The probability of a 50bps rate cut has steadily increased over the past week (it is 63% as of today). The Fed has only cut 50bps in a non-emergency situation once in the past 40 years. In our view, the Fed would be making a mistake as it would imply the economy is much weaker than currently suggested. At the moment, the unemployment rate is 4.2% and the Atlanta Fed's GDPNow forecast for Q3 US GDP is 2.5%. Does that sound like an economy on the precipice of a recession to you?
Growth is normalizing after a strong 12–15-month period partially induced by enormous fiscal stimulus and euphoria over AI. Investors should start to acknowledge and accept that we are in a normalization period, and this is what a normal soft-landing looks like. Sure, if growth materially slows then stocks have a lot of room to fall. But where exactly do we see massive growth risks outside of the commercial real estate market and mounting credit card debt?
Empirical evidence shows that the S&P 500 performs historically better when there is a 25bps cut vs. 50bps.
Here is a chart from Goldman Sachs that shows how the S&P 500 does when the Fed cuts in a non- recession period (blue line) vs. a recession period (gray line). Big difference!
Here is another chart from J.P. Morgan that shows how stocks perform during a soft landing and during a recession. As you can see, stocks perform much better during a soft landing (orange) relative to a recession (light blue). Big difference again!
Astoria primarily serves as an OCIO to independent RIAs and spends most of its time developing long term wealth management solutions using pre-defined factor tilts with a liquid alts overlay.
Debating a 25bps vs 50bps is quite important as recessions can be very disruptive to long term wealth accumulation if portfolios aren’t properly diversified. The S&P 500 is no longer a diversified index given the significant single stock concentration. Hence, Astoria has been advocating for tilting away from the S&P 500 for the past year.
The big revelation we have been arguing in recent months is that the market finally has a catalyst for the rotation to actually occur. For years, market commentators had been advocating rotating away from the S&P 500 but now that the inflation and interest rate cycle has meaningfully changed. Hence, we argue that portfolios have the green light to move out of the S&P 500 index and tilt their portfolio accordingly.
Here are most considerations that advisors that run US centric stock portfolios will likely contemplate.
Buy value. The issue with value investing is that in reality it works once or twice every 10 years. It’s a big academic debate and in our view financial advisors should focus on building wealth and not entertain academic debates. If you are running state pension money or a large family office with multi decade time horizons, sure, value is attractive and should be considered for tilting. However, time horizons have shrunk considerably, and advisors would need to take on huge tracking error risk. The majority of advisors we speak to want S&P 500 like returns with minimal slippage. And their end clients’ time horizons have meaningfully shrunk as well.
Buy dividends. Remember the concept of T-bill and Chill? That was a significant headwind for the dividend cohort. Dividend paying stocks should come back in vogue after 2 years of being shunned with rates at 5%. Astoria believes we need Fed Funds need to fall to around 300bps for investors to sell T- bills to buy dividend paying stocks. Internally, we are warming up to this factor quite a bit.
Buy Small Caps. The issue here is that
1) rates remain high
2) small companies need a few hundred bps of a decline in rates to meaningfully move their bottom line
3) the small cap indices have a lot of regional bank risk (hence, there is commercial real estate risk).
Buy Equal Weight. We like this concept and have used index products to tilt away from the S&P 500 index. However, most US broad based indices which are equal weighted tilt towards mid value. Moreover, in the case of the S&P 500 index, your marginal contribution to risk and return is tiny with each stock weighing 20bps. Moreover, the S&P 500 equal weighted index has 15% in technology while the market cap weighted version has 30% in technology.
Contact us if you wish to learn how Astoria is navigating the interest rate cycle.
Best,
John Davi
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