Trends on Holiday Spends

We recently sat down with Dominic Nolan, CEO of Aristotle Pacific Capital, to get his insights into holiday spending and retail performance in 2024, the equity and bond markets, the economy’s resilience, Fed expectations, and fixed-income opportunities. We finished up with a random round of questions and personal reflection.

Market performance: Total return

Let’s start with markets. U.S. bonds and equities rallied in November. What happened?

I think the markets were reacting to the election results. Expectations are now for more economic growth, deregulation, and lower corporate taxes, and that’s reflected in November’s performance. The S&P 500 Index was up almost 6% last month and 28% for the year. That’s a huge number. And, perhaps most surprisingly to many, the Russell 2000 Value Index was up almost 10% in November and nearly 18% for the year. It’s been an incredibly strong year for equities.

Magnificent 7

What about the Magnificent Seven?

November was another fantastic month. Only one company, Alphabet, had negative performance, and that had to do with company-specific antitrust concerns. What really caught my eye was the fact that Tesla finished up 38% for November, which was almost all its gains this year. Incredible.

And fixed income?

It continues to be a benign year as returns are coupon to coupon plus, but with rate volatility. . After November’s performance, the Bloomberg US Aggregate Bond Index is up almost 3% for the year. Investment-grade corporate bonds are up over 4% for 2024. The standout performers have been high-yield bonds, up over 8.5%, and bank loans, which are up nearly 8.5%. In general, investors should be generally pleased with how their returns have been in 2024.

U.S. Treasury yields declined across intermediate and long maturities in November. What prompted the move lower?

I believe it’s simply an adjustment to the November election results. With the GOP victory, the market was discounting higher growth, higher inflation and more deregulation. To me, things are simply settling back in. The 10-year Treasury has been in the 4 to 4.5% range, but I don’t know how long that will last. I would point out one observation from a chart analysis standpoint: since October 2023, yields are having lower highs and slightly lower lows.

The U.S. dollar has been rallying for the past two months. Do you expect the strength to continue?

Inflation’s coming down, yet rates remain higher. With real rates offering an attractive return, you’re seeing that reflected in currency strength. I don’t know if that will continue but given inflation and Fed expectations along current 10-year Treasury yields, it wouldn’t surprise me if it did.

Economic Dashboard: GDP, Inflation, Jobs and Consumer Spending

What’s the current data telling us about the state of the U.S. economy?

The Atlanta Fed’s GDPNow model recently boosted its GDP forecast for this year from 2.7% to 3.2%, a healthy rate, and inflation is now down to about 2.5%. I’d be surprised if it gets too much lower.. In addition, November’s consumer confidence figures across all income levels are up year over year. The note of caution I see is in the nonfarm payroll numbers, which have slowed down substantially but are still stable. All in all, the economy is chugging along well.

Fed Futures: Accelerating Timing of Rate Cuts (Cuts Expected into July 2025)

The Federal Reserve cut interest rates by a quarter point in November. Is there another cut in the cards for the FOMC’s December meeting?

Here’s where fed funds futures stand right now. The market believes there’s a 77% chance of an interest-rate cut this month, and I do think they will cut. The real question is around the narrative and expecta-tions for next year. Right now, the market is predicting between three and three-a-half cuts in 2025. I personally think there will be three. But it wouldn’t surprise me if the market starts to discount just two cuts next year. That would take us in the mid-threes for fed funds target range. When you think about the 10-year Treasury sitting at about 4.25%, that’s a very positive sloping yield curve.

Do you anticipate friction between the Fed and the incoming administration?

If the economy is going well, there’s no real reason for conflict. The Fed has navigated inflation and raised rates without causing a recession. Now they’re letting up and reducing rates while the economy is still strong. Given everything, I don’t think there’s a problem unless the economy starts to slow down and asset prices drop. In that scenario, I think the Fed gets pressure from the new administration.

Shopping by the Numbers: Beat Expectations but Still Fell Short of Record Levels

Historical Holiday Sales and 2024 Forecast

Let’s turn to holiday spending. To start with, how successful were Black Friday and Cyber Monday?

The economy is resilient, consumer’s resilient, inflation is down—all these things are leading to positive outcomes for the retail sector. The number of in-store and online shoppers over the Thanksgiving weekend were at near-record levels, which is especially impressive since the holiday fell so late in the month and many people had already done some shopping. It’s also interesting to note Black Friday sales attracted significantly more shoppers online (87.3 million) than in-store (81.7 million). This is a secular trend that keeps getting stronger. Overall, the National Retail Federation forecasts a healthy 2.5% to 3.5% year-over-year increase in holiday spending for 2024.

Top Gifts to Give

What are people buying this year?

It’s not the most exciting present, but gift cards have been a choice of more than half the shoppers. The next most popular categories are clothing and accessories, books and other media, personal care and beauty items, and electronics. Home-improvement gifts were the least popular.

Retail Monitor: Total Retail Sales Change Year-over-Year and Month-over-Month

How has overall consumer spending been for 2024?

