How Heavy is the U.S. Debt Burden?

The last several months have seen a steady drumbeat of data to validate both declining inflation and a slowing economy. CPI inflation for June posted a significant milestone with its first negative monthly print since the depths of the pandemic in Q2 2020.

The remarkable deceleration of inflation in the last two years has allowed the Fed to shift focus within its dual mandate. With inflation on track towards the Fed’s 2% target, the Fed has now started an easing cycle to address and halt continued economic weakness.

Even as lower inflation and the onset of monetary easing now become tailwinds for the economy, a number of market headwinds still persist. These include: 1) stock valuations that are higher than normal, 2) escalating geopolitical risks, especially in the Middle East, and 3) mounting uncertainty around the outcome and policy implications of the U.S. elections.

One of the biggest concerns surrounding the elections is the potentially negative impact of both candidates’ campaign promises on an already high level of U.S. national debt. Neither candidate has come across as fiscally responsible; their fiscal profligacy is instead projected to increase government spending by an additional $5-7 trillion over the next 10 years.

The national debt is a topic of great interest and worry to many people. We focus exclusively on fiscal policy risks in this article.

We recognize that this is a highly charged and potentially contentious topic. We refrain from any ideological, philosophical, political or moral judgment on the topic; our views are focused only on the likely economic and market impact of the U.S. debt burden.

We interchangeably refer to the national debt as total public debt from hereon and set out to answer the following questions.

  • How has the U.S. total public debt grown and who are its main holders?
  • How vulnerable are U.S. interest rates to demands for a higher risk premium i.e. greater compensation for bearing risk?
  • Has the higher debt level contributed to higher economic growth and national wealth?
  • How onerous is the current debt burden and what milestones would further exacerbate fiscal risks?

Sizing the U.S. Debt Burden

The most eye-catching depiction of rising government debt is the nearly six-fold increase in its dollar value over the last 25 years. Total public debt has risen from just under $6 trillion at the turn of the century to almost $35 trillion by June of 2024.

Most of this debt was issued to stabilize the U.S. economy from two devastating shocks during this time – the Global Financial Crisis (GFC) in 2008-09 and the global pandemic in 2020. Since stability of economic growth is a key goal of fiscal policy, the most commonly used metric for the U.S. debt burden is the ratio of total public debt to Gross Domestic Product (GDP). Figure 1 illustrates how total public debt as a percent of GDP has grown over time.

Figure 1: Total Public Debt as a Percent of GDP 

Source: Federal Reserve Board of St. Louis, June 2024

The debt-to-GDP ratio has doubled from almost 60% prior to the GFC in 2008 to around 120% in 2024.

It is interesting to note the different trajectories of the debt-to-GDP ratio after the last two crises.

a. GDP growth after the GFC was anemic as it got dwarfed by an extensive deleveraging cycle.

Slow GDP growth post-GFC caused the debt-to-GDP ratio to spike up rapidly from 60% to 100%.

b. Unlike the GFC which was triggered by unsustainable fundamental excesses, the Covid recession was caused by a global lockdown stemming from health safety considerations. Growth rebounded quickly when economies reopened and was further bolstered by government spending.

Faster post-pandemic GDP growth has contributed to a slower increase in the debt-to-GDP ratio from 100% to 120%.

Most people are alarmed and worried about this rapid increase in the national debt. At first glance, their concerns appear to be well-founded. High and rising government debt could reduce private investment, lead to higher inflation and interest rates, reduce economic growth, weaken the currency, limit future policy flexibility, and create inter-generational inequities.

We analyze these risks by looking at who owns this debt and why, what might make U.S. government debt attractive even at these levels, and whether this level of debt can produce any economic benefits.

Contrary to most prevailing opinions, we believe the fiscal outlook is not nearly as dire. We see no meaningful risk to growth, inflation, interest rates or the dollar in the foreseeable future of 3 to 5 years.

We begin by understanding the composition of the national debt.

Who Owns the U.S. Debt and Why?

Mix of U.S. Debt Holders

Figure 2 shows the two main categories of the gross national debt: debt held by the public (i.e. debt owed to others) and debt held by federal trust funds and other government accounts (i.e. debt owed to itself).

Figure 2: Composition of Gross National Debt

Source: U.S. Department of Treasury, December 2023

Of the $34 trillion in national debt at the end of 2023, $7 trillion, or 21%, was intragovernmental debt which simply records a transfer from one part of the government to another. Intragovernmental debt has no net effect on the government’s overall finances.

In Figure 3, we take a closer look at the remaining 79%, or almost $27 trillion, of the gross national debt which is held by the public. This portion is generally regarded as the most meaningful measure of debt since it represents Treasury borrowings from outside lenders through financial markets. Debt held by the public was 96% of GDP at the end of 2023.

Figure 3: Composition of Debt Held by the Public

Source: U.S. Department of Treasury, December 2023

Almost 70%, or $19 trillion, of the debt held by the public is in the hands of domestic institutions. The remaining 30%, or $8 trillion, is held by foreign entities, split almost equally between foreign private investors and foreign governments.

We examine the motivations of these entities for holding the national debt now and in the future.

Many Reasons to (Still) Hold U.S. Government Debt

Figure 3 shows that the single largest holder of the U.S. national debt is the Federal Reserve Board. When policy rates reached their zero lower bound in 2020, the Fed lowered long-term interest rates by buying bonds. As a result, the Fed still holds more than $5 trillion of U.S. government bonds. It is safe to assume that the Fed is a reliable lender to the Treasury and is unlikely to trigger a sharp increase in interest rates through its own actions.

Mutual funds own more than $3 trillion of U.S. government bonds to achieve diversification in investment portfolios. U.S. government bonds are among the few investments that can protect portfolios during downturns. The safety and long “duration” of U.S. Treasury bonds typically enable them to appreciate when stocks decline during a selloff.

Corporate and public pension funds typically have long-term liabilities to meet the pension obligations of their retirees. As a safe long-duration asset class, U.S. Treasury bonds are a core building block for pension funds to hedge their long-duration liabilities.

Japan and China are the two largest foreign holders of U.S. government debt. Low domestic interest rates in Japan make U.S. bonds particularly appealing for Japanese investors. China runs a large current account surplus, primarily from its favorable trade imbalance of exporting more than importing. China is a natural buyer of safe-haven assets for its more than $3 trillion of foreign exchange reserves.

Unlike the U.S. consumer, foreign consumers tend to save more. This results in a glut of global savings that is simultaneously seeking safety, quality, income, and liquidity. There is no other bond market in the world that offers the size and safety of the U.S. bond market. Figure 4 illustrates the relative size of the world’s largest bond markets.

Figure 4: The World’s Top Bond Markets

Source: BIS, Visual Capitalist, Q3 2022

The U.S. bond market is valued at more than $50 trillion and represents nearly 40% of the global bond market. China’s bond market carries risks of fundamental weakness, currency depreciation and capital controls. The Japanese bond market offers unattractively low interest rates. The remaining bond markets are so small that they do not offer a viable alternative to U.S. bonds.

Now, we take a quick look at the empirical evidence on risks associated with high debt and deficit levels.

High debt and deficits are intuitively associated with high inflation and interest rates. It seems reasonable that greater government spending could spur demand and trigger inflation; it could also curtail private investments from the “crowding out” effect of higher interest rates. Any subsequent tightening to tame inflation would then further slow growth down.

It turns out that this storyline has indeed played out a number of times in high-inflation developing economies. However, it may surprise many of our readers to learn that this is not the norm in low-inflation advanced economies 1. It certainly hasn’t been the case in the U.S. for several reasons.

