and applications. Whether we like it or not, we are all likely in for more change than normal as we are only in the first few innings of AI development. The chart below highlights the growing focus on AI on recent earnings calls. As you can see, AI mentions are prevalent across companies within every sector.

Record Number of Companies Within S&P 500 Citing “AI” in Q1’24 Earnings Call, Extending Beyond IT Companies1

Record Number of Companies Within S&P 500 Citing "AI" in Q1'24 Earnings Call, Extending Beyond IT Companies
Source: FactSet, Highest Number of S&P 500 Companies Citing “AI” on Earnings Calls Over Past 10 Years.

Before going any further, here is a quick rundown on what’s going on in the markets. It was another mostly positive quarter with global and US equities up and hedge funds also advancing— both despite seesawing interest rates caused by fears of inflation being stickier than anticipated. As you might imagine, this does not surprise us. And we are increasingly beginning to think that whether the US Federal Reserve (Fed) eases in the third quarter, the fourth quarter, or sometime next year is unimportant. Blasphemy, you say! Of course, the timing of the first easing will impact individual quarterly performance. But a year from now, we believe it won’t really matter to ultimate returns, other than their timing. In the meantime, we will continue to try to take advantage of opportunities created by other investors who react to each of the latest changes in expected timing. For example, we may further extend duration in fixed income if interest rates push high enough.

Of course, it bears noting that if the Fed actually raises rates due to reaccelerating inflation or unhinged expectations — or, if the central bank lowers rates precipitously due to a material economic slowdown or dramatic increase in unemployment — the Fed (and the whole economy!) would indeed matter. In either case, we might need to rethink our positioning.

For now, we expect stocks will rise and fall with rate cut expectations (up when expectations for easing rise, down when they fall). But in the end, we continue to believe the economy is healthy and that stocks will finish the year higher than they are today. Corporate earnings in Q1 were strong, with 81% of S&P 500 companies beating estimates, supporting the view that the global economy remains firm. Yes, valuations are still somewhat elevated, but as mentioned in earlier letters, firm earnings growth this year can support both modestly higher prices and some moderation in valuations. We remain near our funds’ strategic asset allocation targets (65% global equities/20% diversifiers/15% fixed income).

Geo-politics remain messy, but within the range of expectations. We continue to believe that by this time next year both the Middle East and the Russia-Ukraine wars can reach a negotiated settlement (especially important for humanity’s sake). The US elections will be over, and our country will have another chance to come together behind whomever wins. In our view, either candidate will spend too much, keeping pressure on the US budget deficit. From that perspective, we’re rooting against consolidated power where one party controls both the House and Senate in addition to the oval office.

Finally, yes, we did sort of skim over the possibility of inflation remaining too high. We read JPMorgan Chase chairman and CEO Jamie Dimon’s suggestion that the 10-year Treasury could reach 6%, and we take comfort knowing that the Fed read it too. Nobody wants inflation to get out of control again, and the Fed is paying attention. That is why, in our view, they haven’t cut rates even after suggesting it was likely. Like the rest of us, policy makers experienced what 9% inflation feels like; they don’t want to move back there. Accordingly, we believe that rates may stay higher for longer, but won’t need to be raised. To us this implies that the “rules of the investment game” aren’t about to change as they did in 2022, and markets can continue to improve. The biggest long-term concern for us remains the US budget deficit. We recently saw one Wall Street firm publish projections for net coupon supply, specifically what non-Fed investors have to absorb in 2024 by quarter: $340bn, $520bn, $540bn, and $460bn. That’s $1.86 trillion in new coupon debt that investors will need to choose to buy. The good news is that the same firm estimates that US households are now receiving $3.7 trillion per annum in interest and dividend payments. All of these are the biggest numbers we’ve ever seen and may continue to rise for many years to come.

