Despite Higher Rates, Consumers and Companies in Good Shape

We are excited to release our July 2024 Chart Pack, our visual quarterly designed to walk investors through what’s happening in markets and why, what may come next, and how we are positioning RiverFront portfolios. In today’s Weekly View, we picked a couple visuals from the Chart Pack to discuss.

The U.S. economy continues to defy the naysayers with its strength. The foundation for that strength is the healthy condition of both consumers’ and corporations’ balance sheets, an underappreciated asset in our view. For instance, many assume that the large rise in interest rates over the past two years would correspond to a skyrocketing of consumer debt service costs.  However, the monthly carrying cost of that debt as a percentage of disposable personal income remains surprisingly low relative to history, as seen in Chart 1, below.

This dynamic is likely due not only to the sizable wage gains seen over the past couple of years, but also — importantly — to the fact that most US homeowners have locked in lower long-term rates on their mortgage. According to a January 2024 Redfin analysis of data from the Federal Housing Finance Agency’s National Mortgage Database, almost 60% of current mortgages outstanding have an interest rate at or below 4%, and nearly 9 in 10 mortgages outstanding are below 6% — despite a 30-year fixed mortgage rate that currently stands at well over 7% for new mortgages.

A corollary is seen when viewing Corporate America’s balance sheet through the same lens. Conventional wisdom is that higher interest rates are also a major headwind for US companies. For firms with floating debt, suspect balance sheets and cyclical cash flow, that is likely true. In fact, this dynamic is one of the reasons we remain skeptical of smaller-cap stocks, as we wrote about here. However, for many cash-rich US companies — mega-cap technology in particular — many companies are paying less in net interest expense as a percentage of revenue than prior to rate hikes, not more (see Chart 2, below). near lows last reached in the 1960s.

Many of the largest tech companies have fortress-like balance sheets, with tons of cash and low levels of debt. These types of companies have an incredible advantage over others in a world of higher rates, in our view. This is due to the curious fact that these firms have much more cash and cash equivalents sitting in money markets — earning higher rates of return — than they have debt outstanding. This enables them to make MORE money off the non-operating income generated by their higher-yielding floating rate holdings than they are paying in interest expenses. In essence, they are profiting from rates moving higher.

The adage ‘Sell in May and Go Away’ may be weighing on investors’ minds in the summer months, a time of lighter news flow and trading volume. The market averages about one double-digit pullback in a calendar year, which we have yet to experience in ‘24 — this suggests to us the ride could get rockier, especially as we move closer to US election time.

However, our read on stocks’ internal ‘heartbeat’ — the message embedded in the market’s price action — remains strong. Further, we believe the current bull market is based on solid fundamentals, not simply irrational exuberance. The economic strength discussed earlier is filtering into corporate earnings strength, one of the most important determinants of stock prices, in our view. Our asset allocation portfolios remain overweight stocks, with an emphasis on the US.

For more news, information, and analysis, visit the ETF Strategist Channel.

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Definitions:

Mega cap is a designation for the largest companies in the investment universe as measured by market capitalization. While the exact thresholds change with market conditions, mega cap generally refers to companies with a market capitalization above $200 billion.

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Technology and internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market.

In a rising interest rate environment, the value of fixed-income securities generally declines.

Inflation is a gradual loss of purchasing power, reflected in a broad rise in prices for goods and services over time.

Consumer debt consists of personal debts that are owed as a result of purchasing goods that are used for individual or household consumption.

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