The U.S. central bank is highly regarded and enjoys strong global credibility. The Fed successfully kept long-term inflation expectations anchored even as inflation reached 9% in 2022. The big increase in total public debt to GDP from 60% to 100% in the aftermath of the GFC didn’t stoke inflation in the ensuing economic recovery.

The U.S. also has solid governance mechanisms to guard against excessive fiscal dominance; two political parties and two independent chambers of Congress provide institutional checks and balances. The U.S. dollar enjoys significant advantages from its status as the world’s reserve currency. The U.S. is home to many of the most innovative and profitable companies in the world, is blessed with abundant natural resources, and boasts a strong military presence.

We are mindful that high levels of borrowing carry inherent risks and that they cannot keep growing endlessly without consequences. However, at this time, we are hard-pressed to pinpoint a specific threshold at which U.S. government debt would become undesirable or untenable.

From a strictly economic perspective, we believe the current level of U.S. national debt is not particularly problematic.

i. Excluding intragovernmental debt and debt held by the Fed, the U.S. debt-to-GDP ratio falls from 120% to 77%.

ii. The remaining domestic and foreign investors have strong incentives to hold U.S. bonds for safety, liquidity, diversification and hedging needs; in any case, there is no viable alternative to the U.S. bond market.

We conclude with a quick look at how the recent increase in total public debt has coincided with economic or market gains.

National Debt and National Wealth

In the four years from 2019 to 2023, total public debt rose from $23.2 trillion to $34 trillion, while nominal GDP grew from $21.9 trillion to $28.3 trillion. The post-Covid annual growth rate of 6.5% in nominal GDP was a lot higher than the meager 4% annual growth from 2009 to 2019.

A number of factors were different in these two periods. A long cycle of deleveraging restrained growth in the post-GFC recovery. An equally powerful theme in this recovery is the significant, but still nascent, impact of technology and AI on the economy and markets. Over the last few years, pandemic-related health safety needs have spurred numerous technological innovations and inventions.

There is a school of thought that our current GDP measurement may not fully capture all the benefits of technological advancements. We will explore this theme in a different setting at a different time. But for now, this notion prompts us to examine the association of debt levels with other measures of well-being or monetary gains.

In this setting, we identify the U.S. national wealth as a useful measure of prosperity. National wealth aggregates the total nominal value of assets and liabilities across all sectors of the U.S. economy. These assets include real estate, corporate businesses and durable goods; liabilities include foreign claims on U.S. assets.

Figure 5 shows the rapid rise in both national wealth and national debt.

Figure 5: Growth of National Wealth and National Debt

Source: Federal Reserve Board of St. Louis, June 2024

The two biggest components of national wealth, by far, are real estate and domestic businesses. We have long argued that one of the key factors behind the resilience of the U.S. consumer is the wealth effect. Home prices and stock prices are at all-time highs and, as a result, so is household net worth. The top quintile of households by income, who account for more than half of all consumer spending, have particularly benefited from the wealth effect.

Several factors have contributed to the rise in national wealth. It is difficult to ascertain exactly what role the fiscal stimulus may have played in its recent rapid growth. However, we do believe that fiscal policy has contributed in some positive manner to the growth in national wealth.

We look at national debt as a percent of national wealth in Figure 6.

Figure 6: Steady Debt to Wealth Ratio in Last 15 Years

Source: Federal Reserve Board of St. Louis, June 2024

The dollar value of both the national debt and national wealth has nearly tripled from 2009 onwards. As a result of the synchronized growth rate in both metrics, total national debt has held steady between 22-25% of national wealth from 2009.

To the extent that the pandemic simultaneously unleashed both significant fiscal stimulus and highly profitable technological innovation, national debt and wealth have moved in tandem. By this yardstick, the U.S. national debt burden looks less onerous.

Summary

We recognize how intensely people feel about the national debt burden. We also understand that there are several intuitive reasons to worry about it. We pass no judgment to either condone or condemn it in this article; we simply examine its likely economic and market impact in the coming years.

We summarize the many reasons why investors hold U.S. government debt and will likely continue to do so on similar terms.

  • High credibility of monetary policies
  • Unparalleled size, safety, quality and depth of the U.S. bond market
  • U.S. dollar as the world’s reserve currency
  • Lack of viable alternatives for domestic and foreign investors
  • Diversification and hedging needs of long duration asset owners
  • Solid governance against fiscal dominance
  • Global glut of savings
  • Disinflation from technology
  • Vibrant economy and formidable military 

We do not expect the national debt burden to create meaningfully higher inflation, higher interest rates or a weaker dollar in the foreseeable future of 3 to 5 years.

We remain vigilant and alert, but we maintain our conviction that the U.S. economy continues to head steadily towards a new equilibrium. We do not anticipate any imminent major shocks in this new economic cycle and bull market.

1Footnote: “Fiscal Deficits and Inflation”, Luis Catao and Marco Terrones, International Monetary Fund


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Excluding intragovernmental debt and debt held by the Fed, the U.S. debt-to-GDP ratio falls from 120% to 77%.

 

The remaining investors have strong incentives to hold U.S. debt for safety, liquidity, diversification and hedging needs.

 

We do not expect the national debt burden to create meaningfully higher inflation, higher interest rates or a weaker dollar in the foreseeable future of 3 to 5 years.

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Whittier Trust, the oldest multi-family office headquartered on the West Coast, is proud to announce that Robert L. Levy has been elevated to the role of Director of Investments for Whittier Trust Company of Nevada, Inc., as a reflection of his continued dedication and contributions to the firm. In this new role, Robert helps oversee the company’s investment strategy, leads a highly skilled investment team and spearheads the identification and execution of key investment opportunities while guiding client investment policy objectives.

David Dahl, President & CEO of Whittier Trust, commented on Robert’s remarkable career, stating, “Robert has been with Whittier Trust for more than two decades and has consistently demonstrated exceptional investment, acumen and leadership. His track record in identifying profitable opportunities has been instrumental in driving the growth of our investment strategies. We are confident that under Robert’s leadership, our clients will continue to benefit from our firm’s robust investment approaches.”

Robert’s tenure at Whittier Trust began in December 2000, and his contributions have been critical in helping the firm and its clients navigate many complex and unprecedented market cycles. He has played a key role in growing both client portfolios and the firm itself.

As Director of Investments, Robert has a pivotal role in shaping Whittier Trust’s investment philosophy, creating customized strategies for clients, and overseeing the firm’s flagship large-cap equity strategy, known as Corporate America. He will also continue to serve on Whittier Trust’s committee that analyzes, selects, monitors, and advises on external investment managers, ensuring that clients have access to top-tier advisors and exceptional investment guidance.

Robert is an active member of the Nevada community, where he serves on the boards of Whittier Trust Company of Nevada, Big Brothers Big Sisters of Northern Nevada and the Renown Health Foundation. His commitment to giving back is also reflected in his role as Trustee of the Joshua L. Anderson Memorial Foundation and College Scholarship Fund.


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Whittier Trust, the oldest multi-family office headquartered on the West Coast, is pleased to announce that Dean Byrne, CFA®, has been promoted to Executive Vice President, while continuing to serve as Senior Portfolio Manager and Regional Manager of the Whittier Trust Company of Nevada, Inc. In his role, Dean is responsible for leading a team of experienced professionals in delivering customized wealth management services to high-net-worth clients while advancing initiatives to further Whittier Trust’s growth strategy.

Dean Byrne has been with Whittier Trust for more than 20 years, playing an integral role in advising clients on holistic asset allocation, risk assessment, efficient wealth transfer strategies and charitable giving, always emphasizing after-tax performance. As part of Whittier Trust’s Investment Committee, Dean contributes to shaping the firm’s investment strategies and client solutions.