On to Mr. Huang’s Comments

Bill Gates believes AI is a brilliant tool that will provide the biggest productivity advancement in our lifetime. Elon Musk has said AI is more dangerous than nukes and, that someday, it will take all of our jobs. Maybe these opinions are correct or maybe not — time will tell. We do believe that AI will have a material impact on society and the future direction of markets, companies, and individuals. We are already seeing the impact of increased demand for semiconductor chips to support the AI revolution. Accordingly, we thought that this quarter it would be good to share with you a bird’s eye view of what the CEO of NVIDIA, the leading AI “arms dealer” in the world, said on his recent conference call, during which the company reported Q1 revenue up 262% year over year to $26 billion. This has not gone unnoticed by investors, as shown by this chart:

NVIDIA’s Market Cap has Reached $3.1 Trillion in June 20242

NVIDIA’s Market Cap has Reached $3.1 Trillion in June 2024
Source: Bloomberg, as of 6/12/2024, weekly data.

…Which has Exceeded Key Semiconductor Companies’ Market Cap Total of $2.4 Trillion3

Which has Exceeded Key Semiconductor Companies’ Market Cap Total of $2.4 Trillion
Source: Bloomberg, as of 6/12/2024, weekly data.

Jensen Huang on NVIDIA’s May 22, 2024, Q1 Conference Call with Investors:

“The industry is going through a major change. Before we start Q&A, let me give you some perspective on the importance of the transformation.

“The next Industrial Revolution has begun. Companies and countries are partnering with NVIDIA to shift the $1 trillion installed base of traditional data centers to accelerated computing, and build a new type of data center, AI factories, to produce a new commodity, artificial intelligence.

“AI will bring significant productivity gains to nearly every industry, and help companies be more cost- and energy-efficient, while expanding revenue opportunities. CSPs [cloud service providers] were the first generative AI movers. With NVIDIA, CSPs accelerated workloads to save money and power. The tokens [bits of information] generated by NVIDIA Hopper drive revenues for their AI services, and NVIDIA Cloud instances attract rental customers from our rich ecosystem of developers.

“…accelerating demand for generative AI training and inference on the Hopper platform propels our data center growth. Training continues to scale as models learn to be multi-modal, understanding text, speech, images, video and 3D, and learn to reason and plan. Our inference workloads are growing incredibly.

“With generative AI, inference, which is now about fast token generation at massive scale, has become incredibly complex. Generative AI is driving a firm foundation up full stack computing platform shift that will transform every computer interaction. From today’s information retrieval model, we are shifting to an answers and skills generation model of computing. AI will understand context and our intentions, be knowledgeable, reason, plan, and perform tasks.

“Token generation will drive a multi-year build-out of AI factories. Beyond cloud service providers, generative AI has expanded to consumer internet companies and enterprise, sovereign AI, automotive, and healthcare customers, creating multiple multi-billion-dollar vertical markets.”

In the Q&A session that followed, Mr. Huang answered numerous questions and we highlight one here:

Q: “Jensen, what checks have you built in the system to give us confidence that monetization is keeping pace with your really, very strong shipment growth?

A (Jensen Huang): “The demand for our GPUs in all the data centers is incredible. We’re racing every single day. And the reason for that is because applications like ChatGPT and GPT-4o, and now it’s going to be multi-modality and Gemini and its ramp, and Anthropic and all of the work that’s being done at all the CSPs are consuming every GPU that’s out there.

“There’s also a long line of generative AI startups. Some 15,000, 20,000 startups that, in all different fields, from multimedia to digital characters, of course, all kinds of design tool application, productivity applications, digital biology, the movement —the moving of the AV industry to video, so that they can train end-to-end models to expand the operating domain of self-driving cars, the list is just quite extraordinary. We’re racing, actually.

“And the reason for that is because the computer is no longer an instruction-driven-only computer. It’s an intention-understanding computer. And it understands, of course, the way we interact with it, but it also understands our meaning, what we intend that we asked it to do, and it has the ability to reason, inference iteratively to process a plan and come back with a solution.

