The third quarter saw strong market gains driven in part by investors’ positive response to the Federal Reserve’s decision on short-term interest rates. The Dow Jones Industrial Average – which had dipped in Q2 – rose a little over 8% during the quarter. The S&P 500 gained 5.53% and the Nasdaq Composite increased 2.57% as investors rotated away from tech (see Sector Scorecard). Stocks showed mixed performance in July with economic data hinting at a potential shift in the Fed’s stance on interest rates. Growing confidence that inflation was slowing helped the Russell 2000 surge over 10% in July, as small-cap stocks were seen as potential beneficiaries of a rate adjustment.

In August, a disappointing jobs report revealed slower-than-expected job growth and rising unemployment at 4.3%, the highest since October 2021. Despite initial concerns, including a sharp drop in Japan’s Nikkei due to carry trade fears, stocks rebounded mid-month. The slowing rise of both the Producer Price Index (PPI) and Consumer Price Index (CPI) reinforced the narrative of cooling inflation and helped boost investor sentiment. Stronger than anticipated retail sales in July also contributed to growing market optimism.

September saw volatility return as investors awaited an interest rate update. Weak manufacturing data and mixed jobs reports revived recession fears, leading to the S&P 500’s worst week since March 2023. Expecting a cautious approach from the Fed during an election year, investors were surprised when a 0.5% rate cut was announced for the first time in four years. Stocks rallied with the Dow topping 42,000 and the S&P crossing 5,700. [12,13]

 

ECONOMIC CONDITIONS:

U.S. – Growth Holds

GDP: The third estimate of GDP showed the U.S. economy grew 3.0 percent on an annualized basis in Q2, unchanged from the second estimate and higher than the initial 2.8 percent estimate. The final estimate was slightly higher than economists’ expectations of 2.9 percent growth and more than double the first quarter’s 1.4 percent annualized pace. [20]

Labor: Job growth rebounded in August. Last month, the 142,000 jobs added by employers were weaker than the estimated 161,000 economists expected but higher than the downwardly revised job gains of 89,000 in July and 118,000 in June. Unemployment slid to 4.2 percent in August. Wage growth increased by 0.4 percent month-over-month and rose 3.8 percent over the prior 12 months. [21]

Housing: Housing starts rose 9.6% in August, the highest since January 2007, driven by single-family home construction and lower mortgage rates. However, existing home sales fell 2.5%, with the median price up 3.1% year-over-year at $416,700. New home sales dropped 4.7% after a strong July, with the median price at $420,600. [26]

International: Cuts Fuel Optimism

Eurozone: Eurozone shares, as measured by the MSCI EMU index, advanced in Q3 2024, with gains led by real estate, utilities, and healthcare sectors, as the prospect of lower interest rates attracted investors back to previously out-of-favor areas. However, energy and information technology underperformed, posting negative returns for the quarter. The European Central Bank (ECB) held rates steady in July but cut them by 25 basis points in September. Inflation eased, with annual rates dropping from 2.6% in July to 1.8% in September. Despite this, a few indicators pointed to an economic slowdown. September’s HCOB flash purchasing managers’ index (PMI) fell to 48.9, its lowest in eight months, signaling a contraction in manufacturing. The service sector saw a slight rise to 50.5. Weaker PMI data and softer inflation raised expectations for further ECB rate cuts. In France, July’s parliamentary elections produced no majority, and in September, President Macron appointed Michel Barnier as prime minister.

U.K.: UK equities rose in Q3 2024 driven by a landslide Labour Party general election win, fueling optimism for a domestic economic recovery. Expectations of a UK interest rate cut were met when the Bank of England (BoE) made its first rate reduction in four years in August. However, sentiment was dampened by new Prime Minister Keir Starmer’s warning of a “painful” autumn budget, signaling potential tax increases and spending cuts to address a £22 billion public finance shortfall. Speculation arose about which taxes would rise, particularly for higher earners. Despite an initially positive estimate for Q2 GDP growth, the Office for National Statistics later revised it down to 0.5%, lower than Q1’s 0.7% growth. Inflation also ticked up slightly, with annual Consumer Prices Index inflation rising to 2.2%, just above the BoE’s 2.0% target in June.

