Booming Gold
Legendary investor Warren Buffet, chairman of Berkshire Hathaway, was asked about investing in gold, and he was clearly perplexed by the question. His response was that gold (unlike investments in stocks and bonds) doesn’t build value in the economy, doesn’t generate annual dividends or interest, and generally relies on finicky investor sentiment to move its price (and value) up or down. He wondered what one would do with a nest egg in gold, other than admire the sheen and periodically polish it.
But gold investors today are pretty happy with their returns—29% in the first three quarters of 2024—which has pushed the annual return since 2010 up above 10%. The reasons for gold’s advance are not clear, but gold’s popularity tends to rise during periods when people are worried about the government’s ability to pay back its debts—and over the last eight years, total U.S. government debt has risen above $35 trillion, or about 122 percent of the current GDP. The train of logic suggests that the government would, in desperation, devalue the dollar, so it could pay back its debts off of the printing press.
Alternatively, people who believe in an apocalyptic future will focus on a diversified portfolio of gold, canned food and water and a cabin off the grid deep in the woods. This appears to be a growing percentage of the population.
There’s nothing wrong with owning gold in a diversified portfolio, but the precious metal does tend to be an inefficient holding. As mentioned above, it won’t generate any dividends or interest, and the taxation of gold’s returns, unlike traditional investments, is somewhat punitive: investors are taxed at ordinary income rates rather than (lower) capital gains rates if the traditional investments are held for more than a year. Moreover, gold provides a somewhat wilder ride than traditional investments; its standard deviation is 18.07%, which means that two-thirds of the time the price will bounce from +36% to -36%.
The downside volatility tends to be emphasized after a significant runup like the markets have recently experienced. Absent a global flare-up of inflation or warfare, the downside is probably more likely than a great deal more upside.
Is there room on the downside? It’s perhaps worth noting that, despite the high gold prices today, the cost of producing an ounce of gold—which might be a clue to gold’s natural or intrinsic price—averages around $1,345—which is considerably lower than the $2,700 per ounce that gold is currently trading at.
The PE Takeover
Without any particular fanfare, the investment landscape has shifted dramatically, from public companies to firms controlled by private equity. Increasingly, the opportunities to buy corporate growth are being diminished for the average investor, while a small number of wealthy investors are cherry-picking off the top.
In 1996, the U.S. markets included roughly 7,300 publicly-traded companies. Today that is down to 4,300 stocks. At the same time, the number of companies owned by private equity firms—pools of capital owned by wealthy investors—has ballooned from 1,900 to 11,200. Today’s private company market is larger and more diverse than the public markets—a total reversal of the market dynamic in just a couple of decades.
Is this a problem? Yes. The private equity pools of capital are picking out choice corporate opportunities and taking them off the market, essentially pulling their earnings and growth out of the reach of ordinary investors, leaving behind ‘opportunities’ that they consider to be unfavorable. Some observers are calling the current stock market a ‘dumping ground’ for businesses too weak to attract capital from the private markets.
This is surely an exaggeration (Apple, Microsoft, Nvidia and others are still public, after all), but the trend is not the friend of the U.S. economy as a whole. Private companies are not subject to the disclosure and governance rules imposed by the regulators (chiefly the Securities and Exchange Commission), which were meant to make the markets efficient and transparent. The last time private investor pools of capital (the infamous trusts) owned this much of Corporate America was the period right before the crash of 1929.
There’s no reason to panic over all this, but most of us know of situations where a profitable enterprise or two were gobbled up, and their service level dropped in the aftermath. It’s helpful to remember that these private equity pools exist for only one purpose: to take in as high a return as possible—which could upset the delicate balance between serving customers, generating profits and growing the enterprise. It might happen that the companies left behind in the PE buying spree might be the most viable, long-term, after all.
2024 Third Quarter Investment Report
The rarest of economic events is the so-called ‘soft landing,’ where a robust economy (and long-time bullish markets) are gradually cooled without triggering a recession and bear market. We might be witnessing such a phenomenon today, though nobody will quite say we’re out of the woods yet.
The third quarter experienced above-average returns across the board, piling onto the gains for the first two quarters to produce unusual returns for the year. The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—gained 6.16% in the year’s third quarter, and stands at a 20.58% gain since January 1. The Russell 3000 index has gained 20.63% so far this year.
Looking at large cap stocks, the Wilshire U.S. 2500 Large Cap index was up 6.12% for the third quarter, with a 20.76% gain so far in 2024. The Russell 1000 large-cap index is up 21.18% so far this year, while the widely-quoted S&P 500 index of large company stocks gained 5.53% during the year’s third quarter, and is now sitting on a 20.81% gain for the year so far.
Meanwhile, the Russell Midcap Index is up 14.63% in the first nine months of 2024.
