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Third Quarter Review: Equity markets shook off a mid-quarter swoon and continued their uptrend with the Standard and Poor’s 500 Index gaining 5.9%, the Russell 2000 Small Cap Index jumping 9.3%, and the MSCI All World ex-U.S. Index rising 8.1%. With interest rates sharply declining in the quarter, the Bloomberg Aggregate Bond Index gained 5.2%, reversing a decline for the year. Gold rallied 13.2% and the Bloomberg Commodity Index fell 0.6%. Returns for the nine months ended September 30th: S&P 500 +22.1%, Russell 2000 +11.2%, MSCI World ex-U.S. +14.7%, Bloomberg Aggregate Bond +4.5%, Gold +27.7% and Commodities +5.8%.
Market Volatility and Broadening Participation: From mid-July to early August, the S&P 500 fell 8% and the tech-heavy Nasdaq Composite declined 12%. Contributing factors included weak economic releases, a 20% meltdown in the Japanese Nikkei with corresponding volatility in the Yen/$ exchange rate, causing an unwind of the ever present “yen carry trade” (borrow yen to buy U.S. equities). A drop in market interest rates and expectations of supportive Federal Reserve policies helped the market to recover on improved breadth and accelerate into October. Interest rate sensitive sectors Utilities (+19.4%) and Real Estate (+17.0%) led performance in the quarter though Utilities are also being supported by the energy demands of A.I. data centers. The technology sector lagged, gaining only 1.6% with mega-caps Amazon, Alphabet, Microsoft and Nvidia all declining in the quarter. Value, small caps, and international markets broke from the prior two quarters’ trends and outperformed the large cap growth category. Large Cap Growth remains the leader year-to-date as the technology sector tops all sectors with a gain of 29.6%.
The Resilient Economy: The Federal Reserve Board made a somewhat surprising decision during their September meeting to reduce their Fed Funds target by .50% to a range of 4.75% to 5.00% in lieu of the more typical approach of 0.25% in non-emergency situations. The Federal Reserve indicated their aggressive first step in lowering rates reflected an effort to support the labor market and their confidence that the rate of inflation is gradually returning to their 2% target. Since the Fed move, the economic data has perked up adding to the soft-landing hypothesis and momentum to the equity market. The Bureau of Labor Statistics’ September employment report surprised economists with its strength (245K jobs added with expectations for 150K). In addition, the Atlanta Fed Nowcast model was updated to show 3.4% annualized growth in the 3rd quarter from 2.5%. A major caveat is still choppy inflation data, and the inflation reports for September released in early October showed some stickiness in price pressures. This could lead the Fed to disappoint the market by holding off on further cuts in the near term and rates have indeed risen in October. With the S&P 500 overvalued by most traditional metrics, the onus will be on corporate earnings to support the P/E multiple expansion that has occurred this year.
Politics: Obviously, the current quarter encompasses the Presidential election. Importantly, historical studies reveal that there is no identifiable correlation between market returns and the party in the Oval Office or the party that controls Congress. Nevertheless, the outcome will immediately influence expectations around trade and tax policies. The reduction in personal tax rates passed in 2017 with the Tax Cuts and Jobs Act are set to expire at the end of 2025 so that will be a hotly debated issue throughout the year. Unfortunately, neither candidate nor party is interested in fiscal discipline. The budget deficit for 2024 totaled $1.8 trillion, over 5% of GDP, which was previously unheard of in a peacetime economy. Our national debt is over $35 trillion, 120% of GDP and growing, and interest expense on this debt this year was greater than military spending. While this chronic deficit spending has boosted economic activity, this issue will matter to the stock and bond markets at some future date.
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