2024 3rd Quarter Market Commentary
Top Headline for Q3: Let the cutting begin!
As was widely expected, the Federal Reserve Bank (the “Fed”) cut its benchmark interest rate during Q3 by 50 basis points. This cut marked the first downward adjustment since rates were lowered during the COVID crisis (1Q 2020) and will provide some much-needed relief to any individuals or businesses carrying variable-rate debt. This rate adjustment has significant implications across equity and bond markets as was observed in the large price movements during the quarter. For example, certain interest-rate-sensitive sectors soared during the quarter with publicly traded REITs (XLRE) up 17.1% and Utilities (XLU) up 19.4% during the quarter. Moreover, as the overall “yield curve” shifted down to reflect new expectations, medium to long-term corporate and treasury bonds rallied and were generally up 5-10%, depending on duration.
General Market Update
US Equities: The S&P 500 Index rose 5.5% during the quarter while the equal-weight S&P 500 Index (RSP) was up 9.5%. This disconnect is a signal of both a cooling of the red-hot technology sector along with a rally by most everything else, as the equal-weight version is more diversified across sectors and not so top heavy with technology. The technology sector (XLK) finished the quarter slightly down while REITs (XLRE), Utilities (XLU), Industrials (XLI), Financials (XLF) and Consumer Discretionary (XLY) all finished with double digit returns for the quarter. The technology-heavy Nasdaq Composite was up 2.6% while the small company Russell 2000 Index, which benefited heavily from a financial sector rebound, was up 8.9%.
International and Emerging Market Equities: International equity markets started to heat up as central banks around the world began, or continued, interest rate reductions. Both the Schwab International Equity ETF (SCHF), which holds stocks of developed markets excluding the United States, and the Schwab Emerging Markets ETF (SCHE) were up nearly double digits during the quarter. The biggest news on the international front was related to China’s central bank stimulus package which ignited a massive rally in its stock market – up over 25% in under two weeks to close the quarter. The strong performance of China is significant, as it is the largest country allocation within most emerging market ETFs, including SCHE.
Fixed Income and Credit: The fixed-income markets, as would be expected, cheered the rate reduction and rallied during that quarter. Despite a rough first half, most bonds, regardless of duration, are now moderately positive for the year. Inflation continues to improve which led to further reductions in the “long end” of the curve with the 10-year U.S. Treasury yield falling from 4.5% to around 3.8% during the quarter. It seems that investing in the credit market may prove to be more challenging from here. We all enjoyed high rates on our money market accounts and shorter-term bonds, but that opportunity is fading. Moreover, with a 10-year yield at 3.6% and inflation still running at 2.5-3%, it’s hard to get excited about longer-term bonds, and thus we remain overweight in short and medium duration.
Pro-Inflation Investments: The “inflation narrative” seems to finally be taking hold as assets flow into pro-inflation investments. For example, industrial metals (as measured by the ETF DBB) is up over 15% on the year, and gold (GLD) is now up nearly 30%. Neither U.S. presidential candidate has made any indication that balancing a budget is a priority. As such, investors will likely continue to benefit from having some inflation hedging in portfolios. It’s noteworthy that inflation has fallen materially, but it is not yet at the Fed’s “target” level of 2%. It will be interesting to see if that level is attainable in an environment with such large budget deficits.
A Look Ahead
Well, the big event for Q4 is the U.S. presidential election in early November. Looking back over the last 100 years, the S&P 500 Index tends to exhibit significant volatility leading into and following elections. This volatility occurs because (1) the market generally does not like uncertainty, and (2) the market shifts rapidly as the policies of the various candidates become clearer.
We also see the potential for significant volatility in bond portfolios. As mentioned above, the 3.6% yield on the U.S. 10-Year Treasury bond presents the potential for volatility. For example, any reversal of the inflation progress would likely send yields sharply up and bond prices down. The risk of inflation is, in fact, the key risk that the Fed will be seeking to avoid as they continue to lower rates. The path of rates also will have significant impacts on all bond portfolios. If the Fed accelerates or decelerates from market “expectations,” we will experience volatility as prices attempt to quickly adjust.
Overall, it seems that volatility lies ahead. In general, active portfolio management benefits from periods of uncertainty, for it presents opportunities to adjust and rebalance portfolios. This strategy has been effective at both improving returns and lowering portfolio volatility over time. We look forward to the opportunity ahead.