"Dean’s advancement to Executive Vice President acknowledges his exemplary leadership in Nevada and his steadfast focus on delivering personalized, high-caliber service to our clients," said David Dahl, President and CEO of Whittier Trust. "Under his strategic guidance, our Nevada office has seen significant growth and a deepening in the quality of the services we provide to our clients. Nevada, with its unique trust and estate planning capabilities, is a key part of our strategic vision, and we are eager for Dean to continue driving our future efforts there."

Dean Byrne’s extensive background includes his designation as a Chartered Financial Analyst (CFA®) and his involvement with the CFA Society of Nevada. He is deeply connected to the University of Nevada, Reno (UNR), where he received his bachelor’s degree in Finance. Dean serves on the Board of the University of Nevada Foundation and is a member of their Investment Committee. He is also an active member of the University’s Silver and Blue Society and sits on the Advisory Board for the school’s College of Business.

In addition to his professional achievements, Dean contributes to the community as the Treasurer and a member of the Board of Directors of Classical Tahoe, a premier cultural event in the region.

Dean’s promotion is a testament to his expertise, leadership, and unwavering dedication to Whittier Trust’s mission of providing personalized, comprehensive, and local wealth management services. 

 


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Whittier Trust, the oldest multi-family office headquartered on the West Coast, is pleased to announce the promotion of Brittany Renna, CFP®, APMA®, CTFA®, to the role of Vice President, Client Advisor, with the firm’s Newport Beach office.

In her new role, Brittany will deliver a holistic and customized approach to managing clients' wealth and estates, helping them navigate complex financial landscapes and plan for the future. Brittany is known for her deep commitment to working with business owners on pre-liquidity and succession planning strategies. By collaborating closely with estate planning attorneys, tax advisors, and portfolio managers, she creates tailored solutions that address her clients’ specific needs and ensures smooth wealth transitions across generations.

“With the growth we’ve been seeing in the time since Brittany has joined Whittier Trust, we anticipate that she will play a pivotal role in the company’s Newport Beach office, contributing significantly to not only this office but the company’s continued success,” said Lauren Peterson, Senior Vice President, Client Advisor at Whittier Trust. “Her expertise and passion for helping clients with intricate financial strategies make her an invaluable asset to our team. I’m so proud to work alongside Brittany and am excited to see the remarkable things she’ll achieve in this new role.”

In addition to her role at Whittier Trust, Brittany serves on the board of Impact Giving, a women’s collective giving nonprofit based in Orange County. Brittany holds a Bachelor of Arts degree in Economics with an emphasis in Accounting from the University of California, Los Angeles, and a Master of Science in Personal Financial Planning from the College for Financial Planning. Brittany is also a Certified Trust and Fiduciary Advisor (CTFA), Certified Financial Planner (CFP), and Accredited Portfolio Management Advisor (APMA).

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For more information about Whittier Trust's wealth management, estate planning and family office services, start a conversation with a Whittier Trust advisor today by visiting our contact page.

 

 

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The Big Central Bank Dilemma

The U.S. economy and capital markets continued to surprise investors through the first half of 2024. The year began with high hopes that the rapid disinflation of 2023 would continue in an orderly and uninterrupted manner. This in turn spurred optimism that the Fed would be able to cut rates as early as in March. At that stage, the consensus expectation for monetary policy was 6 to 7 rate cuts in 2024 alone.

These hopes were dashed in the first quarter as inflation readings came in higher than expected. The economy remained unusually resilient as job growth and consumer spending exceeded expectations. In a matter of just
a few months, the timing of rate cuts has changed dramatically. In early July, the Fed’s projections called for just one rate cut in 2024; the market was pricing in two. Not surprisingly, bond yields have also remained higher; most bond market indices generated flat returns in the first half of 2024.

Under normal conditions, such a hawkish pivot in monetary policy might also have derailed stocks, especially at their loftier valuations during most of 2024. Instead, U.S. stocks performed remarkably well in the first half of 2024. The S&P 500 index rose by 15.3%, the Nasdaq 100 index surged 17.5% and the Russell 3000 index gained 13.6%.

Even as monetary policy expectations disappointed, the stock market derived its strength from stellar earnings growth. Most investors were caught flat-footed by their belief that the consensus double-digit earnings growth rates for 2024 and 2025 were simply too high. On the other hand, we had formed the minority view in our 2024 outlook that not only were these earnings levels likely to be achieved, but they could even be exceeded. Stocks handily outperformed bonds in alignment with our tactical positioning.

The resilience in economic activity and inflation at the beginning of the year gave rise to a new theory in support of higher-for-longer interest rates. By historical standards, a Fed funds rate of 5.4% should have been significantly restrictive in slowing the economy down. In fact, many had expected the 11 rate hikes in this tightening cycle to cause a recession by 2024.

A plausible explanation for the muted impact of higher interest rates is that the post-pandemic economy is operating at a higher speed limit. This possibility has several implications. It suggests that the neutral policy rate to keep this economy in equilibrium is also higher. If this were true, then the actual policy rate is not nearly as restrictive as what history would suggest. A higher neutral rate also suggests that eventual Fed easing won’t be as significant as expected. And finally, in this setting, all interest rates would end up higher than expected as well. We explore the possibility of a change in the neutral rate in our analysis.

Recent economic data, however, is now beginning to reverse. The last couple of months have seen renewed evidence of cooling inflation, a weaker job market and a softer economy. By the end of the second quarter, both headline and core inflation had receded to 2.6%, the unemployment rate had risen above 4% and real GDP growth in 2024 was tracking below trend at around 1.5%.

This recent decline in inflation and economic activity poses a difficult dilemma for the Fed. As long as growth was resilient, the Fed had the option to remain patient and keep rates high. Indeed, their policy so far has focused on avoiding the policy mistakes of the late 1970s. If they ease too soon, a potential surge in economic activity might rekindle inflation and send it higher.

However, as growth deteriorates and inflation heads lower, the risks of waiting too long may now outweigh the benefits of being patient. Several sectors of the economy remain vulnerable to the prolonged impact of higher interest rates. These include the highly leveraged private equity and commercial real estate businesses and the less regulated private credit markets. The balance of risks may well tilt towards growth and away from inflation. The Fed is clearly focused on this dynamic; Chairman Powell began his semi-annual July congressional testimony by observing that “reducing policy restraint too late or too little may unduly weaken economic activity and unemployment.”

As a result, the Fed finds itself at a crucial juncture in formulating future monetary policy. In addition to getting the timing of rate cuts right, it also needs to assess the proper neutral rate in this new cycle to calibrate the eventual magnitude of easing.

We focus our article on fully understanding this big central bank dilemma. We offer policy recommendations that may yet allow the Fed to thread the needle and engineer a soft landing. Finally, we juxtapose the Fed’s likely course of action with the divergent easing paths of foreign central banks.

  • Is there a new neutral rate at play? How has it changed? What are its policy implications?
  • When should the Fed make its first rate cut? How many should they do? At what speed?
  • What are the implications of divergent central bank easing policies across regions?

The Neutral Rate

We have previously written about how the U.S. economy is now less rate-sensitive than ever before. Consumers and corporations alike have locked in low fixed rates well into the future; they are more immune to rising rates than they were in the past.

However, the unexpected resilience of the U.S. economy is also starting to spur a new theory about future Fed policy. The key concept in this line of thinking is the so-called neutral interest rate. First, a quick definition. The neutral rate is the equilibrium policy rate that allows an economy to achieve its full potential growth at stable inflation. In other words, it is the steady-state policy rate that is neither restrictive nor accommodative; it is neither expansionary nor contractionary.

While it is intuitive, a major practical limitation of this framework is that the neutral rate is unobservable and, therefore, cannot be measured. It can only be estimated ex-ante; it is eventually validated ex-post by trial and error from actual realized outcomes of growth and inflation.

