Q3 2024 - A Market Review
Markets were volatile in Q3 with increased uncertainty around economic growth, but the welcome return of Fed rate cuts and solid earnings overcame anxieties and generated new S&P 500 highs.
Q3 market color courtesy of finviz.com
Stock markets started the third quarter with a continuation of the first-half rally thanks to excellent Q2 earnings results and generally solid economic data. However, while the S&P 500 hit a new all-time high in mid-July, the second half of the month proved to be more tricky. Volatility was driven by an intense rotation within the S&P 500 from the heavily-weighted tech sector (which makes up than 30% of the value of the index) to other, smaller market sectors such as utilities, financials and industrials.
The impetus for this dramatic rotation was a combination of profit-taking following the substantial tech stock rally, some air finally coming out of the AI balloon, and a larger-than-expected decline in inflation which caused Treasury bond yields to fall sharply as investors anticipated imminent and then frequent interest rate cuts by the Federal Reserve. That expectation boosted the economic outlook and caused investors to begin to rotate towards market sectors that could benefit more directly from a strong economy and lower interest rates.
So, while investors didn’t exit the market entirely, the decline in the tech sector weighed on the S&P 500 and was not fully offset by gains in other areas of the market. The S&P 500 finished July well off the mid-month highs and with just a small gain, up 1.1%.
The late-July volatility continued into early August as a much-weaker-than-expected July Jobs Report, released on August 2nd, added to economic concerns. The unemployment rate rose to the highest level since November 2021 and investors’ fear of an economic hard landing triggered a sharp, intense decline that saw the S&P 500 fall 3% on Monday, August 5th, the worst one-day selloff for nearly two years. However, that decline proved brief as economic data over the next few weeks was generally solid and that helped calm investor anxiety.
Then, on August 23rd, at the Fed’s Jackson Hole Economic Symposium, chairman Jerome Powell told markets the “time had come” for the Fed to cut rates. That all but guaranteed a rate cut at the September meeting. That message further fueled the rebound in stocks and the S&P 500 finished August with a 2.3% gain, completing an impressive rebound from the early-month weakness.
The rally persisted into the often troublesome month of September thanks to growing certainty of a Fed rate cut later in the month that offset lackluster economic data. The August Jobs Report, released in early September, was another disappointment and again increased concerns about an economic slowdown and stocks were modestly volatile to start the month.
However, following that report, numerous financial journalists and ex-Fed officials made public calls for the Fed to cut interest rates by a “jumbo” full half point rather than the previously-expected quarter point at the September meeting and market expectations for such a larger-than-expected cut helped offset rather underwhelming economic data and the S&P 500 hit a new all-time highs again ahead of the Fed decision.
Then on September 18th, the Fed met these market expectations with the jumbo cut and slashed interest rates for the first time in four years, promising additional rate reductions between now and year-end and again in the first part of 2025. Investors welcomed this news and the S&P 500 surged to further new highs and finished the month and quarter with solid gains, adding to the strong year-to-date return.
Finally, politics and the looming presidential election did impact markets during Q3. Investors started the quarter anticipating a comfortable Trump victory and Republican control of Congress, based on polling following Biden’s catastrophic performance at the June debate and after the first of two failed assassination attempts on the Republican candidate.
However, those expectations changed rapidly following Biden’s withdrawal from the race and nomination of Harris as the replacement candidate. As the third quarter ended, national polls were slightly favoring the Democratic candidate while the outlook for the control of Congress went back to being uncertain again.
Third Quarter Performance Review
Investor expectations for falling interest rates and bond yields were the major influences on index, sector and factor performance during Q3, as markets were broadly positive but with some notable changes in leadership.
Starting with market capitalization, Small Caps outperformed Large Caps for the first time in 2024 as investors rotated out of many of the big names and into more economically sensitive smaller ones, as they historically have received the most benefit from the lower borrowing costs that result from falling interest rates.
From an investment style standpoint, Value handily outperformed Growth, although both styles posted positive returns for the quarter. The outperformance of Value was further evidence of the significant rotation we saw away from the tech sector (which dominates most growth funds) to lower price/earnings ratio stocks and more economically sensitive parts of the market such as financials, industrials, utilities and others.
On a sector level, nine of the eleven S&P 500 sectors finished Q3 with a positive return and that extended the broad year-to-date rally. Evidence of the influence of lower yields on returns can be seen in the sector outperformers, as utilities and real estate, two sectors that boast relatively large dividends and most benefit when bond yields are falling, handily outperformed the remaining nine S&P 500 sectors.
Looking at sector laggards, the tech and energy sectors were the only sectors to finish the third quarter in the red, as investors rotated out of tech and towards those higher dividend and more cyclically sensitive sectors. Energy, meanwhile, was the worst performing sector in the quarter as concerns about global growth (especially in China) weighed on oil demand expectations.