“And so, every aspect of the computer is changing in such a way that instead of retrieving pre-recorded files, it is now generating contextually relevant, intelligent answers.”

There is much more from this call that humbles us to read. Technology always moves faster than most of us can imagine. Today, it appears to be accelerating at an even faster pace. The importance of AI and the chips it is built on is not lost on countries either. This chart shows the importance most every country is placing on improving their onshore capabilities in the production of semiconductor chips.

Country’s Rate of Growth in Fab Capacity
US fabrication facility (fab) capacity as measured by wafer starts per month (WSPM) is projected to triple over the next decade, increasing by 203%, the largest projected percent increase in the world4

Country’s Rate of Growth in Fab Capacity
Source: Semiconductor Industry Association, BCG, May 2024.

What this portends for each of us and for the entire world is hard to predict today, but change is coming in many areas.

It is hard to have a strong opinion about the impact of AI, because we are so early in its evolution today. Asked to share our thoughts at such an early stage is condemning us to future embarrassment. We are constantly trying to catch up with the latest advancements and expect this will continue for many years to come. Therefore, it is with great humility that we share our early thoughts on how we believe AI might shape the future.

How will AI Shape the Future?*

The future will be much faster paced than most people are accustomed to. The success of AI will enable those with mastery to change the direction of existing or new firms with a few keystrokes rather than the long and laborious time required to change hearts and minds of co-workers, bosses, and boards. This acceleration of pace will require each of us to adapt and to change much faster. Some will excel in this environment, but many will likely be replaced by machines that can do their jobs faster, better, and cheaper, and without the coddling required to maintain harmony within an organization.

Many try to compare this to the internet bubble in the late 1990’s/early 2000’s. True, there are similarities, including the prospects of AI breaking out of the tech space to become a productivity and growth enhancer across many industries. The breadth of possibilities has encouraged us to be more understanding around current valuations. New technologies with universal application do not arrive on the scene very often, so properly valuing the most exposed companies today is more difficult than valuing a more entrenched and understandable business. There are also differences from the internet period, some of which make forecasting valuations even more difficult. First, the companies leading the charge today are the best and biggest in the world, locked in an existential fight to lead the AI charge. NVIDIA, the preeminent pick-and-shovel provider, grew its $26 billion Q1 revenue from $19 billion three months earlier, and from just $7.2 billion the year before. The company’s customers are essentially the Magnificent Seven, each spending billions to lead in the creation of new revenue streams. Those who can build those revenue streams and fund continuing innovation have the potential to lead technology advances for many years to come. That deep-pocketed corporate spending differs greatly from the internet age, which largely relied on private or other finite pools of capital.

In the early days, AI will most likely find uses in more prosaic tasks, such as operating call centers and writing the most basic portions of software and first drafts of often-written letters and emails. In time, life-extending medical breakthroughs in gene editing and molecular biology, quantum computing, fusion research, and a deeper understanding of what humans really want when they ask for something will all likely see AI applications. Elon Musk postulated that if the number of workers times productivity-per-worker = gross domestic product (GDP), then combining AI with the robots Tesla intends to deliver this year could remove the limit on GDP by essentially making the number of workers limitless.

Less optimistically, this could prove a tricky time for humanity, especially if capable robots can be fitted with the intelligence of a machine that knows everything that has come before it and can process new data with extreme speed. Some suggest that successful people will gravitate away from trying to compete with AI on an intellectual level and focus more on social skills where they will be dealing with humans and emotions. If AI does displace humans as the smartest entities on earth, we will need strong global AI governance policies and enforcement mechanisms to ensure a fair and just transition. Managing this new world for the betterment of all mankind will be hugely important and likely difficult with global guidelines that can be adhered to and enforced. If a rogue actor enlists AI for nefarious purposes, it could become very difficult for those playing by the rules. We suspect other resource constraints will develop and could be contested by those willing to break the rules.

How Are We Incorporating AI at TIFF?