Many believe that the neutral rate is now permanently higher. They, therefore, contend that there are far fewer rate cuts ahead of us. The more profound implication of this assertion is that higher rates may prevail forever, not just for longer. Market expectations have clearly moved in this direction. We see this in Figure 1.

Figure 1: Market Expects A Higher Neutral Rate Than The Fed Does

Source: Bloomberg, FactSet

The navy line in Figure 1 depicts the market’s estimate of the neutral rate. It is derived from a useful, but less widely followed, measure of future expected risk-free rates. We describe this technical metric as simply as possible and explain how it becomes the market’s proxy for the neutral rate.

The Overnight Index Swap (OIS) is a useful tool to hedge interest rate risk and manage liquidity. For our purposes here, we can think of the OIS rate as the fixed rate for which one is willing to receive a floating rate in exchange. This floating rate is typically tied to an overnight benchmark index such as the Fed Funds Effective Rate. The OIS 5y5y rate shown as the navy line in Figure 1 can be interpreted as the fixed rate for a period of 5 years, starting 5 years from now, at which one would be willing to receive the overnight floating rate in exchange.

In its simplest form, it reflects the market’s projection of the average overnight or risk-free rate over a 5-year period, which begins 5 years from now. Because the OIS 5y5y rate is a proxy for the overnight rate in the longer run, it is the market’s estimate of the neutral policy rate.

The setup for defining the market neutral rate was tedious, but analyzing it is fascinating. Before we do so, here is a quick and far simpler word on the light blue line in Figure 1. It is the Fed’s projection of the long-term or neutral policy rate.

In Figure 1, we see that the market neutral rate has long been anchored by the Fed’s estimate of the neutral rate. Since 2012 in the post-GFC era, the market neutral rate (navy line) has consistently remained below the Fed’s neutral rate (light blue line).

This trend has reversed in the last two years. In recent weeks, the overnight swaps market has been pricing the neutral rate at just below 4% (e.g. it was 3.7% on July 8). On the other hand, the Fed’s long-held estimate of the neutral rate has been 2.5%; the Fed has now revised it up to 2.8% as of June 2024.

The market neutral rate burst above the Fed’s neutral rate in early 2022. We believe the initial 2022 spike in the market neutral rate was driven by expectations of higher inflation. We believe its subsequent rise in the last 12 months has been fueled by expectations of long-term economic resilience.

The Fed’s policy rate is currently at 5.4% and the true neutral rate will determine how low it can go. If the market is correct about the new neutral rate being closer to 4%, cumulative Fed easing will be a lot less than what may have happened in previous regimes of a lower neutral rate.

We offer our own view on where the new neutral rate may emerge in the coming months. We believe it is higher than the Fed’s 2.8% projection, but it is nowhere close to the market’s expectation of around 4%.

As we mentioned at the outset, the neutral rate is unobservable and hard to measure. But we do know that the nominal neutral rate is influenced by inflation. It is also affected by changes in the trend growth rate. We believe each of these factors will be higher in the next cycle and create a new neutral rate of 3.0-3.2%.

We have maintained for a couple of years now that the Fed’s 2% inflation target will likely be elusive. An aging population, along with new potential immigration barriers, will constrain the supply of labor and create a higher floor for wage inflation. We also believe that impediments to global trade in the form of tariffs and a populist mindset of de-globalization will potentially lead to higher inflation. We expect trend PCE inflation to settle at 2.3-2.4%.

We also expect a small increase in trend GDP growth. We have seen a recent rebound in productivity growth; we expect this to become a more secular trend as technology, AI, robotics and automation drive further productivity gains. We also expect the U.S. economy to be modestly more resilient and impervious to higher inflation and interest rates.

We summarize this section with the following observations.

  • We believe a new neutral rate is at play in this economic cycle.

    • It is higher than the Fed’s estimate of 2.8%, but well short of the market’s expectation of 3.7%. We peg it to be around 3.0-3.2%.
  • The market may be mistaken in expecting significantly higher trend inflation or trend GDP growth.

    • Technology remains a powerful disinflationary force.
    • Increases in trend GDP growth will inevitably be bounded by a slowing labor force and only modest productivity gains. The market may be erroneously extrapolating recent economic resilience too aggressively, too far out into the future.

Future FED Policy

Magnitude of Rate Cuts

Our discussion on the likely neutral rate going forward makes it easier to anticipate future Fed policy. The Fed funds rate is currently at 5.4%; we estimate the new neutral rate to be 3.1%. We believe this leaves room for 8 to 9 rate cuts in the next 18 to 24 months. The speed at which the Fed is able to implement these rate cuts will depend on how rapidly inflation and economic growth can cool off.

Timing and Trajectory of Rate Cuts

We preface this discussion with our most startling takeaway. We believe the timing and trajectory of rate cuts, to a large extent, will simply not matter. In many ways, we already have evidence to that effect; they haven’t mattered so far in 2024. Expectations for rate cuts this year have gone down from 6 starting in March to just 2 now by December. And yet, the stock market has been strong; the S&P 500 index was up more than 15% through June.

Our logic for this assessment is simple. As long as the market can anchor to the total magnitude of likely rate cuts based on an understanding of the neutral rate, it will likely look through the timing of the first rate cut and the subsequent speed of the next few.

We, nonetheless, believe that the following sequence of rate cuts may be optimal in balancing both inflation and growth risks.

  • We see sufficiently softer inflation and growth to implement the first rate cut in September and two more by December 2024.
  • We believe the Fed can get to a neutral rate of 3.0- 3.25% before the end of 2026.
  • We hold out the caveat that no Fed action for the next 6 months would be a policy misstep.

Global Central Bank Divergence

Global central banks have been remarkably coordinated and synchronized since the onset of the Covid-19 pandemic in 2020. All of them eased immediately and dramatically to support economic growth during the global lockdowns. Post-pandemic inflation, induced by this flood of liquidity, was also a global phenomenon, which then led to a synchronized global tightening cycle.

As inflation and growth begin to cool down across the world, there is some angst that global monetary policy will not be fully in sync during the upcoming easing cycle. We have already seen this happen. The Fed is still on the sidelines awaiting its first rate cut. In the meantime, the Swiss National Bank has already cut rates twice this year, the European Central Bank (ECB) has eased once, the Bank of England hasn’t moved yet and the Norges Bank has indicated that they won’t ease until 2025.

We believe that the more disjointed global easing cycle is actually justified from a fundamental perspective. These differential easing paths are largely being driven by different growth dynamics across the world. We see this in Figure 2.

Figure 2: 2024 Real GDP Growth Estimates Across Regions

Source: FactSet

Recent GDP growth has been higher in the U.S. than in Europe. It is no surprise, therefore, that the Fed has more flexibility to ease at a slower pace than the ECB does.

We still expect the overall trend towards easing to be consistent across central banks. We believe that the Bank of Japan will be the only major central bank that won’t cut rates by the end of 2025. Many others will begin to do so in 2024. A global easing cycle is about to begin and global short rates are expected to decline by almost 150 basis points over the next 18 months.

We believe stronger growth fundamentals will continue to favor U.S. stocks and the U.S. dollar. As a convenient and desirable byproduct, the strength in the U.S. dollar will continue to be disinflationary and bolster the case for a sustained Fed easing cycle.

Summary

We explored several nuances of the upcoming central bank dilemma. We examined the prospects of a new neutral rate for the U.S. economy, the magnitude and timing of likely Fed rate cuts and the potential for any adverse effects from divergent easing across global central banks.

