MARKET COMMENTARY:
• We continue to believe that the US inflation rate won’t be able to return to the very low levels targetedby the Federal Reserve anytime soon. The inputs that kept inflation so low for so long (cheap labor; cheapgoods; cheap energy as an input to manufacturing) have all changed. Additionally, we see bothPresidential candidates as inflationary based on a willingness to grow Government spending. Trump maybe even more inflationary as protectionism (tariffs) can drive the price of imported goods higher andtighter immigration policies can drive the cost of labor higher.
• Portfolios should have robust exposure to real assets and other strategies that can perform in this type ofpersistently inflationary environment. A simple portfolio consisting of equities and bonds only will besuboptimal if our view is correct.
• The concentration of the largest names in the S&P 500 has never been greater. This is worth watching, asif the market’s mega-darlings start to falter beyond a typical pullback, the negative impact on the price ofthe S&P500 could be significant.
• Demand for downside protection in the US equity markets remains anemic. Put option skew remains low,and strategies that sell volatility are in high demand, and the demand is increasing. Additionally, 0 DTEoptions are now roughly 50% of daily option volume. Don’t underestimate the potential for a violentdownside repricing in equity indices if the volatility sellers are caught offsides.
Next week brings the July FOMC meeting and the market is expecting the Fed to signal a rate cut in September islikely. Markets imply that the probability of a September cut of 25 bps is close to 100%.
An interesting question being circulated is if the US economy needs lower rates? Certainly, it would help the realestate markets, particularly commercial real estate which has localized areas of stress due to higher financingrates. According to MCSI’s Capital Trends US Distress Tracker, US commercial property distress reached $94.2billion in 2Q 2024, up $2 billion from 1Q 2024. Office buildings are the property type with most distress, followedby apartments. San Francisco, New York City and Chicago lead in terms of locations of properties in distress.
But does the US economy need it overall? It appears that economic growth has perhaps accelerated since June. Jim Bianco has discussed this extensively for those who follow. Economic surprise indices have been trending higher, the Atalanta Fed GDP Now has been moving higher, the Dallas Fed weekly economic index has beenmoving higher and one of the purest forms of discretionary spending, airline travel, continues to break records interms of volume of passengers.
Despite all of the above, some areas of consumer discretionary spending are deteriorating, the unemploymentrate is trending higher, credit card defaults are rising, and bankruptcies are increasing. Is this simply the result ofa continually widening gap between the “haves” and “have-nots”, meaning the middle class and above are livingwell, but the economically challenged are breaking?
Will we get a 25 bps rate cut in September and perhaps another in December and that is it? If inflation starts toincrease again and growth remains robust (our bias), will it be difficult for the Fed to cut more? Small cap stockshave recently surged relative to large caps, partly driven by large call option purchases by institutional investors.Small cap companies are more sensitive to high interest rates as they have fewer funding options. Will small capsbe able to build on the recent momentum if the Fed truncates the expected rate cutting cycle? It is going to be aninteresting fall for politics, the Fed and markets.
Sundial Trend Table:
STRATEGY COMMENTARY:
As a reminder, our Sundial Dynamic All-Weather Portfolios attempt to achieve positive returns regardless of themacroeconomic regime, such as positive or negative growth, or an inflationary or deflationary environment.
This is achieved through a few key principles:
• Utilize multiple asset classes and strategies, beyond traditional equity and fixed income markets
• Utilize both active (tactical) and passive (buy and hold) strategies
• Recognize that some investments are stability seeking (short volatility bias) and others are instability ordislocation seeking (long volatility bias) and it is critical that a portfolio contains both.
The desired result is a portfolio of non-correlated revenue streams, that exhibits attractive asymmetry throughtactical allocations and return stacking, truncates the downside in adverse markets, and is fully offensive inconstructive markets.
Tactical Equity Strategies:
Allocation: High end of the target range
Comment: Our systematic equity strategies continue to be our highest conviction equity exposures. Thesestrategies have generally done an excellent job of identifying single name equities that can outperform the overallmarket, and they have also managed risk well in overall market drawdowns. We continue to methodically dial upexposure to these strategies as they are performing as expected and the environment is very constructive.
