What's in the Name?

This is such a confusing time of the year for me.  It’s 97 degrees out, yet Halloween decorations are on the shelves and pumpkin spice has returned with a vengeance.  We’re looking at Q2 GDP data while feeling like autumn is right around the corner.  On top of that, we’re heading into the weakest month of the year on average dating back to 1948, and just over two months until the presidential election, which is preceded by the most volatile month of the year.  There is so much going on that it sometimes seems hard to focus on the big picture.  The big picture is that the final three months of the year, on average, are among the best for market returns.  Even bigger yet, is that we stay focused on the years ahead and not the next few weeks or months.  We’re running a marathon, not a sprint.  It’s always worth keeping that in mind.

Before we get to the inflation data, I wanted to share a change that is upon us and will impact how we view fixed income in the near and medium term.  In early 2023, we added a money market position to our models to take advantage of interest rates that hadn’t been seen in over fifteen years.  It was a way to remove volatility while receiving a nice return on a risk-free asset.  In early 2024 we removed the cash position as we anticipated that continued strong economic growth would propel stocks higher as has occurred.  However, with the first Federal Reserve interest rate cut a few weeks away, we now believe reinvestment risk is a growing threat to fixed income.  To hedge against this, we began extending the duration of our individual bond holdings this spring by buying corporates with maturities from 2030-2032.  Not only did we lock in great yields, but we were able to buy issues with coupons above 5% in many cases.  As interest rates fall, the value of these holdings should be appreciated, and we may find ourselves in a position to sell fixed income with a nice gain.  If you have money stashed away in a high yield money market account, understand that current yields will likely begin falling soon and it may be worth considering your next steps.

Now to the big news this week.  The Core PCE Price Index, which excludes food and energy, increased 2.6% y/y in July, less than expected and unchanged from the previous month.  The Fed considers the core PCE index a better indicator of underlying inflation than either the core consumer price index (CPI) or the headline PCE price index.  The inflation data shows that inflationary pressures remain subdued with Fed Chair Jerome Powell last week indicating that “it’s time” for policy to adjust.  Unless next Friday’s jobs report is really weak, the Fed is on track to start its rate-cutting cycle with a 25bp point reduction at its next meeting.  The probability of a 25-basis point rate cut is 69.5%, while the probability of a 50-basis point cut hovers around 30%.

While consumer demand has remained robust this year, it is becoming increasingly clear that there is a shift in spending patterns.  Dollar General had an earnings announcement this week, in which it reported missing on both the the top and bottom lines.  It went a step further in reducing guidance for sales for the remainder of the year, suggesting that its customers are struggling to make ends meet. The stock fell 32% on the news.  But you may also be surprised to find that people at the other end of the spectrum are also cutting back.  Both MasterCraft Boat (MCFT) and Malibu Boats (MBUU) saw sales plunge 60% and 57% respectively in their fiscal fourth quarter.  Malibu Boats saw its profit margin plunge by 88% as high interest rates and falling demand hit its bottom line.  From a profit of $1.37 a year ago, MasterCraft reported a loss of $0.04 in fiscal Q4.  Despite consumer sentiment rising, consumers appear to be pulling back, and it is not just at the lower end of the retail spectrum.

In closing, I want to relay a bit of information that may provide some insight into the cost of producing a luxury product versus its markup.  Thanks to an investigation by Italian prosecutors into labor abuses, we now know how much it costs to produce a Dior handbag.  I hope you are seated.  Citing documents examined by authorities, Reuters reported a couple of months ago that Dior paid a supplier $57 to produce bags that retailed for $2,780.  The working conditions of the supplier are what is under investigation, but can we talk about the markup?  In the same investigation, Armani paid contractors $99 per bag for products that sold for more than $1,900 in stores.  I believe in free markets and if you want a Dior or Armani bag, I am happy for you.  Just know that you’re almost entirely paying for the name.  Now you know. 

Bruce J. Mason, MBA