Q4 2024 Newsletter
Q3 2024: The Market is Resilient
We hope this message finds you well and that your fall is off to a wonderful start.
With the changing color of the leaves, we have also started to see a change in stock market leadership. Only 25% of stocks in the S&P 500 managed to outperform the index in the first 6 months of the year, the lowest since 1999. In contrast, over 60% of stocks outperformed the index in Q3, the highest level since 2002. Let’s dive into some of the key narratives unfolding in markets and geopolitics.
Equity Market Review
In anticipation of the first US interest rate cut in four years, the market built on the gains from the first half of the year. The S&P 500 was up 5.89% for the quarter and 22.08% YTD through the end of Q3. There was a notable shift this quarter as the rally in stocks broadened out beyond technology and domestic stocks. Cyclicals and Small Caps outperformed in the third quarter, as evidenced by the performance of the Russell 2000 (US Small Cap Index), which was up 9.27% in the quarter. Additionally, International and Emerging Market equities as measured by the MSCI EAFE index (+7.26% in Q3) and the MSCI EM Index (+8.72% in Q3), respectively, notched notable gains for the quarter. One of the larger events in Emerging Markets came from China, where a program of rate cuts and major stimulus measures spurred emerging market equities late in the quarter. While China’s stock market enjoyed a strong boost, it remains to be seen whether their policymakers are committed to supporting the economy. This is a key theme to follow in the weeks and months ahead.
The S&P500 top performing sectors in 3Q were Utilities (+19.37%) and Real Estate (+17.17%). Both are sectors that benefit from falling interest rates. Investors also appear to be pricing in more positive sector dynamics going forward. An interesting data point in Q3 is that value stocks (+9.43%) significantly outperformed growth stocks (+3.19%). We would assert that the third quarter’s equity price movement is a healthy reality check. While US Large Cap growth (especially technology) has outperformed and dominated the financial news cycle, there is no rule that dictates it will continue to do so. The Nasdaq performance of only +2.8% in 3Q is testament to that. Somewhat surprisingly, the strong rally in equities has been paired with a standout year for gold, up 27% YTD as measured by the GLD ETF. Explanations for this occurrence vary widely, with the most likely driver being increased central bank purchases of gold and nervous investors looking for a safe haven.
Volatility in the Markets
As we mentioned in last quarter's newsletter, while the market has continued to demonstrate its resilience, the chance for a larger drawdown is increasing. Even with valuations at the high end of their typical range, many investors continue to favor equities versus other asset classes. There are risks to this equity preference, not the least of which is volatility.
The S&P 500 experienced its largest decline this year when the index fell 8.5% from July 16 through August 5. The decline was short-lived as the market rebounded by over 11% to close the quarter. We must remember that significant drawdowns and bouts of volatility generally occur at least a few times per year. There are risks to any investment, which makes strategic time horizons and discipline in down cycles critical for asset allocation decisions.
Given elevated valuations, the market is looking for an excuse to sell off. The volatility experienced in August was a wake-up call. The VIX spiked to the highest levels since the early days of the pandemic in March of 2020. A confluence of factors contributed to this global sell-off and accompanying massive spike in the VIX; such as the potential Fed pause, higher Japanese interest rates, and election concerns.
Earnings, Earnings, Earnings.
With the start of Q3, another round of earnings activity comes into focus. As mentioned in our last newsletter, S&P500 EPS YoY growth reflects weaker consumer sentiment as estimates are down to 4.1%, from 8.9% last quarter. If estimates are accurate, it will mark the fifth consecutive quarter of YoY earnings growth for the S&P. The MAG 7 stocks are heavily weighted in these calculations, which contributed to the lower growth estimate. However, as earnings reports have started to trickle in, we’ve seen data indicating closer to 7% EPS YoY growth. While we’re still seeing consecutive quarters of earnings growth, we do expect the magnitude of this growth to drop. This is due to several factors, including signs of weaker consumer sentiment, high borrowing costs for corporations and households, housing market gridlock, and a reduced tailwind from pandemic-era stimulus measures. When adding in the grim reality of a federal deficit that requires attention sooner than later, monitoring downside risks is the prudent path forward.
Event-Driven Investing? Depends on the event.
In what is shaping up to be an interesting second half of the year, the third quarter hosted several key geopolitical events. As with all our communications, any discussion of geopolitics focuses on the potential economic effects of global affairs and is specifically apolitical in nature. The Republicans and Democrats both survived their respective conventions, with Vice President Harris taking over the Democratic ticket in place of President Biden. Recent polling shows Harris and Trump in a close race, which is causing concern among many in the US, though US stock and bond markets have largely shrugged off these concerns so far.
Across the Atlantic, we continue to see geopolitical risks in the Middle East significantly ratcheted up and the escalating conflicts could certainly have an impact on markets, especially oil. OPEC cutting oil demand forecasts is another indicator of faltering economic strength. Together these factors could drive gas prices higher.
The Bank of Japan raising interest rates led to major market volatility, in part due to traders using the Yen as a low-cost means of funding currency trades. While Japan held rates close to zero for over twenty years, investor sentiment towards the Yen and Japanese equities appears to be strengthening. The world’s fourth largest economy has been fighting the headwinds of demographic change and persistent disinflation. Any changes in this dynamic would be cheered by markets, and we continue to monitor the situation closely.
The uncertainty driven by US election concerns and changes in monetary policy from Japan, China, and Europe have led to rising bond prices, with the Bloomberg Aggregate Bond Index up 5.2% in Q3. The 2-Year Treasury yield fell to 3.64% and the 10-Year Treasury fell to 3.78% in Q3. A flat yield curve, as evidenced by the .14% difference between 2- and 10-year yields, is an indication that growth expectations for the long term continue to remain under pressure.