A core component of our job at TIFF is to deploy your capital based on our best estimate of future economic conditions. When a breakthrough technology emerges that could change the future, it is important for us to incorporate that development into our assessments. Because we believe the recent AI advances represent such a breakthrough, we have made three early adjustments to business at TIFF. First, we started to incorporate elements of AI into our workflow and processes to enhance productivity. Second, we shifted some capital within our portfolios to managers we believe are best positioned to make use of this new technology in their processes. Third, we have been careful not to be too far underweight the mega-cap stocks that are most directly involved in leading the AI charge. It is inevitable that some of our assessments will be wrong and that we will need to learn and adjust, but that’s OK. As Woody Allen once said, “90% of life is showing up.” We will keep learning and trying our best to keep our investments aligned with our best judgments of the future.

The economic trend toward “winner take more,” which we are seeing in the hyper scaling of some large tech companies, will likely continue and may even accelerate. Warren Buffet’s shift from buying OK companies at great prices to buying great companies at OK prices will likely be rewarded more than ever. It may be that buying great companies at any price becomes a common practice for a period of time. In the end, of course, history has shown that if this sort of stock market behavior gets taken to an extreme it can end badly.

The AI shift could happen faster than we imagine. Over the next several years it will be important for each of us to understand how AI is evolving and being incorporated into both business and people’s daily lives. We all want to hand off the boring, mundane, or difficult parts of our jobs and keep those bits we like. In a perfect world that may be possible. If you enjoy a thinking job, it may be harder to achieve. Nevertheless, we remain optimistic that harnessing AI for good is what lies directly ahead, and any potential downsides will be farther off in the future.

As always, we very much appreciate the opportunity to help manage your capital and to help you achieve your organization’s goals. We are here to assist you in any way possible, so please reach out and let us know how we can help.

Your TIFF Investment Team

*With great thanks to Oliver Bardon, Brad Calder, Trevor Graham, and Zhe Shen for their help and insights in thinking and writing about how AI might shape our future.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance. There is no guarantee that any particular asset allocation or mix of strategies will meet your investment objectives.

These materials are being provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute an offer or advertisement of TIFF’s investment advisory services or investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

These materials may contain forward-looking statements relating to future events. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of such terms or other comparable terminology. Although TIFF believes the expectations reflected in the forward-looking statements are reasonable, future results cannot be guaranteed.

Footnotes

  1. Source: FactSet, Highest Number of S&P 500 Companies Citing “AI” on Earnings Calls Over Past 10 Years.

  2. Source: Bloomberg, as of 6/12/2024, weekly data.

  3. Source: Bloomberg, as of 6/12/2024, weekly data.

  4. Source: Semiconductor Industry Association, BCG, May 2024.

1st Quarter 2024 CIO Commentary

Let the Good Times Roll

Executive Summary

The past five months have been great. The Mag 71 continue to lead the way, gaining 36% over that spell! Stocks globally have returned 24%, only slightly behind the S&P 500, up 26%. Even small cap stocks, shown as the Russell 2000, and value stocks (Russell 1000 Value) are up 29% and 24%, respectively, since October of last year.

Select Equity Indices: Cumulative Returns
(October 31, 2023 to March 29, 2024)2

Select Equity Indices: Cumulative Returns
Source: Bloomberg.

Only emerging markets are “lagging” – with a gain of 15%. This, of course, is due to policies that China continues to implement, constraining their returns to -2%. As a recently reformed, formerly overweight Chinese equities investor, we are disappointed to see China’s leadership continue to pursue these unproductive policies. Until China adopts a more market-friendly approach, it is unlikely that their stock markets will see significant recovery. We feel nervous saying that, because, if their policies do change, today’s valuations suggest a substantial upward move is possible. We remain at market weight to Chinese equities. This is a good reminder that valuations alone are not a reason to buy or sell a stock, though they do provide insight into potential future performance.