Japan: The Japanese stock market experienced significant volatility in Q3 2024. After reaching a high in early July, the market corrected sharply by late July, driven by weaker U.S. economic data and the Bank of Japan’s decision to raise interest rates. This led to a sharp strengthening of the yen against the U.S. dollar. Japanese shares stabilized in late August, helped by the U.S. Fed’s rate cut and expectations of expansionist policies from potential LDP leader Sanae Takaichi. However, the market fell after Mr. Ishiba won the leadership run-off. TOPIX Total Return ended the quarter down 4.4% in local currency, with domestically oriented sectors like retail and construction performing well, while exporters struggled. Smaller companies outperformed large caps.

 

EQUITIES: Shifting Leadership

U.S. EQUITIES: US shares advanced over the quarter but sector performances were mixed as some previous winners lagged. Meanwhile, other sectors that had previously been shunned gained renewed favor with investors. All sectors aside from energy posted positive returns but top performing sectors included utilities and real estate while information technology posted only a small advance. Changing expectations for the path of US interest rates shaped the quarter and contributed to the divergent sector performances. The US Federal Reserve (Fed) had left interest rates on hold at a 23-year high in July. However, this was followed in early August by weaker jobs data. The non-farm payrolls report showed that 114,000 jobs were added in July, well below the consensus expectation of 175,000, while the unemployment rate rose to 4.3%.

DEVELOPED INTERNATIONAL EQUITIES: International stocks underperformed U.S. equities. The MSCI ACWI Ex-USA Index rose 1.0%, while the MSCI EAFE Index fell 0.4%. Eurozone shares declined due to uncertainty from French parliamentary elections and reduced expectations for interest rate cuts. The information technology sector gained, led by semiconductor stocks, while the consumer discretionary sector declined. The European Central Bank cut rates by 25 basis points in June, with inflation rising to 2.6% in May. The economic recovery slowed, with the HCOB composite PMI dipping to 50.8 in June. Political gains for right-wing nationalist parties and French election surprises added to market uncertainty.

 

EMERGING MARKETS: Emerging market (EM) equities delivered strong gains in Q3, outperforming developed markets. It was a volatile start to the quarter, when technology-related stocks sold off sharply and a Bank of Japan interest rate hike resulted in carry trades being unwound. Subsequent to these events, however, US and Chinese monetary policy easing measures helped EM post particularly strong returns in September. Thailand was a top performer over Q3 with returns supported by currency strength and delivery of the first phase of a new government stimulus package in September. China also posted double-digit returns in US dollar terms against a backdrop of monetary stimulus measures announced in September, and in anticipation of further measures which may include fiscal stimulus. South Africa was notably strong on the smooth formation of the Government of National Unity (GNU) and as the central bank followed the Federal Reserve’s lead in September and cut interest rates for the first time since 2020. India and Brazil underperformed with the latter negatively affected by the central bank reversing recent monetary easing by raising rates to contain inflation, and the government loosening fiscal spending. Taiwan lagged the broader index, particularly earlier in the period, amid a wider global sell-off in technology-related stocks, while Colombia’s index market lagged its EM peers amid a weaker oil price.

 

FIXED INCOME: Falling Yields

U.S. FIXED INCOME: The third quarter saw the start of the interest rate-cutting cycle in many major economies. In the US, the combination of a stronger-than-anticipated decline in July’s non-farm payrolls, a high-trending unemployment rate, and a larger-than-expected drop in inflation in August spurred the Fed’s decision to begin its long-awaited cutting cycle with a 50 bps cut.

The cut and expectations of faster monetary policy easing by the Fed led to a weaker dollar against major currencies. In the bond market, US Treasury yields fell substantially over the quarter with 2-year yields leading the way, falling 111 bps, as the yield curve steepened to reflect the outlook for lower interest rate policy. (Yields move inversely to prices and a steeper curve indicates that long-term yields are rising at a faster rate than short-term yields). On the corporate bond front, US investment grade performed strongly although global high yield still outperformed global investment grade.