Internationally, foreign markets outperformed the S&P 500 in Q3 as the relative underperformance of the tech sector was a headwind on S&P 500 returns. Foreign developed markets are far less reliant on the tech sector and saw a solid rally as investors anticipated additional rate cuts from the European Central Bank (ECB) and other major global central banks. Emerging markets also outperformed the S&P 500 as well as foreign developed markets as the Chinese government announced numerous stimulus measures late in September and that boosted Chinese stocks and emerging market indices and ETFs.
Commodities were mixed, but in aggregate saw moderate losses in the quarter thanks mostly to the weakness in oil prices. Oil declined sharply as global demand expectations were reduced courtesy of soft Chinese economic data early in the quarter and on generalized global growth concerns. Gold, however, staged a strong rally thanks to elevated geopolitical uncertainty and the weaker dollar, as the price of gold reached a new all-time high.
Switching to fixed income markets, the leading benchmark for bonds (the Bloomberg Barclays US Aggregate Bond Index) saw a very strong quarterly return thanks to a combination of falling inflation, mixed U.S. economic data and investors’ anticipation of an aggressive rate cutting cycle from the Fed.
Looking deeper into the bond markets, longer duration bonds handily outperformed those with shorter durations as investors reached for longer-term yields amidst falling inflation and underwhelming labor market data and an expected unwinding of the inverted yield curve that has seen short term rates exceed long term ones for over two years. Bonds rallied across the board, however, with shorter duration bonds also showing positive returns in Q3.
Turning to the corporate bond market, investment grade bonds slightly outperformed lower quality “junk” bonds although both saw strong quarterly gains. For the first time in 2024, investors favored investment-grade bonds amidst increased economic uncertainty, as they sought the safety of higher-rated securities over the increased yield associated with those carrying more credit risk.
Q4 Market Outlook
With the start of the Fed’s rate cutting cycle now under way and the general pace of future cuts now broadly known, focus for the final quarter of 2024 will likely turn more towards economic growth, domestic politics and global geopolitics. Given the current unstable nature of all of these factors, it’s reasonable to expect periods of elevated volatility over the coming months (but, as we saw in Q3, markets can still move higher even amidst a backdrop of increased instability).
Starting with economic growth, expectations for aggressive Fed rate cuts helped investors look past some soft economic reports during the quarter. However, with any uncertainty about the timing of those rate cuts now behind us, we should expect markets to become increasingly sensitive to any disappointing economic data, especially in the labor market.
Bottom line, with the S&P 500 at or around record highs, the market has totally priced in a soft landing, so if the economic data in Q4 is weaker than expected and recession fears grow, that will likely increase the vulnerability of stock markets to a sharp fall between now and year-end.
Politics, meanwhile, will become a more direct market influence as we approach the November 5th election and possibly beyond. Depending on the expected and actual outcome, we could see an increase in macro and microeconomic volatility that could impact the broader markets as well as specific industries and sectors (e.g. oil and gas, renewables, financials and others). That volatility will stem from the uncertainty surrounding potential future policy changes (or lack thereof) towards important financial and economic issues such as taxes, tariffs, global trade, welfare reform, infrastructure spending and the long-term fiscal health of the United States.
Finally, geopolitical risks remain elevated and while the war between Russia and Ukraine and the escalating conflict in the Middle East hasn’t yet had a substantial negative impact on global markets so far this year, that’s always a possibility and these situations must be consistently monitored as any spread of the conflicts could well affect markets, regardless of any Fed rate cuts or U.S. election outcomes.
In summary, as we start Q4 we are confronted with a good number of these economic, political and geopolitical uncertainties. But market performance has been very strong in 2024, momentum remains decidedly positive and the indexes have proven extremely resilient throughout the year as demonstrated by the 43 new all-time record closing highs in the S&P 500 through the best first three quarters of any year since 1997.
Additionally, current economic data is still pointing to that soft economic landing. Finally, while political headlines may cause short-term investor anxiety, history is extremely clear: over time, the S&P 500 has consistently advanced regardless of which party controls the government and the average annual performance of the S&P 500 is solidly positive during both Republican and Democratic administrations.
So, while there is a risk of elevated uncertainty between now and year-end and it’s reasonable to expect an increase in short-term volatility, the fundamental underpinnings of this market remain largely positive.
Something else that history has clearly demonstrated is that a well-planned, long-term focused and diversified financial plan and investment strategy can withstand virtually any market surprise and related bout of volatility.
I remain constantly vigilant on behalf of Anglia Advisors’ clients regarding both their portfolio risk and the economy and will continue to keep you informed of my opinions with my weekly market review every Sunday.
If you are already a client, I want to thank you for your ongoing confidence and trust. Please do not hesitate to contact me with any questions, comments or to schedule a portfolio review.
If you aren’t a client yet, please reach out and I’d be delighted to discuss bringing you into the Anglia Advisors family.
Simon Brady CFP® CETF®. Founder, principal Anglia Advisors.
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