The Economic Data is a Mixed Bag
Overall, 2024 economic data has been stronger than anticipated, but more recent data in Q3 has sent mixed signals. A weak jobs number from July (+114k vs +175k expected) improved in both August (+142k vs +161k expected) and in September (+254k vs +150k expected). The improving trend in jobs data was mirrored in the unemployment rate, which fell to 4.1% (from 4.3%) in September.
The ISM Non-Manufacturing Index (representing the service sector) rose to 54.9 in September, a strong reading and well above the consensus expectation of 51.7. (Levels >50 signal expansion; <50 signal contraction). After some relatively shaky months (48.8 in June, 51.4 in July, 51.5 in August), this upside surprise left the index at its highest level in almost two years.
While the services sector has turned around since that June reading, the manufacturing sector is still mired in a slump. The ISM Manufacturing Index reading was 47.2 in September. Interestingly, in the last two years, activity in the manufacturing sector has contracted for all but two months. US GDP growth is primarily driven by consumer spending, but that doesn’t mean a downward trend in manufacturing can afford to be ignored. This is another data set we are monitoring closely into the end of the year.
Inflation Continues to Cool
Inflation continues to head in the right direction based on the Q3 readings for CPI (Consumer Price Index) and PCE (Personal Cost Expenditure). CPI rose 0.2% in June, putting the 12-month inflation rate at 2.9%, the lowest since March 2021. The CPI in August was +0.2%, leaving the 12-month inflation rate at 2.5%. It is interesting to note that, after this inflation print, market expectations were at 85% for a 25-basis point cut at the September Fed meeting. We now know that didn’t happen and the Fed chose to be more aggressive (cutting 50 basis points), despite the moderating inflation figures. The September reading shows YoY inflation at 2.4%. Despite headline inflation going down, this latest reading showed that in the food category eggs are up 39.6% (largely because of the avian flu), and butter is up 7.8%. Motor vehicle insurance is up 16.4%. Pushing inflation downward, prices at the gas pump declined 4% in September.
Housing accounts for the largest share of CPI and has been a big stumbling block in getting inflation back to its target level. Shelter inflation (which includes rental prices and equivalent measure for homeowners) has gradually declined but remained stubbornly high. However, shelter inflation was only up 0.2% in September, down from up 0.5% in August. That is a very encouraging signal and potentially a sign that the housing supply/demand imbalance is leveling out. With the potential for lower mortgage rates going forward, we continue to view inflation cautiously as there are many crosscurrents at play.
The Federal Reserve – They Did!
“After the last few months of economic, labor, and inflation data, markets have begun to fully price in at least one rate cut for 2024. It’s critical to look back at the expectations of a year ago, with most market participants pricing in five or more cuts in 2024. Recent Fed speeches have indicated that the committee is now more open to a rate cut versus earlier this year.” That was the start to our Fed-specific commentary in the last newsletter. With the suspense of the first rate cut behind us, the market has quickly moved to when the next cut(s) may take place. We continue to argue that the Fed likely moved too fast in cutting 50 basis points, but there is time to let the data determine whether more actions are necessary. Rather than get out the Ouija board for the next few meetings, a continued focus on labor and inflationary data should guide the way. If anything, the uncertainty regarding monetary policy may be a healthy headwind for the market versus any uncertainty stemming from the election or geopolitical events. As always, time will tell.
Looking forward, if all these data sets continue to be better than estimated, the Fed will struggle to cut rates as much as projected. The bond market has figured this out, as evidenced by the ten-year Treasury yield moving back above 4% after bottoming out at 3.6% on 09/18 (Fed rate cut announcement). Our stance is that any pause in rate cuts due to economic strength is a good problem to have.
While on the topic of the Fed, many of their tightening cycles have led to recessions, but not all of them. There are a few examples in the 1990s where the economy was able to avoid a recession despite a restrictive monetary policy. See the chart below for more specific data.
Q4 Outlook – A Stormy Q4? Certainly, for Mother Nature.
After the devastating Hurricane Helene, Mother Nature started Q4 with a bang and another major storm, Hurricane Milton. Fortunately, the storm damage and loss of life was not nearly as devasting as with Helene. Will the market hit its own hurricane in Q4, or will resiliency continue? We certainly see potential for a spike in volatility given the calendar of market-moving events. The US election is November 5, followed on 11/6 by a Fed meeting, and another Fed meeting in mid-December. The continued escalation of conflicts in the Middle East and Europe may also have effects on domestic and international markets.
We believe the market’s rotation towards other asset classes and other market capitalizations (towards small- and mid-cap instead of primarily large-cap) will continue. We also see opportunities in some markets outside of the United States. Central bank easing overseas started well before the first interest rate cut here in September, meaning the impact on overseas economies will likely be felt sooner than here. As rates hover and macroeconomic growth persists, we are still finding interesting opportunities in fixed income. Add in the impact of declining money market rates and you have a solid pillar for portfolios going forward.
If you have any questions, please join us for our upcoming webinar “Rates, Elections & Opportunities Ahead” on Wednesday October 23rd at 5pm PST. If interested, please email info@heliumadvisors.com to RSVP and request the Zoom invitation.
Wishing you a wonderful rest of your Fall and Happy Halloween!
Stay safe, stay healthy, and go Vote!
Your Helium Advisors Team
Sources/Credit – FactSet, YCharts, FRED, CNBC, U.S. Bureau of Labor Statistics, Federal Reserve, BCA Research