Developed International Fixed Income: July saw the Labour Party take a landslide victory in the UK general election. Gilt yields remained largely unchanged as the election result had been priced in by the market. The BoE announced a 25 bps rate cut in August, which was the first modification since the onset of the Covid-19 pandemic, but kept rates on hold in September. UK gilts rallied over the quarter, fueled by the government’s promise to kick-start economic growth, with investors increasing their bets on two more BoE interest rate cuts before the end of the year. The ECB also cut interest rates by 25 bps. German and French 10-year government bond yields declined over the quarter (meaning prices rose) but underperformed relative to Italy and Spain, which were the strongest performers in Europe. Canada’s central bank continued to cut rates in response to positive moves in the cost of goods and services, as well as higher unemployment. Lastly, the Japanese yen gained strength against the dollar, partly due to the actions of the US Federal Reserve, but yen strength was further supported by the Bank of Japan’s decision to increase interest rates.

 

QUARTERLY FOCUS: A Big Move

At the Jackson Hole symposium in August, Fed Chair Jerome Powell indicated that it was time to adjust monetary policy, which many investors welcomed. By September, markets became volatile as investors anxiously awaited updates on interest rates following the Federal Reserve’s two-day meeting. The Fed ultimately cut interest rates by a half percentage point during the September 17–18 Federal Open Market Committee (FOMC) meeting, lowering the target range for the Fed Funds rate to 4.75–5.0 percent (see the updated rate forecast below). This marked the first change in the rate in 14 months and the first reduction in short-term rates in four and a half years.

A majority of FOMC voting members suggested that rates could further adjust during the remaining Committee meetings in 2024. However, Powell, in a speech to the National Association for Business Economics following the meeting, emphasized that the Fed was not on a “preset course.” The September decision was based on “greater confidence that inflation is moving sustainably toward 2 percent” and a belief that “risks to achieving its employment and inflation goals are roughly in balance.”

Investor opinions on the state of the economy varied. Equity investors generally viewed the Fed’s 50 basis point cut as appropriate, while bond market participants believed that more aggressive cuts were necessary to prevent an economic recession. Meanwhile, others saw the economy as overheating and feared that further rate cuts could reignite inflation.

Many investors are optimistic, believing the rate cut has helped engineer a “soft landing” for the economy. This group argues that the current interest rate environment is maintaining a healthy balance, with inflation approaching the Fed’s target and unemployment near a level consistent with price stability. Price pressures have eased, and while the goods sector has weakened in the U.S. and abroad, the service sector has allowed both the U.S. and other developed economies to continue expanding. Growth in services is crucially dependent on a robust labor market, and many central banks, including the Fed, see additional rate cuts as a necessary precaution to maintain momentum in services before any downturn. Key to achieving a soft landing is ensuring previously struggling sectors like housing and manufacturing also experience a recovery.

On the other hand, bond investors argue that central banks may have started cutting rates too late, perhaps six to twelve months behind the curve. Signs of a U.S. recession, they argue, are becoming more evident and will likely intensify in the coming months. Other developed economies have already experienced recessions over the past year. Historically, early recessionary indicators such as a re-steepening yield curve, a drop in ISM manufacturing new orders below 45 (signaling a weakening in discretionary demand), rising household deposits, and falling business deposits (as consumers hold back on spending) point toward a recession. These signals are rarely neutral in their effects on prices and often lead to deflationary pressures. The bond market is particularly sensitive to these pre-recessionary signals.

Each of these viewpoints reflects the complexity of the global economy and the difficulty in navigating it. Some investors believe the Fed’s actions have been adequate to maintain stability, while others feel more drastic measures are necessary to fend off a potential downturn. The divergence of opinions highlights the challenges central banks face in balancing economic growth, inflation, and employment in an interconnected world.

