Grey Owl Capital Management letter for the third quarter ended September 30, 2024.
“I believe in the Golden Rule— The Man with the Gold… Rules.” - Mr. T
Dear Client,
Inflation is set to reaccelerate as growth remains positive, yet slow and decelerating. Stagflation is on the horizon. Gold has already performed well this year and has acted as a buttress to our portfolio. We expect that to continue.
In the third quarter, gold’s positive performance accelerated, and long-dated bonds joined equities and gold with positive performance. After a flat second quarter, commodities were down from July through September. With both growth and inflation decelerating, equity strength was anomalous, but the other primary assets performed exactly as one would expect.
More on that below, but first, a review of recent performance for “primary” assets and the Grey Owl All-Season strategy.
For the third quarter of 2024, US equities were +5.8%. Global equities were +6.4%. Gold was the best performing primary asset class, up +13.1%. For the first time this year, long-dated US Treasury Bonds increased gaining +7.9% during the quarter. Commodities were down -5.2%.
During this period, the Grey Owl All-Season strategy returned +3.4% versus the 60/40 index return of +5.9%. For the full year through the end of the third quarter, the Grey Owl All-Season strategy is up +8.6% compared to the 60/40 index return of +12.9%. For the month of October through Friday, October 18th, the Grey Owl All-Season strategy is up approximately +0.5% while the 60/40 index is exactly flat at 0.0%.
Towards the end of the quarter and into October, the Grey Owl All-Season strategy began shifting toward assets that perform well in a stagflationary environment. Stagflation is when economic growth decelerates at the same time inflation accelerates. If you remember the 1970s, you understand stagflation.
While growth is positioned to continue decelerating, we expect it to remain positive. This is an environment where gold, equities, and commodities are set up to do well. As such, we have and are increasing our exposure to commodities for the first time this year. Equity exposure remains diversified across global equities and we are broadening our allocation to emerging markets.
Economic Growth
In our last letter, we noted that the manufacturing sector growth that persisted for nine months through March 2024 had slowed for three consecutive months. It continued to slow in the third quarter and remains well below 50, i.e. in a mild contraction.
Recall that the (PMI) summarizes in a single data point the state of the US economy. The PMI is a “diffusion index” which aggregates survey data from decision makers throughout the manufacturing economy. The questions are around the managers’ expectations (e.g. “do you plan to acquire more or less inventory next month compared to this month) and are thus a leading indicator of economic activity.
On the other hand, after the slightest contraction in June, the service sector is again showing positive growth.
The “soft landing” persists… for now.
Reiterating our point from last quarter, the trend in weekly initial jobless claims amplifies the idea of economic stagnation. Claims continue to climb. We are still a way from the 300k “threshold” where jobless claims have historically been followed by a rapid drop in payrolls, but this trend bears watching.
Further, when viewed over the period since 2021, payrolls continue to grow at a slower and slower pace. Again, amplifying the idea that the economy is stagnant. Job creation has been decelerating for the past four years.
Inflation
The 5-Year Breakeven rate is starting to show a modest increase in inflation expectations.
Commodity prices are more ambiguous. Are they moving sideways, or is there an upward bias?
Most importantly, the forward-gold price (a concept created by David Ranson at HCWE5), a longer-term indicator, continues to point toward increasing, unrelenting inflation.
In the short-term, Hedgeye’s Monthly Inflation Nowcast is forecasting September as the cycle low in inflation. Reacceleration higher starts in October.
Market Signals
US Equity market performance remains resilient and has broadened significantly since 2023. In addition, global equities are now broadly trending positive. This includes the large markets of both China and Japan. Market internals remain constructive as summarized by the positive spread between buying power and selling pressure via CFRA Lowry Research depicted in the chart below.
Current Positioning
Our current positioning remains constructive. We have exposure to idiosyncratic risk-assets including gold, momentum, and emerging markets. We have recently added more exposure to commodities, commodity equities, and additional emerging markets. We have decreased exposure to fixed income. Our cash position is low.
The US economy has held up better and longer than most believed possible. While the evidence points to unsustainable government borrowing as the most likely explanation, it is impossible to say when it would truly become unsustainable. For the next several months and quarters, the spending is set to continue to take capital from the productive private sector. With a weak dollar (relative to gold), inflation is poised to reassert itself. Stagflation is the most likely outcome.
As always, if you have any thoughts regarding the above ideas or your specific portfolio that you would like to discuss, please feel free to call us at 1-888-GREY-OWL.
Sincerely,
Grey Owl Capital Management, LLC