In traditional diversifiers markets, the Bloomberg US Aggregate and Merrill hedge funds indices are making some progress, returning 8% and 8%, respectively, in the past five months. Commodities, as seen in the Bloomberg Commodities Index and WTI oil, have returned -3% and 4%, respectively, in the same period.

Select Diversifier Indices: Cumulative Returns
(October 31, 2023 to March 29, 2024)3

Select Diversifier Indices: Cumulative Returns
Source: Bloomberg.

Stocks, bonds, and hedge funds are up, as gas has seen a modest increase and other raw materials have had a modest decrease. The past five months have been great overall.

The most likely explanation for these good returns is that the economy and earnings have remained stronger than expected and inflation has remained quiescent, boosting investor confidence. Quarterly real GDP was 4.9% in Q3 2023 and 3.2% in Q4 2023, and the Atlanta Fed GDPNow Tracker is expecting 2.5% GDP growth in Q1 2024.4 These solid reports have helped sustain job gains at a rate of 225k per month for the past year.5 Recovering supply chains have allowed the Consumer Price Index to decline from 5.0% in March 2023 to 3.2% year over year. Despite continued debate among investors on whether the Fed has achieved its target, the Fed’s efforts to curb inflation have enabled the economy and employment to thrive and the stock market to reach new highs. The market environment has exceeded most investors’ expectations. Typically, a normal election year suggests a more modest start to the year, but a healthy finish:

Market Expectations During a Presidential Cycle
(2024 to 2028)6

Market Expectations During a Presidential Cycle
Sources: Ned Davis Research, Inc., Bloomberg.

Fingers crossed this dynamic continues, with the market returns in the back half of this election year exceeding the already strong start to 2024.

 

Where to From Here?

We have been hearing about companies expecting sales, profits, and employment to grow stronger still in 2024. Meanwhile, margins are expected to expand on declining input costs and more modest wage gains, which have been around 4%. Aren’t one company’s input costs another company’s revenue?

The bull case continues as shelter inflation – mostly owners’ equivalent rent, which accounts for about 36% of the CPI calculation – is expected to fall from 6.0% in February 2024 toward the real-time Zillow Rent Index rate of 3.5%.7

US CPI Urban Consumers Owners’
Equivalent Rent Versus US Zillow Rent Index All Homes
(March 2019 to February 2024)8

Year-Over Year Comparison of US CPI Urban Consumers Owners’Equivalent Rent Versus US Zillow Rent Index All Homes
Sources: Bloomberg, Bureau of Labor Statistics. All data is year over year. Zillow data is smoothed seasonally adjusted.

Translating this projection into overall CPI: If 36% of the CPI falls from 6.0% to 3.5% and other factors hold steady, the CPI will fall from 3.2% to 2.2% – very near the Fed’s inflation target. If this were to happen, we could anticipate stock markets to continue pushing higher and rates to fall somewhat further.

Meanwhile, as noted earlier, positive performance is beginning to broaden out within the stock market. Typically, the best stock market advances are those that carry the most stocks along as they hit new highs. Narrower stock markets – like the one we experienced last year, when only a few names accounted for much of the performance – can mask structural challenges. When most names are making new highs, it suggests a very positive fundamental backdrop. This year’s markets suggest a much more positive environment in the US and globally. Some stock market pundits even believe that stocks could “melt up,” rallying like it’s 1999. Others are more negative, as we discuss below.

 

What Can Go Wrong?

There are two major conflicts raging in the world. Russia’s war with Ukraine has moved into its third year, and the Israel-Hamas War is in month six. Each of these conflicts has the potential to escalate into a wider geographic conflict that would have much greater impact on the global economy. Despite the duration of the Ukraine war, the prices of commodities from Russia and Ukraine have not spiked, nor has the price of energy sourced in the Middle East and Russia, though shipping costs and time through the Red Sea have been impacted. The US is fortunate to be able to feed and provide sufficient energy for its population, insulating us from the immediate risks facing most other regions, especially those near the conflicts or those heavily dependent on the commodities these regions supply. Putting aside for the purposes of this investment letter the human tragedies propagated by these wars, from a pure economic perspective, the risk to the US appears lower than for many other regions.

