Oct 18, 2024 2024 3rd Quarter Investment Commentary
- The S&P 500 gained 5.9% in the quarter and reached new all-time highs. Non-US markets saw a strong recovery, particularly in China.
- The Federal Reserve cut interest rates by 50 basis points in September to support economic growth, which boosted bond prices and led markets to anticipate further easing.
- The environment for equities remains favorable with strong earnings, easing inflation, and falling rates.
Market and Economic Summary
Despite a handful of volatile days in the third quarter, equity markets continued to post new all-time highs. US large-cap stocks, as measured by the S&P 500, advanced for the fifth straight month and ten out of the last eleven months. It gained 5.9% during the quarter, pushing its year-to-date performance to 22.1%. Mixed economic data, however, made for an uncertain path along the way. The S&P 500 declined 8% in August and 4% in September before recovering to new highs. The market’s upward movement was not just led by technology stocks, as seen earlier in the year, but by broader participation across sectors, regions, and sizes.
Stocks also performed well outside the US, with non-U.S. equities outperforming U.S. stocks for the quarter. Emerging markets were buoyed by a strong recovery in Chinese equities, which surged by 24% in September alone. Meanwhile, the European Central Bank and the Bank of England also moved towards more accommodative policies, aligning with the Federal Reserve’s accommodative stance. This international policy alignment supported global markets and helped maintain positive investor sentiment. It is important to note that there are increased risks in non-US equities and emerging markets, including currency risk, regulatory risk, credit risk, and geopolitical risk.
The Federal Reserve’s decision to cut interest rates by 50 basis points in September represented a significant policy shift. This move, larger than the expected 25 basis points, was the first rate reduction in four years and highlighted the Fed’s focus on promoting economic growth over combating inflation. This shift in monetary policy also led to a reassessment of future interest rate expectations, with markets anticipating further easing over the next 24 months. The decline in yields provided a boost to bond prices, resulting in positive returns for fixed-income investors.
A potential reason for further easing expectations was that the economic data remained mixed. Inflation showed signs of cooling, which was a positive development; however, job growth slowed, contributing to uncertainty around the economic growth outlook. While the labor market continued to grow, signs of weakness emerged, including a rising unemployment rate and fewer new jobs created than in previous quarters. Below is a summary of the benchmark returns. (1)
Markets
During the third quarter, financial markets experienced a significant shift, moving away from growth areas of the market toward value and small-cap. Market breadth was notably strong throughout the third quarter, with nearly 70% of stocks outperforming the S&P 500 Index (compared to just 25% in the first half of the year). This broad-based participation suggested that market gains were not concentrated in just a few large-cap stocks but were more evenly distributed, a sign of a healthier market.
Corporate earnings were another important driver of market performance in the quarter. Overall, profit margins for U.S. publicly listed companies appeared healthy and stable. The earnings season was defined by strong results, with 79% of S&P 500 companies exceeding earnings expectations (2), reflecting a favorable economic backdrop for many companies. Strong corporate earnings were supported by a combination of factors, including effective cost management, improved profit margins, and resilient consumer demand. However, profit margins for smaller companies, as measured by the S&P 600 Index, have been deteriorating for more than two years. Going forward, lower interest rates may give a much-needed boost to the smaller companies’ earnings.
Despite the positive earnings environment, stock valuations remained a growing concern and potential risk factor. The forward price-to-earnings (P/E) ratio for the S&P 500 stood at 20.6, above both the 5-year and 10-year historical averages (3). These elevated valuations suggest that much of the positive economic outlook may already be priced into the market, potentially limiting the scope for further gains in the near term.
The Federal Reserve’s decision to cut rates by 50 basis points significantly impacted bond yields, leading to a decline in interest rates across maturities before the rate cuts were even announced. However, since the Fed’s cut in short-term rates, longer-term bond rates have risen. This move may reflect that the bond market had already priced in an aggressive rate-cutting cycle — one that may take the Fed’s target federal funds rate from its current 5% down to 3% by the end of 2025. Unless a recession drags rates lower, which we don’t expect anytime soon, the boost to the economy from lower borrowing costs (e.g., on mortgage rates, auto loans, etc.) may be mostly behind us.