We summarize our key takeaways below. We believe:

  • There is a new and higher neutral rate of 3.0-3.2% for the U.S. economy in this cycle.
  • While above the Fed’s long-held view of 2.5%, our estimate of the neutral rate is well below market expectations of around 4%.
  • The market is likely overestimating the neutral rate by extrapolating significantly higher trend inflation or trend GDP growth.
  • With the Fed currently at 5.4%, our 3.1% estimate of the neutral rate leaves room for 8 to 9 rate cuts in the near term.
  • Inflation and growth dynamics suggest that the Fed can get to the neutral rate in 18 to 24 months.
  • As long as the markets can anchor to the likelihood of 8-9 rate cuts in aggregate, the actual timing and trajectory of Fed rate cuts will not matter to a large extent.
  • We see enough weakness in inflation and economic growth to advocate the first rate cut in September and two more by December 2024.
  • No Fed action for the next 6 months will likely constitute a policy misstep.
  • Global monetary policy is likely to be less synchronized in the upcoming easing cycle, but not in a materially adverse manner.

We have been increasingly confident that high inflation and interest rates will soon subside. We also remain confident in the earnings outlook. With the tailwinds of accommodative monetary policy and strong earnings growth, we rule out a bear market scenario or even a prolonged correction for U.S. stocks.

Our sustained risk-on positioning in the last two years has worked well. We maintain a similar, but more modest, posture going forward. We continue to exercise prudence in managing client portfolios.

To learn more about our views on the market or to speak with an advisor about our services, visit our Contact Page.

We believe there is a new and higher neutral rate of 3.0-3.2% for the U.S. economy in this cycle.

 

We believe the market is grossly overestimating the neutral rate at around 4%.

 

With the Fed funds rate at 5.4%, our 3.1% estimate of the neutral rate leaves room for 8 to 9 rate cuts in the next 18 to 24 months.

From Investments to Family Office to Trustee Services and more, we are your single-source solution.

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Watch this video of Sandip Bhagat, our Chief Investment Officer, discussing the latest market insights.

Relative Value... Opportunities or Mirages?

The dramatic melt-up in stock prices during the fourth quarter of 2023 continued into early 2024. Fears of an impending recession continued to recede and economic activity exceeded expectations. Job growth is now down to pre-Covid levels and remains solid. With the Fed firmly on pause after ending rate hikes in 2023, expectations of a pivot to rate cuts took hold during the first quarter.

Stronger-than-expected growth and the potential advent of monetary easing propelled the S&P 500 higher by 10.6% in the first quarter. The Nasdaq 100 rose by 8.5% and the Russell 2000 index of smaller companies gained 5.2%.

The unexpected economic strength was also accompanied by unexpected increases in monthly inflation. Forecasts for the number of Fed rate cuts fluctuated wildly and fell from 7 to 3 by the end of March. Bonds sold off as a result and the 10-year Treasury bond yield rose from 3.9% to 4.2% during the quarter.

Several concerns still linger in investors’ minds. The recent uptick in inflation may halt or reverse the downward trend of disinflation. A higher-for longer restrictive Fed might derail the economy and the stock market. The generally reliable signal from an inverted yield curve is still calling for a recession. And finally, many fear that stock valuations may be dangerously stretched and earnings expectations may be unrealistically lofty.

We addressed these concerns in our 2024 outlook published last quarter. We devote this article to a deeper dive on stock valuations. As investors fret high stock valuations, especially in mega-cap growth companies, they are now searching for more attractive “relative value” opportunities within the global equities universe.

Small cap and international stocks have significantly underperformed in recent years. As a result, their valuations have declined. On a relative basis, their valuation differential to U.S. large cap stocks is now approaching all-time lows.

Figure 1 illustrates the stark valuation differentials between U.S. large (LRG), mid (MID) and small (SML) companies and those in the developed (DEV) and emerging (EM) international markets. We show P/E ratios for each equity index based on 2024 earnings estimates.

Figure 1: P/E Ratios Across Size and Regions

Source: FactSet, US Large: S&P 500 Index, US Mid: S&P 400 Index, US Small: S&P 600 Index, Developed: EFA ETF, Emerging: EEM ETF

A similar valuation dispersion is also observed between value and growth stocks. Value stocks are those that trade at lower P/E multiples; they have underperformed growth stocks by a wide margin in recent years. One of the widely believed stock market anomalies is the propensity of value stocks to outperform growth stocks in the long run.

At this point in the cycle, a big valuation gap is only one of many factors that make small cap, value and international stocks more interesting. Small cap and value stocks usually outperform during a revival of growth after a slowdown. As the prospects of a recession abate, we are conceivably at an inflection point for the resumption of economic growth.

International stocks perform better when the global economy improves and the dollar remains weak or neutral; both of these conditions are likely to prevail in the coming months. And finally, the breadth in the U.S. stock market is remarkably narrow. At the end of March, the top 10 stocks in the S&P 500 index made up an extraordinary 34% of its market capitalization and accounted for 82% of its return in the last 15 months. If breadth expands to more normal levels, value and small cap stocks will most likely benefit.

We recognize these arguments in favor of small cap, value and international stocks. We are even intrigued by their potential to enhance portfolio returns.

But are small cap, value and international stocks truly attractive “mispriced” opportunities, or are they mirages and potential value traps?

We look for important fundamental differences between these equity sub-asset classes which may explain their big valuation differentials. We identify and examine three key differentiators within the equity universe.

  • Sector composition
  • Growth prospects
  • Fundamental quality

We find that there are sufficiently large variations in these fundamental factors to justify the divergence in relative valuations.

We caution, therefore, that “all that glitters may not be gold” in the world of relative valuations. Investors will be better served to look past mirages and avoid value traps where cheap stays cheap or gets even cheaper.

Sector Composition

The U.S. has produced some of the world’s most innovative, successful and dominant companies in recent years. Most of them are either Technology companies or ones whose business model leverages technology in a big way.

On many levels, U.S. large companies exemplify the New Economy where technology lowers costs and increases growth, profits and productivity. Developed international companies lie at the other end of the spectrum. Financials and Industrials dominate the developed international index within a more conventional Old Economy setting.

Figure 2 arrays the sector weights for U.S. large, mid and small companies and those in the developed and emerging international markets.

Figure 2: Sector Weights Across Size and Regions

Source: FactSet, US Large: IVV ETF, US Mid: IJH ETF, US Small: IJR ETF, Developed: EFA ETF, Emerging: EEM ETF

Figure 2 shows larger sector weights within each of the five equity indexes in deeper shades of blue. Two key observations jump out from the heat map of sector weights.

i. The Technology and Communications sectors make up almost 40% of LRG, but are less than 15% of MID, SML and DEV.

ii. Conversely, the Financials and Industrials sectors make up almost 40% of MID, SML and DEV, but are just around 20% of LRG.

At its core, the higher weight in the higher P/E Technology and Communications sectors and the lower weight in the lower P/E Financials and Industrials sectors make LRG more expensive than MID, SML, DEV and EM.

We can adjust for sector weight differentials by equalizing all sector weights to a common level e.g. those seen in LRG. We can then compute sector-adjusted P/E ratios for each of the five equity sub-indexes.

Figure 3 shows sector-adjusted P/E ratios for a more apples-to-apples comparison with equal sector weights.

Figure 3: Sector-Adjusted P/E Ratios across Size and Regions

Source: Same as Figure 1

We can see that the green sector-adjusted P/E ratios show less dispersion than the original blue P/E ratios. The higher valuation of the U.S. large cap index is attributable to the presence of several leading companies whose superior fundamentals command a premium valuation. We believe sector composition is one reason why U.S. large cap stocks are justifiably more expensive.