Globally, geopolitical risks seem to be rising. More people will vote in 2024 than ever before, as approximately 64 countries and the EU will hold elections that represent the voices of 49% of the global population. Citizens of Brazil, Russia, South Africa, India, Korea, Taiwan, Indonesia, Iran, Turkey, Germany, Italy, Spain, the UK, Australia, Canada, and the US, among others, will all vote for their leaders in 2024. In every election cycle, we hear “This is the year that your vote matters more than ever before”; somewhere in the world that will likely be true in 2024. It will be interesting to see how voters approach elections in 2024. Will they vote for left- or right-leaning candidates, for established or newer faces, for more aggressive or passive approaches, or for more fiscally conservative or progressive policies? The combinations and permutations of qualifications are many and make these global elections important indicators of the direction geopolitics might take in coming years.

Here in the US, we are now about eight months from our elections. Few Americans seem excited to vote for either major party’s presidential candidate, though many seem excited to vote against one or the other. This will be the oldest pair of candidates ever on the ticket. Both are current or past presidents and are generally well known by the electorate. It is hard to imagine that anything we learn between now and the election will be enlightening in a positive way. We are expecting a very expensive, mudslinging contest from now through election day – with an absence of the uplifting sort of election speeches we have heard in the past. The best-case scenario is a calm election where one candidate wins convincingly over the other and neither side can claim that any sort of unfair practices swayed the outcome. Worse still would be some sort of violence that occasionally occurs in less-developed countries, but typically not in the US. Once we get past this election, it is likely that markets will breathe a sigh of relief, which suggests gains may follow.

Expected Market Behavior by Election Outcome
(January to December 2024)9

Expected Market Behavior by Election Outcome
Sources: Ned Davis Research, Inc., Bloomberg.

Potentially more important than the above factors will be the question of inflation. Inflation seems to be coming down, with supply chains normalizing. We continue to believe that the last 1% to 2% decline to target will be the most difficult to achieve. If, for any reason, inflation does not get back to target, then the markets will have to adjust to a new reality, with likely negative consequences. Although inflation at 3% versus 2% may not seem like a big difference, that one extra point of inflation means the value of the US Dollar will fall by 26% in a decade and by 52% in 25 years, versus “only” falling 18% in 10 years and 39% in 25 years in a scenario where inflation is at 2%. Stated in reverse, the value of the USD will be 29% greater in 25 years with 2% inflation than with 3% inflation. Also, after having declared a 2% target for decades, the Fed would take a hit to its credibility by accepting 3% inflation, with unknown destabilizing effects on investor psyche, US debt-issuance costs, and markets.

This is important to markets. Prior to the easy money policies in place from the Great Financial Crisis until recently, the 10-year Treasury yield averaged 126 basis points more than inflation. Since then, it has averaged 77 basis points less than inflation.10 If we move back into a higher 3% inflation regime with a larger risk premium built into bond yields, we could see longer-term rates remain above 4%, rather than move down toward 3% or lower. This higher rate – and therefore, higher cost of capital – would slow borrowing and economic growth in the economy, likely resulting in lower long-term stock-price multiples (and prices). This decline likely wouldn’t happen all at once but could prove a headwind to markets for a few years as investors come to realize that 2% inflation will not return.

US 10-Year Treasury Yield Versus CPI
(January 1983 to February 2023)11

US 10-Year Treasury Yield Versus CPI
Source: Federal Reserve Bank of St. Louis.