Stocks also factored in rate cuts in advance. The S&P 500 gained 24% during this latest Fed rate pause (from the last hike on July 27, 2023, until the cut on September 17, 2024). That marked the best stock performance during a Fed pause in at least 50 years, covering nine cutting cycles. This is a great reminder that the market prices are based on forward-looking expectations.
Equity markets generally perform well on Fed easing, particularly when rate cuts are not accompanied by a recession. During the first year of a rate-cutting cycle accompanied by a growing economy (no recession), stocks tend to generate above-average gains. The S&P 500 gained 14% on average during those 12-month periods (4). If a soft landing is achieved, further gains for stocks could lie ahead.
Recessions are rarely a complete surprise, and market strength was a good sign for continued economic growth. Rising stock prices may reflect investor confidence in future economic prospects and increased corporate profitability. It’s rare for the business cycle to peak in the periods following such substantial gains.
There are important Risks to consider— Growing global trade tensions between the US and China could blossom into an outright trade war. There are rising geopolitical risks in the Middle East. The war in Israel has the potential to grow into a wider conflict. There is also the possibility of terrorism or outside economic shocks impacting our market models negatively.
Economy
Economic growth continued to remain healthy in the third quarter, supported by various factors, including increased consumer spending, business investment, and government spending. Official GDP figures were not released as of this writing, but according to the Federal Reserve’s GDPNow model, economic growth for the quarter was estimated at 3.1%.
The Federal Reserve’s decision to cut rates by 50 basis points in September was a major development. This marked the first rate cut in four years and represented a clear pivot towards a more dovish monetary policy stance. By reducing interest rates, the Federal Reserve aimed to stimulate economic activity, support growth, and counteract potential headwinds. The Federal Reserve was expected to continue this path, with further rate cuts expected by the bond market over the next two years.
Most central banks around the world were also cutting rates. Compared to 2022, this global policy shift attempted to provide a cushion against potential economic challenges, but the success of this approach will depend on various factors, including the trajectory of inflation and broader global economic trends.
The health of the labor market will be crucial in determining the success of the Federal Reserve’s accommodative policies, as sustained job growth is necessary to support consumer spending and overall economic activity. Initial jobless claims and reported layoffs remained historically low, indicating that the labor market remained relatively stable. Last week the Bureau of Labor Statistics reported that the U.S. economy created 254K new jobs in September, well above consensus estimates.
It is worth noting that job growth hasn’t kept pace with labor supply growth over the last year. A post-pandemic immigration surge and higher labor force participation, rising to levels last seen in 2008, have left some new entrants into the workforce without a job. Overall, a recessionary cycle of job and income loss leading to reduced spending and more layoffs wasn’t apparent, supporting the case that U.S. labor markets were simply normalizing rather than flashing a recession warning.
The health of U.S. consumers remained a fundamental pillar of economic growth during the third quarter. Household balance sheets remained strong, with the real disposable income growth and net worth near all-time highs, and debt servicing costs remained well below average.
We are monitoring potential warning signs. There were signs that consumers were becoming more cautious as spending growth began to slow, particularly among the lower-income demographic. The moderation in consumer spending could pose a risk to future economic growth, particularly if the labor market continues to weaken. Maintaining consumer confidence and spending will be essential for sustaining the current economic expansion and ensuring that recent policy measures have their intended effect.
Inflation remained a key consideration for policymakers and investors alike during the third quarter. While inflation showed signs of cooling, it remained above the Federal Reserve’s long-term target. Improved inflation readings over the past year, with inflation just above the Fed’s target, supported the decision to cut rates. The moderation in inflation was a positive sign, as it indicated that price pressures may be easing, which could provide additional support for economic growth.