Passive Equity Strategies:
Allocation: Low end of the target range
Comment: Our passive equity longs remain at the low end of our targeted range. These positions are mostly inETFs and other diversified exposures. We have not tinkered with exposures much in all in the past 2 years. Withequity indices close to all time highs, and concentration in the largest names so heavy, we prefer to wait for asignificant pullback before adding any additional exposure.
Yield Generating Strategies:
Allocation: High end of the target range.
Comment: A full allocation reflects the attractive opportunity set. There are so many strategies that cangenerate a high single digit and even mid to high double digit annual returns with modest risk. We continue toutilize mostly alternative yield generating investments that focus on private credit, bridge lending, commercialreal estate deals, and tranched insurance risk related strategies. We expect the returns in these strategies toremain in the double digits for the foreseeable future. Specifically related to commercial real estate, our highestfocus is industrial properties. Both flex industrial and specialty properties such as luxury garages are where webelieve the best risk reward is right now.
Trend Following and Inflation Benefitting Strategies:
Allocation: High end of the target range
Comment: Trend following strategies have generally performed very well in 2024, although they have given backsome of their year to date gains. We continue to believe the uncertain macro environment is constructive for“dislocation seeking” trend following strategies. We were never believers in the stock and bond only portfolio,and we continue to hold the view that owning government bonds will not act as much of a portfolio hedge as longas inflation remains above target. Trend following strategies are a far better portfolio diversifier.
Long Volatility / Long Convexity Strategies:
Allocation: High end of the range
Comment: We continue to maintain maximum exposure to these strategies, and when we take on a newportfolio, this is also one of the first positions we initiate. The cost of tail protection (skew) remains extremelylow, the potential for a left fat tail is elevated in our opinion, and we are strong proponents of this exposure in allportfolios.
CHARTS & TABLES:
Interesting Theory from Michael Gayed: Is there a massive carry trade in the market consisting of funding in Japanese YEN (very low rates) and then buyinghigh momentum US equities (large cap tech stocks)? High correlation between a strengthening YEN and the fall of the MAGS ETF along with commentaryaround the possible large margin call this month. Or perhaps it is simply traditional risk off behaviors in both…
Similar behavior between the YEN and the QQQ ETF.
Disclaimers
This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities nor does itconstitute tax advice. This information is for informational purposes only and is confidential and may not be reproduced or transferredwithout the written consent of Sundial. Past performance is not indicative of future results. Statements and opinions in this publication arebased on sources of information believed to be accurate and reliable, but we make no representations or guarantees as to the accuracy orcompleteness thereof. These materials are subject to a more complete description and do not contain all of the information necessary tomake any investment decision, including, but not limited to, the risks, fees, and investment strategies of an investment.This correspondence may include forward-looking statements. Forward-looking statements are necessarily based upon speculation,expectations, estimates and assumptions that are inherently unreliable and subject to significant business, economic and competitiveuncertainties, and contingencies. Forward-looking statements are not a promise or guarantee of future events.Benchmarks and indices are presented herein for illustrative and comparative purposes only. Such benchmarks and indices are notavailable for direct investment, may be unmanaged, assume reinvestment of income, do not reflect the impact of any trading commissionsand costs, management or performance fees, and have limitations when used for comparison or other purposes because they, amongother things, may have different strategies, volatility, credit, or other material characteristics (such as limitations on the number and typesof securities or instruments) than the Firm. It should not be assumed that your account performance or the volatility of any securities heldin your account will correspond directly to any comparative benchmark index. We make no representations that any benchmark or index isan appropriate measure for comparison. The S&P 500® Index is a stock market index from S&P Dow Jones Indices. It is a marketcapitalization weighted index of 500 of the largest U.S. companies, designed to measure broad U.S. equity performance.Asset allocation and diversification will not necessarily improve an investor’s returns and cannot eliminate the risk of investment losses.There are no assurances that an investor’s return will match or exceed any specific benchmark.
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