Weekly Commentary | September 22, 2024 | Fed Cuts Big Boosting Our Duration Bets

Summary

• The Fed's 50 bps rate cut, the first in over four years, has driven large cap indices to record highs and boosted small caps.

• Cyclical, mid-caps, and high-quality dividend payers are expected to perform well post-cut, remaining cheaper than megacap tech stocks.

• The Fed's dual mandate is shifting focus from inflation control to labor market support, with inflation down to 2.5% and unemployment rising to 4.2%.

• CEF market discounts have stabilized, with notable corporate actions including distribution increases, tender offers, name changes, and repurchase programs.

Macro Picture

The Fed delivered the first rate cut in over four years and started the cycle with a larger cut of 50 bps. This helped the large cap indices hit fresh record highs.

The rally was also relatively broad with small caps outperforming - something we've been pushing for investors to participate in. The Russell 2000 index remains almost 9% below its all-time high so it has room to run. That high, by the way, was last hit in November of 2021!

Cyclical, mid-caps, and high-quality dividend payers may also perform well after the cut as they remain cheaper relative to megacap tech stocks.

The dual mandate is likely causing the Fed to shift focus from quelling inflation to supporting the labor market. Inflation has fallen from 9.1% in June 2022 to 2.5% in August. However, the unemployment rate is moving higher from 3.4% to 4.2%, triggering the Sahm Rule.

I think the 50 bp cut was really a July cut that they likely regretted not making and a 25 bp cut for September. Thus, it was a catch-up move. Powell made it clear that 0.5% cuts are not the norm, and smaller cuts remain the baseline for the upcoming meetings.

This is what we have on tap for this week:

CEF Market Review

Discounts took a bit of a breather remaining relatively stable with taxables only 60 bps away from, on average, having no discount and munis now at an average -5.8% discount. We've seen an extraordinary amount of tightening so far this year and taxables look like they may be close to end of the line for that tailwind.

From a NAV perspective, preferreds and utilities did the best (given their rate sensitivities) with both NAVs up over 1.5% on the last week. Discounts likewise rallied for total returns up around 2%.

In the last month, most CEF bond NAVs are up 1% - 2% with discounts up another ~1%. It's been a broad based rally. The returns in these funds in the last week are roughly the same as the Vanguard Total Bond Market ETF (BND) for the last five years.

Data by YCharts

But before you say that these funds are probably up about the same over the last five years... it's not even close. Preferred CEFs, despite banking weakness, are up much more.