We’ve seen consistent growth year-over-year growth throughout the year, generally in the 2 to 3% range. Through October, we haven’t had a negative month compared to last year. Consumer spending continues to be strong.

Fixed-Income Yields and Year-to-Date Returns

Now let’s talk bonds. Where do you see opportunities in fixed income today?

I love the fact that investment-grade corporate bonds are now yielding 5% and bank loans, an underrated asset class that we’ve been constructive on for almost two-plus years, have returned over 8.5% for the year, slightly under high yield. We’ll see how that race between bank loans and high yield ends up. The yield for bank loans is still 200-plus basis points higher than high-yield bonds. So, how have loans underperformed high yield when their yield is 200 basis points over? The fed finally cutting rates led to shorter-end bonds appreciating. In fixed income, that’s a reflection of positive convexity. Meanwhile, loans continue to clip coupon and have had little price volatility. I still like the loan side. I do believe fixed-rate yields are at the higher end of the range, but I said the same thing 50, 60 basis points ago. So, I certainly didn’t get that right when rates were at 3.8% or 3.9% on the 10-year Treasury. It seems to be settling in at this 4 to 4.5% range. So, I very much like the investment-grade and the bank loan trades.

Let’s shift gears and go to the random round, starting with MicroStrategy.

It’s a rocket, and I am perplexed at the premium. MicroStrategy feels to me like an active bitcoin equity.

Market surprises after the election.

Rates moving up as fast as they did. I think the market got a little overzealous, but in general, the market is behaving as you would think after the results of this election.

Tariffs in 2025.

I don’t know if the tariff talk is posturing or real. Will there be an increase in tariffs? I would say yes, to the degree is unknown.

Bitcoin vs. gold.

It hasn’t been much of a contest in 2024. Bitcoin is up 127% year to date vs. gold, which is up 28%.

Last one: Do you open a present on Christmas Eve or do you save it all for Christmas Day?

Our family is PJs on Christmas Eve, presents on Christmas Day.

How about a personal reflection as we close out the year?

I’ll keep this simple: Embrace the holiday spirit. Host a party, volunteer, donate, go caroling, bake a holiday treat, and/or start a tradition. We all are given the opportunity to do any or all of these things. I’ll be taking advantage of that. I hope you do, too.

Definitions

The 2-year Treasury yield is the interest rate the U.S. government pays to borrow money for two years. The 10-year Treasury yield is the interest rate the U.S. government pays to borrow money for a decade.

Bank loans (or floating-rate loans) are financial instruments that pay a variable or floating interest rate. A floating rate fund invests in bonds and debt instruments whose interest payments fluctuate with an underlying interest rate level.

Basis points, otherwise known as bps or bips, are a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form.

The Bloomberg US Aggregate Bond Index (Agg) is composed of investment-grade U.S. government bonds, investment-grade corporate bonds, mortgage pass-through securities, and asset-backed securities, and is commonly used to track the performance of U.S. investment-grade bonds.

The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government-related bond markets.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.

A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.

The effective yield is the return on a bond that has its interest payments (or coupons) reinvested at the same rate by the bondholder.

Fed funds futures are a tool used by traders and institutions to hedge or bet on changes in the federal funds rate, which is key to U.S. monetary policy.

The federal funds rate is the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight.

The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve System that determines the direction of monetary policy.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. The nominal GDP growth rate compares the year-over-year (or quarterly) change in a country’s economic output to measure how fast an economy is growing. Real GDP is GDP adjusted for inflation.

GDPNow is a forecasting model that provides a "nowcast" of GDP growth.

High-yield bonds are debt securities, also known as junk bonds, that are issued by corporations.

An inverted yield curve occurs when the yield on 2-year Treasuries is higher than the yield on 10-year notes.

Investment grade refers to the quality of a company's credit. To be considered an investment grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's.

Leverage refers to using debt (borrowed funds) to amplify returns from an investment or project.

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-value ratios and higher forecasted growth values.

The Russell 2000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell1000 companies with lower price-to-book ratios and lower expected growth values.

The S&P 500 Index is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States.

The S&P 500 Equal Weight Index is the equal-weight version of the widely used S&P 500 Index, which is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States.

Spread is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, represented by treasury bonds. Spread income refers to the additional income from this difference.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security.

Yield is the income returned on an investment, such as the interest received from holding a security.

A yield curve plots the interest rates of bonds that have equal credit quality but different maturity dates.

Yield-to-worst is the lowest potential yield that can be received on a bond without the issuer defaulting.

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Any performance data quoted represent past performance, which does not guarantee future results. Index performance is not indicative of any fund’s performance. Indexes are unmanaged and it is not possible to invest directly in an index. For current standardized performance of the funds, please visit www.AristotleFunds.com.

The views expressed are as of the publication date and are presented for informational purposes only. These views should not be considered as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment or market. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed herein are subject to change without notice as market and other conditions warrant.

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