Equities and elections
Even if recession risk appeared to be low, the wide-ranging implications for tax policy, regulation, trade, and more had investors nervous about the potential impact of the presidential election on the economy. As the race intensifies, it’s crucial to remember that while elections are important for the country and its citizens, our investments are with companies not governments.
The uncertainty around policy outcomes has historically caused market volatility in the weeks leading up to elections, but once the uncertainty passes, companies can adapt quickly and operate profitably. History shows that the stock market has experienced long-term growth under both major political parties. It is not the case that the market or economy crashes when one political party is in office. This is because the underlying drivers of market performance – economic cycles, earnings, valuations, etc. – are far more important than the person or party who occupies the White House.
Portfolio Positioning
We still see a positive fundamental backdrop for equities. U.S. inflation continued to ease, short-term rates fell, and were likely to fall further, and economic growth remained positive. In addition, corporate earnings were strong. Technical indicators also continued to be positive for stocks. At the same time, a pullback wouldn’t be surprising given the fact that market volatility generally increases leading up to an election.
We remained overweight stocks during the quarter. Stocks remained in a strong uptrend, and we think it is best to overweight while the trend is in our favor. In addition, easing monetary policy, Chinese stimulus measures, and potentially broadening earnings growth should be favorable for equities. Within equities, we continue to see attractive opportunities outside of US growth equities. We still like undervalued parts of the market—such as exposure to US large value and US midcap.
Turning to bonds, a new regime of positive correlations between stocks and bonds suggests that higher interest rates have the power to “break” things on the equity side. In addition, we are not getting paid much more interest to take on the risk of longer maturity bonds, so we remain overweight shorter-term bonds. We expect a more gradual easing path while longer-term fixed income remains vulnerable to higher interest rates.
Regardless of the future path of rates, it’s important to remember the role of bonds in a portfolio. In a well-diversified portfolio, high-quality fixed income can provide a cushion with less risk compared to equities, particularly for investors who are spending from their account.
Not all portfolios are identical. We manage accounts with additional complexities not discussed in this update. Some of the statements are forward-looking but do not guarantee future performance. Please reach out to your advisor with any questions.
Footnotes:
[1]Morningstar Direct, as of 9/30/2024S
[2]FactSet as of 9/30/2024
[3]FactSet as of 9/30/2024. 5-year average of 19.4. 10-year average of 18.0
[4]Piper Sandler. 2019 episode excludes period of COVID selloff & recovery. 1980 periods goes through the first rate hike. Data from 3/14/1974 ? 8/31/2024.
Index Definitions:
- The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the US investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.
- The Standard & Poor?s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It cannot be invested into directly.
- The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell Index, which
represents approximately 10%of the total market capitalization of the Russell 3000 Index. - The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of approximately 800 stocks and is designed to measure equity market performance in 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, , Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.
- The MSCI EAFE(Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index of approximately 900 stocks and is designed to measure equity market performance in 21 developed market countries outside of North America.
- The SG Trend Index is a subset of the SG CTA Index and follows traders of trend following methodologies. The SG CTA Index is equal weighted, calculates the daily rate of return for a pool of CTAs selected from the larger managers that are open to new investment.
- Swiss Re Global Cat Bond Index tracks the aggregate performance of all catastrophe bonds issued offered under Rule 144A. The index captures bonds denominated in any currency, all rated and unrated cat bonds, outstanding perils, and triggers. The index is not exposed to currency risk from non-USD denominated cat bonds.
- The Nasdaq Composite Index is a market capitalization-weighted index of more than 3,000 stocks listed on the Nasdaq stock exchange.
Company News
Market Commentary
Retirement Planning
Tax Planning
Cyber Security
Important Disclosures
Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).
This is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein and take no responsibility therefore.
Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.
For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.
2024 4th Quarter Investment Commentary