Unfortunately, higher rates also mean higher interest expense for the US government. We’ve written about the deficit before, but always suggested it was an insidious problem to be dealt with in the future. Unfortunately, the future is rapidly approaching. A recent Schwab piece suggests that Medicare and Social Security benefits will be reduced starting in 2031 and 2033, if not reformed soon. It is hard to imagine deficits declining because either Biden or Trump propose spending less after the election. This “future” is now seven and nine years away, respectively. Sometime soon, we need rational people to sit down and craft a reasonable and fair solution to this problem. Any cure will most certainly require some combination of an extension of the age of benefit eligibility; an increase in the tax levied along the way, in increments and to higher income levels than now; and possibly means testing. Although it is unfair to take benefits away from those that rely on them, it is equally unfair to pass the entire burden onto future generations. It will be a difficult balancing act, but one we must soon confront. (This may be what record high prices for “stores of value” gold and bitcoin are signaling.)

The slow-moving nature of our deficit challenge suggests it is unlikely to disrupt markets in a surprising or volatile fashion, but rather in a more subtle way. Higher interest expense will either increase the budget deficit further or crowd out discretionary spending, including education, infrastructure, and defense; these could all be cut if we do not get our fiscal house in order. It seems clear at this juncture that Modern Monetary Theory has seen its best days and will return to the back bench for at least another few cycles.

Today, US government debt is increasing by $1 trillion about every 100 days.12 Yes, you read that right. A simple – but hopefully unlikely – thought experiment might be to imagine that the deficit adds $7 trillion to our $34.5 trillion debt in the next two years. Then ask yourself, “What if our average interest rate hits 5%?” Spending more than $2 trillion on interest expense is the near equivalent of 39% of the US government’s total tax revenue. In 2023, total discretionary spending by the US government was about 27% of spending, or $1.7 trillion, and interest expense was another $1.0 trillion.13 If interest expense rises another $1.0 trillion, where will the money come from?

Gross Interest Payments on Federal Debt
(1951 to 2023)14

Gross Interest Payments on Federal Debt
Sources: Ned Davis Research, Inc., Department of Commerce.

Addressing this challenge won’t be simple, but the rewards will be substantial. Any progress could provide a strong positive catalyst for better markets. Electing leaders who inspire unity and collaboration among Americans is key to overcoming our greatest obstacles. Identifying a leader capable of rallying the nation to confront and tackle this issue head-on won’t be easy, but it’s imperative we don’t wait too long before the problem becomes intractable. The time is ripe for a new American hero to emerge and galvanize the country into action on this critical issue.

Until we see signs of progress, however, we are likely to remain somewhat cautious on fixed income as we believe the purchasing power of future dollars received may be less than investors currently anticipate. If this view becomes more widespread it could cause rates to rise and bond prices to fall. Paradoxically, it might help equity prices as the relative value of stocks would likely hold up better than that of bonds.

 

Other Market Considerations

For now, markets should continue to benefit from the solid backdrop of a strong economy and jobs growth coupled with declining inflation. However, if inflation stops falling or even returns, markets could reverse. Inflation reports are one of the most obvious items we are monitoring. A pivot higher on inflation would cause us to become more cautious: This would likely push the Fed to raise short rates, which would hurt US and global markets. Conversely, if the Fed were to cut rates with inflation stuck above 3%, it could signal that the Fed sees economic challenges ahead. We would also be concerned that any potential market rally could be jeopardized by inflation reignited by looser economic conditions; this could ultimately put us back into the environment described above. A decline in corporate earnings would be concerning, especially if Nvidia reports a slowdown in its business or more broadly in the Artificial Intelligence (AI) sector. Further, if new government regulations on AI are perceived as burdensome, leading stocks – particularly those in the Mag 7 and their associated ecosystems – could decline, potentially dragging down overall market performance. Any sort of unrest ahead of elections or a rise in geopolitical concerns that causes commodity or energy price hikes could hurt markets. More positively, a change in policy direction from Chinese leadership could improve the Chinese and global economies.

Although we left many potentially market moving events off the short list above, you can see that most of our concerns today still revolve around inflation. If we can successfully conquer this issue, our collective financial futures will be brighter. Once we pierce the fog of fall elections, we expect markets can continue to grind higher. Strong leadership in much-needed deficit-reduction efforts would also be helpful. How we handle this challenge may be the next big issue for America.