Growth Prospects

The most general framework for stock valuations is based on discounted cash flow analysis. The price of a stock today is the present value of all future cash flows. In a simplified model with constant parameters, the P/E multiple can be estimated from the dividend payout ratio, the growth rate of cash flows and the required rate of return.

It is both well-documented and intuitive that the higher the growth rate, the higher the P/E multiple. The required rate of return incorporates a “risk premium” which compensates investors for bearing greater risk. The more risky the stock, the higher the required rate of return and the lower the P/E multiple.

We first look at the growth rate of earnings and then the riskiness of companies to understand variations in P/E ratios.

Even though stock valuations are a function of both growth rates and riskiness, a useful heuristic has evolved over the years for those investors who wish to focus primarily on a company’s growth prospects. The P/E to Growth (PEG) ratio divides the stock’s P/E ratio by its growth rate. Although blunt and narrow in scope, this simple adjustment neutralizes the effect of growth rates on P/E ratios. The higher the growth rate, the lower the PEG ratio and the cheaper the stock valuation.

While intuitive, the actual calculation of the PEG ratio is a bit complicated by the difficulty in estimating growth rates. Although historical earnings growth rates can be easily calculated, they may not be a reliable indicator of future growth rates. Analyst earnings estimates are generally available for the next two fiscal years; longer-term future growth rate estimates are either unreliable or simply not available.

Since the PEG ratio is a simplified valuation metric, estimation errors in growth rates become less meaningful. In any case, growth rates tend to be fairly correlated over time and, therefore, do not change abruptly.

We compare the three U.S. equity indexes on PEG ratios in Figure 4. We use available analyst earnings estimates to calculate future intermediate term growth rates. The P/E ratio is still based on 2024 earnings estimates.

Figure 4: PEG Ratios across U.S. Size Indexes

Source: Same as Figure 1

We saw earlier that, based on just P/E ratios, LRG is more expensive than MID, which in turn is more expensive than SML.

Figure 4, however, depicts a different picture after adjusting for growth. The PEG ratios for the three equity size indexes look more uniform; MID actually looks the most expensive based on this measure. This shift in relative value comes from differences in earnings growth rates. LRG has a stellar double-digit earnings growth rate while MID has a growth rate which is only half as high.

The high growth projections for the Magnificent 6 (Nvidia, Microsoft, Apple, Alphabet, Meta and Amazon) highlight the importance of this factor. The Magnificent 6 are expected to grow sales by 13%, earnings by 17% and free cash flow by 22% annualized over the next five years; it makes perfectly good sense for this impressive growth trajectory to drive elevated P/E multiples.

We conclude this section with a simple observation. The higher valuations of U.S. large cap stocks may be more attributable to higher growth rates than to mere speculation.

Finally, we take a look at the diffuse and amorphous concept of fundamental quality to further understand differences in P/E ratios.

Fundamental Quality

We have so far discussed size, value and growth; they are all fundamental drivers of stock valuations and returns. The common theme across these three factors is that they can be defined easily and measured fairly precisely. Size is simply market capitalization, value is the ratio of price to earnings, sales, free cash flow or book value and growth measures the annualized change in earnings, sales or free cash flow.

Unlike these clear and homogenous factors, the concept of quality tends to be more nebulous and heterogeneous. Some investors may associate high quality with high profitability; they would focus on return on assets, return on equity and return on invested capital. Others may look for more efficient capital allocation in the form of reduced debt, higher dividends and more share buybacks.

Yet others would approach quality from the perspective of how risky a company is. In this instance, higher quality would imply better balance sheets and stronger income statements derived from superior business models. Attributes that capture high quality in this vein may include low earnings variability, low volatility of operating margins, low financial or operating leverage and low accounting accruals.

The heterogeneity of high-quality companies and their myriad risk exposures make it difficult to quantify the impact of the quality factor on valuations. Nonetheless, it is reasonable to infer that high quality embodies stability, durability and resilience and should lead to higher valuations.

For the scope of this article, we stick with a qualitative discussion of the quality theme. We look at return on invested capital (ROIC) as a broad measure of profitability. Companies invest capital in people and assets to earn a rate of return. In order to be accretive to economic value, this return must exceed the firm’s weighted average cost of debt and equity capital.

The return on invested capital is a powerful profitability metric that affects both current valuation and future earnings and returns. Large increases in ROIC will enhance firm value and generate higher returns. A high level of current ROIC captures past value creation and is reflected in higher valuations.

We examine ROIC and other measures of profitability for our five equity indexes. We also look at the relative volatility of earnings and margins. Here are some generalized observations.

a. The return on invested capital for U.S. large companies is higher than it is for any of the other size or regional indexes. In fact, the ROIC for LRG is almost double the ROIC for SML. The same is true for return on equity.

b. Return on invested capital for LRG now exceeds 10% and its return on equity is greater than 20%. These are unprecedented levels of profitability for any stock market index. We believe these levels and trends are sustainable for U.S. large companies.

c. At the same time, the relative standard deviation for ROIC as a risk measure is almost twice as high for MID and SML as it is for LRG. The relative standard deviation for operating margins follows a similar pattern.

U.S. large cap stocks have higher financial and operational quality. They are fundamentally more profitable and less risky than their small cap and international counterparts. We believe a big portion of their premium valuation comes from the positive quality differential in their favor.

Summary

Investors are mindful of high stock valuations overall and the potential for a broadening of this stock market rally beyond mega-cap growth companies. Against this backdrop, they are focused intently on uncovering relative value within equity sub-asset classes such as small cap, value, international developed and emerging market stocks.

We assess whether the big valuation differential between U.S. large cap stocks and the other equity sub-indexes is justified fundamentally or simply a profitable mispricing opportunity. We look at sector composition, growth prospects and fundamental quality as potential drivers of valuation differentials.

U.S. large cap stocks have a greater representation of highly profitable, faster growing and higher P/E Technology and Communications companies. They also encompass higher fundamental quality as defined by a myriad of factors.

In large part, small cap, value and foreign stocks are cheaper for a good reason. They are more heavily invested in less attractive companies and industries which exhibit lower profitability, slower growth, lower quality and greater fundamental risk in earnings and margins.

We believe that adjusting for sector composition, growth rates and fundamental quality eliminates most of the valuation differences across equity sub-indexes. It may yet make sense to look beyond U.S. large cap stocks. We believe the reason to do so would be for the macro considerations of a revival in growth and risk appetite; it is less likely because of fundamental mispricing at a micro level.

We are more comfortable that the coast is becoming clearer for risk assets. Since economic growth is stronger than expected, we do not expect a higher-for-longer interest rate backdrop to derail stocks. At the same time, we remain vigilant for unforeseen and unexpected risks to our outlook.

To learn more about our views on the market or to speak with an advisor about our services, visit our Contact Page.

 Sector composition is one key reason why U.S. large cap stocks are justifiably more expensive.

 

The higher valuations of U.S. large cap stocks may be more attributable to higher growth rates than to mere speculation.

 

U.S. large cap companies also have higher financial and operational quality — they are more profitable and less risky.

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Whittier Trust, the oldest wealth management firm headquartered on the West Coast, announced six promotions across its California and Nevada offices. The promotions reflect Whittier Trust's commitment to investing in key talent and ensuring exceptional service for its clients.

Promoted Executives:

Jeffrey J. Aschieris: Vice President, Client Advisor

Amanda Buntmann: Vice President, Client Advisor

Kayla La Dow: Vice President, Portfolio Manager

Danielle Delmar: Vice President, Human Resources

Keith S. Fuetsch: Vice President, Client Advisor

William Alec V. Gard: Vice President, Client Advisor

 

"These well-deserved promotions recognize the consistent high performance and exceptional client focus these individuals demonstrate. We are proud of our team's expertise in providing personalized service to our valued clients," says David Dahl, President and CEO of Whittier Trust. "We're proud to say that the Whittier Trust standard of personalized service is upheld by experienced and skilled client advisors and portfolio managers, and this group excels at addressing the needs of our growing client base."