 

DPWM OUTLOOK: Elections

As the 2024 presidential election approaches, investor concerns about how portfolios will perform under a Republican or Democratic administration are inevitable. To help ease these concerns, it’s essential to focus on a long-term perspective. One common misconception is that economic conditions and policies under a specific party will mirror historical patterns when that same party was in power. However, the president is only one of many factors that can influence the market, and other variables often have a stronger and faster impact than any administration’s policies.

Macroeconomic factors such as interest rates, inflation, economic forecasting, policy changes, and global events like wars tend to affect the economy much more quickly than any new legislation from a president. Predicting a leader’s policies and attempting to time the market around an election is rarely a winning strategy. Instead, building and maintaining a diversified portfolio is one of the most reliable ways to achieve long-term wealth, regardless of who occupies the White House. Historically, stocks have performed well over the long term, regardless of whether a Democrat or a Republican was in office. Investors should remain focused on diversification as their most effective tool rather than letting political perceptions disrupt sound investment strategy.

Despite the headlines, concerns about the election, and signals of a potential economic slowdown, the major U.S. indices remain near all-time highs, with valuations that still seem reasonable. A resolution to the ongoing trade war, along with moderate earnings growth, could shift current pessimism into renewed optimism and possibly lead to new record highs.

During times of significant uncertainty, such as the upcoming U.S. election, it is easy to view potential outcomes as binary—either good or bad. However, reality is often much more nuanced. Both candidates have laid out their positions on key policy areas, and while it’s possible to hypothesize how those policies might impact certain sectors, mapping them directly to sector returns is a complex and uncertain task. Historically, U.S. markets and sectors have performed well across different administrations and various compositions of Congress. If anything, the data suggests that strong stock market outcomes transcend the political party in office.

While political uncertainty always presents challenges, investors can still prepare for potential outcomes by understanding how future policies might affect the economy. Our base case remains optimistic, projecting a “soft landing” for the economy. We expect that supportive fundamentals coupled with easing inflation will give central banks room to lower interest rates, which should help sustain economic growth. That said, one risk scenario is that inflation could remain stubbornly high, with the outcome of the election potentially contributing to this scenario. Regardless of the election’s results, it’s important for investors to remember that the market is shaped by a broad set of influences beyond just politics. Long-term success relies on sticking to time-tested strategies, such as diversification, rather than reacting to short-term political shifts.

As investors think through portfolio implications of the election, staying focused on strategic long-term goals is as important as ever. November’s results will certainly influence how the issues highlighted above ultimately get resolved, but investors should not lose sight of the fundamental drivers of market returns. Rather than trying to predict election outcomes and their impact on markets, we believe in preparing for different economic scenarios, remaining historically aware, and avoiding the urge to be overly reactive to changes in political leadership. At DPWM, we remain vigilant about current events and the signals of a slowing expansion, but we also stay committed to investment strategies that have historically withstood political and economic upheaval.

 

 

CITATIONS:

1. WSJ.com, September 30, 2024
2. WSJ.com, July 31, 2024
3. WSJ.com, July 31, 2024
4. WSJ.com, July 31, 2024
5. NBCNew.com, August 2, 2024
6. CNBC.com, August 5, 2024
7. WSJ.com, August 14, 2024
8. Reuters.com, August 23, 2024
9. WSJ.com, September 3, 2024
10. WSJ.com, September 6, 2024
11. WSJ.com, September 11, 2024
12. WSJ.com, September 19, 2024
13. CNN.com, September 20, 2024
14. SectorSPDRS.com, September 30, 2024
15. Forbes.com, September 30, 2024
16. MSCI.com, September 30, 2024
17. MSCI.com, September 30, 2024
18. MSCI.com, September 30, 2024
19. MSCI.com, September 30, 2024
20. Finance.Yahoo.com, September 26, 2024
21. WSJ.com, September 6, 2024
22. MarketWatch.com, September 17, 2024
23. KPMG.com, September 17, 2024
24. Reuters.com, September 18, 2024
25. Realtor.com, September 19, 2024
26. Zillow.com, September 25, 2024
27. WSJ.com, September 11, 2024
28. KPMG.com, September 26, 2024
29. CNBC.com, September 30, 2024