 

What We’re up to in Our Portfolios

We’re optimistic about the potential progress for our country and markets over the rest of 2024. The past five months may have pulled forward some of this year’s returns, but a strong fundamental backdrop coupled with declining inflation would be a continuing tailwind – if we can avoid some of the challenges mentioned above. Within our portfolios, we have maintained our allocations, with 65% in equities, 20% in diversifiers, and 15% in fixed income. We slightly extended our bond duration in the first quarter from 4.25 years to 4.5 years, versus the Bloomberg US Aggregate duration of approximately 6.25 years. We have only modest over- and underweights in geographic regions and sectors. The relatively positive fundamental backdrop we see is balanced by above-average valuations in many markets, especially the US. Our belief that equity markets generally move up and to the right keeps us mindful of being less than 65% exposed to the highest-returning liquid asset class in the world. This discipline has been beneficial over the past year, when many thought valuations were too high and reduced equity exposure. We also continue to believe that private markets offer attractive and idiosyncratic exposure not available in the public markets and, where appropriate, can augment long-term returns further.  Similarly, we continue to believe that our well-diversified and less-correlated hedge fund portfolios should: a) provide some downside protection if equity markets pull back; and b) generate better returns than fixed income under most scenarios. Our manager relative performance has been better in the past 12 months than it was in the prior year. If we could find an excellent partner in Japan, we would replace our passive exposure there but otherwise we are happy with our roster.

As always, we very much appreciate the opportunity to help manage your capital and to help you achieve your organization’s goals. We are here to assist you in any way possible, so please reach out and let us know how we can help.

Your TIFF Investment Team

Footnotes
1 Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla.
2 Source: Bloomberg.
3 Source: Bloomberg.
4 Source: Federal Reserve Bank of Atlanta.
5 Source: Bureau of Labor Statistics.
6 Sources: Ned Davis Research, Inc., Bloomberg.
7 Sources: Bloomberg, Bureau of Labor Statistics.
8 Sources: Bloomberg, Bureau of Labor Statistics. All data is year over year. Zillow data is smoothed seasonally adjusted.
9 Sources:  Ned Davis Research, Inc., Bloomberg.
10 Source:  Gavekal Research.
11 Source: Federal Reserve Bank of St. Louis.
12 Source: Bank of America research.
13 Sources: Ned Davis Research, Inc., Department of Commerce.
14 Sources: Ned Davis Research, Inc., Department of Commerce.

 

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance. There is no guarantee that any particular asset allocation or mix of strategies will meet your investment objectives.

These materials are being provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute an offer or advertisement of TIFF’s investment advisory services or investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

These materials may contain forward-looking statements relating to future events. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of such terms or other comparable terminology. Although TIFF believes the expectations reflected in the forward-looking statements are reasonable, future results cannot be guaranteed.

4th Quarter 2023 CIO Commentary

In financial markets, the impact of bad news can vary. Often, it’s straightforwardly negative, and other times, paradoxically, it becomes good news. Currently, the markets are eagerly awaiting an economic slowdown that could reduce job and wage growth. This hope is driven by the belief that the Federal Reserve will then be able to initiate an easing cycle, rewarding investors for looking beyond a potential recession towards brighter economic prospects. This is the market’s version of anticipating future opportunities, much like “skating to where the puck will be. “Historically, during economic downturns, this anticipatory behavior pushes earnings multiples higher as current earnings hit their lowest point. This contrasts with robust economic conditions where earnings are at their peak and earnings multiples are closer to their lows. If markets accurately predict shifts in interest rates and earnings, this pattern makes sense. However, as we’ve witnessed this year, markets can sometimes prematurely discount changing earnings or future interest rate levels, necessitating corrections back to previous levels when conditions revert, as occurred this fall.

This is an excerpt from a longer commentary. Please Download the PDF to read the entire 4th Quarter 2023 CIO Commentary.