Whittier Trust's Commitment to Growth:

The promotions follow Whittier Trust's relocation to Pasadena in November 2023 and are part of a strategic plan to ensure continued growth and exceptional client service. Whittier is committed to investing in talented employees and ensuring that services exceed the expectations of our clients.

The following outlines the updated titles and expertise of the recently promoted executives detailed by the Whittier Trust office.

Newport Beach Office

Jeffrey J. Aschieris - Vice President, Client Advisor:

Jeff Aschieris specializes in trust administration, estate planning, and tailored family office services with a focus on personal financial planning for Whittier Trust clients. Holding an MBA from the USC Marshall School of Business and a Bachelor's degree in business administration from the College of Charleston, Jeff is a Certified Trust and Fiduciary Advisor (CTFA). He is also a two-time national sailing champion and an enthusiastic runner who volunteers with Ainsley's Angels, a charity dedicated to involving wheelchair-bound individuals in running races.

Danielle Delmar - Vice President, Human Resources:

Danielle Delmar previously served in the role of Manager, Talent Acquisition & Leadership Development. She leverages her six years with the firm and her twenty years of experience across multiple professional industries to source and hire top-tier talent. Danielle is deeply involved in her local community, balancing her professional responsibilities with raising her two teenage children. Her international career journey spans from Sydney, Australia, to New York, and she now resides in Newport Beach.

Kayla La Dow - Vice President, Portfolio Manager:

Kayla La Dow guides high-net-worth families through asset allocation, risk evaluations, capital market expectations, and the importance of after-tax performance within their portfolios. As a Vice President and Portfolio Manager, she plays a pivotal role in assisting clients with both asset allocation and asset location as she navigates complex balance sheets and portfolios. Kayla has been with Whittier Trust since 2016 and holds an MBA from the USC Marshall School of Business. In her spare time, Kayla assists a local Newport Beach foundation as a grants manager and trustee, helping support local, national, and international youth athletic endeavors. In her leisure time, you’ll find her traveling or enjoying time on the water.

Pasadena Office

William Alec V. Gard - Vice President, Client Advisor:

Alec Gard manages and advises high-net-worth clients, specializing in working with clients' network of trusted business professionals to solve complex estate planning challenges. He holds a B.S. in Finance from George Mason University, certifications including CTFA and AIFM®, and is currently pursuing an MBA at the USC Marshall School of Business. Alec draws on his East Coast upbringing, lifelong passion for golf, and almost 10 years in the industry to provide unique solutions to his clients' wealth management needs.

Reno Office

Keith S. Fuetsch - Vice President, Client Advisor:

Keith Fuetsch provides financial and fiduciary services for high-net-worth individuals and families. With more than five years in Wealth Management, he collaborates closely with clients and advisors to tailor investment and wealth strategies to unique needs, goals, and values. Keith is a Certified Financial Planner™ (CFP®), a Certified Trust and Financial Advisor (CTFA), and holds a Bachelor's and a Master's degree from the University of Nevada. He is also an active member of the Reno community, serving as a board member of the University of Nevada College of Business Alumni Association and the Reno Connection Network.

West Los Angeles Office

Amanda Buntmann - Vice President, Client Advisor:

Amanda Buntmann specializes in providing philanthropic advisory and administrative services to high-net-worth clients. With a decade of experience in nonprofit organizations, Amanda brings a wealth of expertise to her role, supporting foundations and donor-advised funds and ensuring clients can confidently pursue their philanthropic endeavors. Currently completing her Certified Trust and Fiduciary Advisor designation (CTFA™), Amanda already holds a Chartered Advisor in Philanthropy (CAP®) designation, as well as Bachelor's and Master's degrees from the Universities of San Diego and Arkansas respectively.

"I want to celebrate the hard work and dedication these impressive individuals have poured into this company. We're overjoyed to serve alongside them in their new roles and are excited to see the great things they accomplish for Whittier Trust and our clients on the road ahead," says Dahl.

Your family office is a point of pride as well as a smart way to manage your business and personal affairs. But you don’t have to have a gold nameplate and command your own staff to reap all of the family-office benefits. In fact, a multi-family office typically offers greater advantages—and ironically, more control—than a single-family office. Here are six ways that a multi-family office gives you more.

Security & Compliance

Infrastructure, cybersecurity, compliance training . . . it’s tedious, it’s frustrating, and if you’re not out in front of it, you're putting yourself at risk. That’s a lot of pressure for your staff and family. At a multi-family office, we have expert teams on top of changing trends, regulations, and demands.

Flexibility to Evolve

It’s a common misconception that a single-family office will better address your family’s unique needs. But how can it, when it means you have to hire staff for each new development in your life? When your time is spent handling payroll, office space, and interpersonal dynamics, you’re left with less control of your life. The multi-family office infrastructure is designed to give you all the flexibility you need without worrying about reducing, reorganizing, or adding to your team. We hold your business and interests together as you evolve.

Trust & Objectivity

How well do you know your staff and trust their commitment to your goals? Are you certain they won’t be swayed by their own interests? Can they safely suggest different points of view, or do they perhaps feel pressure to agree and conform? How do you gauge their loyalty while allowing dissent? By its very nature, the multi-family office has checks and balances against rogue players or people pursuing their own self-interest. We act as fiduciaries, bound to manage your affairs to your greatest benefit, not ours.

Proactive Leadership

Successful executives are problem-solvers and often visionaries as well, always looking down the road for the next big thing and for solutions to potential issues. But a healthy company doesn’t rely on one leader to see everything. The cross-pollination among executives at a multi-family office creates an acutely proactive environment. Staff at a single-family office, on the other hand, tend to be more reactive to their specific set of circumstances, because focusing on that one family’s needs is the efficient thing to do.

Plus, some multi-family offices, such as Whittier Trust, have robust service offerings spanning various departments. Whether you need help launching a family foundation, acquiring or managing real estate, exploring alternative investments, or working through estate planning options to fit your unique needs, it’s all under one umbrella and at our fingertips.  

Privacy & Continuity

By definition, a single-family office should excel at protecting your privacy. But it can be difficult when multiple branches of a family want to keep their affairs separate. Sometimes you may even end up competing for staff loyalty. Your advisors at a multi-family office act as neutral mediators to help prevent these sorts of conflicts and maintain each family member’s interests and privacy. You can rely on that same team to help facilitate succession planning and generational wealth transfer and provide continuity for decades.

Help with Family Dynamics

No matter which type of office you have, family governance is typically led by a powerful patriarch or matriarch. But with a multi-family office team, there’s a counterbalance to that control dynamic. There are other voices suggesting governance structure and helping organize a family council or regular family meetings, ensuring everyone is heard and respected, and that everything can run smoothly.

How to Transition

So what if you currently have a single-family office and want to transition to a multi-family office? It doesn’t have to be complicated. There are natural points in any business for pausing and reassessing, and given how expensive and stressful a single-family office can be, simplicity and cost-effectiveness are always good reasons for a change. 

Let everyone know it’s time for a fresh analysis and audit of operations. Make it clear that during this transition, you will be analyzing risk and cash flow, prioritizing different investments to accommodate family member’s preferences, digitizing documents, etc. Perhaps you will be adding new services as well, such as philanthropic strategy, trust services, real estate, private equity, or direct investment in alternative assets. Because your team at the multi-family office will be accustomed to working with a wide variety of families, you can maintain relationships with existing staff and integrate key players into your new multi-family office.