As measured by the Russell 2000 Small-Cap Index, smaller companies posted a 11.17% gain in the year’s first three quarters. The technology-heavy Nasdaq Composite Index has gained 21.80% so far this year.
Foreign markets are also experiencing above-average returns. The broad-based EAFE index of companies in developed foreign economies gained 6.65% in the third quarter, and is now up 10.40% for the year. Emerging market stocks of less developed countries, as represented by the EAFE EM index, gained 7.79% in dollar terms in the third quarter, and are up 22.89% so far this year.
Real estate securities recovered in the third quarter, with the Wilshire U.S. REIT index up 15.19% for the most recent three months, to push it into a 14.88% gain for the year so far. The S&P GSCI index, which measures commodities returns, lost 7.87% in the second quarter, but is only down 0.51% in 2024 so far. Gold prices are booming, up 13.67% for the quarter and 28.36% for the year, to a record $2,686 an ounce
The S&P 500 utilities index, a broad measure of the performance of utility stocks, is posting a remarkable recovery, gaining 18.46% in the most recent quarter, now delivering 27.45% for the year.
The bond markets responded to the Fed’s lowering of baseline rates by experiencing modest rate declines all the way up and down the yield. Yields on 10-year Treasury bonds fell to 3.88%, while 30-year government bond yields stand at 4.25% today. Five-year municipal bonds are yielding a 2.35% aggregate rate, while 30-year munis moved from roughly 3.79% in the second quarter to 3.52% today.
As has been the case for most of 2024, the U.S. markets seem to be testing new highs every week or so, in a smooth ride with little volatility. That is not normal, but there aren’t any clear signs of a storm on the horizon. Manufacturing activity continues to be strong, construction spending is relatively robust, the unemployment rate, which seemed to be rising, has leveled off at a level that most previous economies would consider extremely bullish. Hourly wages for American workers continue to rise faster than inflation, currently at a 3.8% annual rate, compared with 2.5% inflation. That aforementioned inflation rate is very close to the Federal Reserve’s 2% target, which might mean that the Fed has room to lower rates going into 2025.
Meanwhile, GDP growth is running at 3.4%, personal income and disposable personal income among consumers keeps rising (albeit incrementally) and consumption (a key component of economic growth) remains strong. As a direct result, corporate profits have continued to rise.
The chief worry now is oil supply disruptions as the conflict in the Middle East heats up. If the conflict escalates, the world would experience higher oil prices. The impact would be moderated in the U.S., which is energy-independent currently and actually exports fossil fuels, but global supply and demand has rippled into American gas stations (and production costs) in the past. Of course, there are bigger worries when two major conflicts seem to be escalating, and especially when they involve countries with nuclear capabilities.
Oh, and you might have noticed that there’s a Presidential election going on in the U.S. The interesting thing about elections is that there’s never any clear connection between who wins in November and what the markets will do in the immediate aftermath. Policies can affect the economy, but until we know what those policies will be, it’s hard to judge what kind of impact to expect.
It’s helpful to remember that the markets have continued to rise through both parties temporarily occupying the White House and holding majorities in Congress. There’s no good reason to imagine that this long-term trend will suddenly change, though history does tell us to expect more volatility in the future, up and down, than we’ve experienced in the recent past. It’s always helpful to have your seatbelt buckled.
Sources:
https://www.investmentnews.com/equities/will-gold-continue-to-shine-through-year-end/257488
https://thehill.com/opinion/4911128-debt-crisis-election-year/
https://www.forbes.com/advisor/investing/guide-to-investing-in-gold/
https://fred.stlouisfed.org/series/GVZCLS
https://www.advisorperspectives.com/articles/2024/10/02/becoming-dumping-ground-stock-market
Wilshire index data:
https://www.wilshireindexes.com/products/ft-wilshire-index-series-index-returns-calculator
Russell index data:
http://www.ftse.com/products/indices/russell-us
S&P index data:
https://www.spglobal.com/spdji/en/indices/equity/sp-500/#overview
https://www.marketwatch.com/investing/index/spx
Nasdaq index data:
http://quotes.morningstar.com/indexquote/quote.html?t=COMP
http://www.nasdaq.com/markets/indices/nasdaq-total-returns.aspx
International indices:
https://www.msci.com/real-time-index-data-search
https://www.msci.com/end-of-day-data-search
Commodities index data:
https://www.spglobal.com/spdji/en/index-family/commodities/broad/#overview
Utilities index:
https://www.spglobal.com/spdji/en/indices/equity/sp-500-utilities-sector/#overview
Treasury market rates:
http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Bond rates:
http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/
https://www.theguardian.com/business/2024/mar/20/federal-reserve-interest-rates
Economic data
https://www.statista.com/statistics/273418/unadjusted-monthly-inflation-rate-in-the-us/
https://www.bea.gov/news/glance
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