Why Whittier Trust

Whittier Trust brings your investments, real estate, philanthropy, administrative services, trust services, and more under one roof—without you having to manage it. You maintain control over your portfolio, while your trusted team of advisors ensures that your investments work in concert with your estate plan. You get holistic, personalized, and responsive service with scalable efficiency. And you and your family get your lives back to enjoy.

For those seeking a seamless transition to a multi-family office, Whittier Trust stands out as an optimal choice. By entrusting your affairs to Whittier Trust, you not only maintain control over your portfolio but also gain access to a dedicated team of advisors committed to aligning your investments with your estate plan. Experience the benefits of holistic, personalized, and responsive service, all while enjoying the freedom to focus on what truly matters—your life and your family. Make the switch today and discover the peace of mind that comes with having Whittier Trust by your side.

_____________

Written by Elizabeth M. Anderson, Vice President of Business Development at Whittier Trust. For more information, start a conversation with a Whittier Trust advisor today by visiting our contact page.

 

Despite domestic and geopolitical uncertainty, equity portfolios performed quite well in 2023 as measured by the S&P 500 Index. The market return was largely driven by the seven largest constituents of the S&P 500, also known as the Magnificent Seven. The Magnificent Seven includes: Apple, Microsoft, Alphabet, Amazon, Meta Platforms, Nvidia, and Tesla. These companies account for over twenty-eight percent of the S&P 500 Index and collectively more than doubled in 2023.  The spectacular returns concentrated in a few names left the average stock returning less than half of the S&P 500 Index overall.  The Magnificent Seven masked the underlying share price weakness of most stocks in the S&P 500 Index.  The concentration of returns and weightings raises the question of whether the S&P 500 Index should be dissected for opportunities and imperfections.

S&P 500 Index

This leads us to our next point in which we discuss the construction of the S&P 500 Index and lessons to learn from the evolution of the index.  The S&P 500 Index is often referred to as a “passive index,” meaning there is not an active manager changing the constituents of the Index on a regular basis.  It may come as a surprise that in any given year there are several changes to the S&P 500 Index.  As companies are acquired, merged, or face challenging times, they must be replaced in the index so there remain exactly 500 companies.  Over the past decade a shocking 189 companies were added to the S&P 500 Index! 

Before we delve into the implications of the 189 additions to the “passive” S&P 500 Index, we should highlight that over 28% of the S&P 500 Index is now in just seven companies, aka the Magnificent Seven.  These seven companies are the largest because of their extraordinary performance over the past 15 years.  The magnificent seven returns (measured in multiples) since the market peak before the Great Financial Crisis (12/31/2007) through the most recent quarter (12/31/2023) are as follows:

  • Apple 32.1x
  • Google (Alphabet) 8.1x
  • Nvidia 63.4x
  • Amazon 32.8x
  • Tesla 156.3x (since IPO in 2010) (1.1x since S&P 500 Index inclusion in 2020)
  • Microsoft 14.5x
  • Meta 12.0x (since IPO in 2012) (6.5x since S&P 500 Index inclusion in 2013)

Usually, we talk about stocks and bonds in percentage terms reserving double digit multiples on investment for only the best Venture Capital hits.  In this case, writing about Apple stock’s 3,113% return (32.1x multiple) if purchased at one of the worst times in history (right before the financial crisis) through today seems absurd.  Thus, we can simply say that an investment in 2007 would today be worth 32.1x as much including dividends (equally absurd you say!).  This is a great reminder of how favorable investing in high quality companies can be over long periods of time.  (Imagine a game table in Las Vegas that gave you a greater than 50% chance of winning each day, a greater than 65% chance of winning over one year and a nearly 100% chance of winning over multiple decades.  You would want to play that game and only that game for as long as you possibly could.)  While the magnificent seven have all returned multiples of investment since 2007, the S&P 500 Index has also returned a handsome 4.5x (347%) return over that time frame. 

The 189 additions to the S&P 500 Index

Now back to the 189 companies that were added to the S&P 500 Index in the last decade. The 189 additions have been selected by a committee known as the S&P Dow Jones Indices Index Committee (within S&P Global).1  These additions have to be disclosed before they are added to the index.  Thus, the average of those 189 stocks saw a bump immediately before they were added to the S&P 500 Index.  On average, those 189 stocks returned 11% over the three month period prior to the announcement date.  As more and more investors allocate a portion of their portfolio to index funds, the newly added stocks see more and more demand for their shares ahead of being included in the index.  According to the Investment Company Institute, midway through 2023 there were over $6.3 trillion dollars invested in S&P 500 Index funds in the United States.  As a company is added to the S&P 500 Index there is significant buying power behind that addition.  

Magnificent Seven

The Magnificent Seven stock price appreciation in 2023 reflects their strong fundamentals.  These seven companies generally have high margins, low input costs, strong balance sheets, and no unionized labor.  Conveniently avoiding the major pitfalls of 2023.  Perhaps more importantly, the strong performance from the top seven companies and the outsized weightings of those companies, obfuscates the weakness of the other 493 stocks that are on average still down from the beginning of 2022.  After two years of negative returns for the majority of the stocks in the index, perhaps there are some bargains out there for long-term investors.

Conclusion

We can draw a number of conclusions from the above analysis:  

  1. The S&P 500 Index returns over the next few years will be heavily dependent on the Magnificent Seven. Fortunately, the majority of the Magnificent Seven have low debt levels, high profit margins, low labor expense relative to revenue, and are cash generative (higher interest rates may boost earnings).  
  2. The imperfect index will continue to evolve and change despite the passive moniker.  
  3. Being attentive to potential index inclusions will be ever more important as the size of assets invested in the index grows faster than the index itself.
  4. 2023 market returns have been skewed by the Magnificent Seven leaving potential bargains beneath the surface.  
  5. Finally, investing in high quality companies may pose risks in the near term, but continues to look favorable over extended periods of time.

 

Endnotes:

      Source:  S&P Global
      Source:  Bloomberg Intelligence
      Source:  Investment Company Institute

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Whittier Trust, the oldest multi-family office headquartered on the West Coast, is pleased to announce the recent hiring of Gregg Millward as Vice President, Client Advisor in its Pasadena office. In this role, Gregg provides a comprehensive range of wealth management, family office and trust services to affluent individuals and families, working closely with clients and their advisors to tailor strategies that meet their unique needs. He will be pivotal in fostering multi-generational relationships in the service of stewarding and growing family wealth. 

"We welcome Gregg Millward to the Whittier Trust family with open arms," said Peter Zarifes, Managing Director, Director of Wealth Management operating out of Whittier Trust’s Pasadena Office. "His years of experience in philanthropic giving is bolstered by a clear dedication to fostering relationships across generations. This aligns perfectly with our commitment to providing unparalleled service and highly personalized wealth management."

Before joining Whittier Trust in 2023, Gregg spent more than 15 years at the University of Southern California. He most recently served as Senior Associate Director at The Center of Philanthropy & Public Policy, where he collaborated with philanthropic families, individuals and corporations to optimize the approach and maximize the impact in their charitable giving.

In expressing his excitement about joining Whittier Trust, Gregg Millward stated, "I'm genuinely honored to be joining Whittier Trust. The firm's commitment to client-centric service is well known, and its implementation of philanthropy and family-office services as tools to bring families together strongly resonates with my values. I'm looking forward to contributing to Whittier Trust's ongoing success and serving our clients with the utmost level of care and professionalism.” 

Gregg holds a Master's in Educational Leadership from the University of Southern California and a Bachelor of Science from Kutztown University of Pennsylvania. He also possesses an executive certificate from the Sports Management Institute. When not in the office, Gregg has demonstrated his commitment to community service by serving on the Swim With Mike Foundation board and contributing to various nonprofits.

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