October 4, 2024
Following a sharp shock to markets in August, more settled conditions prevailed in September with markets taking heart from a jumbo cut in US interest rates. September marked the conclusion of the third quarter of 2024 with solid returns across most major asset classes, despite facing several episodes of market volatility. The long-awaited initiation of the Federal Reserve’s rate-cutting cycle in September, coupled with a more dovish stance from Japanese officials and bazooka stimulus measures in China, alleviated investor concerns and fuelled a strong stock rally as the quarter ended. The “great rotation” towards cyclical and small-cap stocks early in the quarter shifted back to big tech and AI by the end of September. Stock markets displayed optimism with strong earnings forecasts. Developed market equities achieved a 6.5% return during this period. Areas of the stock market that had previously struggled with high interest rates outperformed, with small caps rising by 9.5% and global REITs posting an impressive 16.2% return. On the other hand, growth stocks saw a slight decline from their recent highs but remain up over 20% year to date. Fixed income markets benefitted from the expectation of lower rates, with the Barclays Global Aggregate index returning 7.0% in the third quarter. Both government bonds and credit produced solid returns, while emerging market debt rose by 6.1% during the quarter. Commodity performance was relatively subdued, with a return of just 0.7% for the quarter. Amid growing concerns about the global economy, Brent Crude oil prices dropped by 17%, while gold surged to new all-time highssupported by rate cut expectations and the geopolitical tension in the middle east.
Macroeconomic Data, Fed and Interest Rates:
US macro data overall remained upbeat, with both retail sales and industrial production expanding in August. Labour market dynamics appeared more mixed: the pace of job gains was weaker than anticipated again, though the unemployment rate edged lower to 4.2% and initial jobless claims fell to their lowest level in four months. The US headline inflation rate fell to 2.5% (y/y) in August, its lowest reading since early 2021. Core inflation remained at 3.2%, largely due to the sticky services CPI component. Overall, US output was still tracking at an above-trend pace for the third quarter.
The U.S. Federal Reserve has officially shifted its focus from fighting inflation to prioritizing stabilizing the labor market with their first fed funds rate cut since 2020, bringing the Fed fund rate down to a range of 4.75% to 5%. The Fed opted for a bolder move in cutting by 50 basis points (bps) instead of 25 bps. Additionally, as seen by the quarterly projections by a majority of officials, they are targeting quarter-point rate reductions in both November and December. After the announcement, Fed Chair Jerome Powell said, “This decision reflects our growing confidence that with an appropriate recalibration of our policy stance, strength in the labor market can be maintained in a context of moderate growth and inflation moving sustainably down to 2%.”
Fixed Income:
Bond markets performed well in both Europe and the United States. The rate cuts by the Fed and ECB in September, along with confirmation that financial conditions would continue to ease in the coming months through further monetary easing, drove bond yields lower. The US 10-year yield fell to its lowest monthly level since May 2023, reaching 3.75%. After nearly two and a half years, The Treasury yield curve (measured by subtracting the yield on the two-year Treasury bond from the yield on the ten-year Treasury bond) un-inverted in early September and steepened to 15 basis points at month end. Historical precedent suggests that an inverted yield curve signals recession. For now, the end of the inversion reflects a shift in market sentiment and is supportive of a “soft landing” outcome. In September, the Bloomberg Global Aggregate Index (the benchmark for developed-country investment grade bonds) hedged in dollars rose by 1.3%. In the corporate bond market, credit spreads remained at record lows. The U.S. High Yield (HY) index and the European HY index increased by 1.6% and 1.0%, respectively, for the month, while the index for top-rated companies rose by 1.7% in the U.S. and 1.2% for European firms.
Equity Markets:
September is traditionally considered to be a weak month in stock markets. This time the stock market opened the month with a sharp downturn, falling for four consecutive days before quickly reversing course to reach new all-time highs. The largest catalyst was the Federal Reserve’s 50 basis point cut on September 18. Rate cuts and steady economic data have underpinned the performance of U.S. equities. The S&P 500 Index was up 2.1% for the month ending at an all-time high, taking the third quarter return to 5.9% and the year-to-date to a buoyant 22.1%. Large-cap stocks outperformed small-cap stocks in September. September also saw the stock market return to the familiar leadership of big tech and AI after initially rotating to long-overlooked areas of the market, primarily cyclical and smaller stocks, earlier in the quarter. For the full quarter, the leading sectors remained Utilities, Real Estate, Industrials, Financials, Materials, and Staples. Ten of 11 large cap sectors finished higher in Q3, led by Utilities, (+19.4%), REITs (+17.2%), Industrials (11.6%), Financials (+10.7%) and Materials (+9.7%). Energy (-23%) was the only sector in the red but stands with a respectable 8.4% total return YTD. Regardless of leadership, the underlying mood was that of exuberance, fuelled by robust earnings projections and expectations of more Fed rate cuts to come.
Other Major Markets:
In other equity markets, Asia ex-Japan emerged as the top-performing major region, with a return of 10.6% for the quarter. After remaining stagnant for much of the period, Asian stocks surged towards the end of September following the announcement of the new bazooka stimulus measures by Chinese policymakers. While many of these measures, such as interest rate cuts and lower downpayment requirements for home purchases, had been introduced individually over the past year, the coordinated announcement in September clearly signalled Beijing’s commitment to supporting the Chinese economy and markets. China’s Shanghai Shenzen CSI 300 Index rallied 25% over the ensuing five sessions. On the other hand, in Japan, there was another small sell-off at the end of September when the Liberal Democratic Party elected its new leader, who is considered to favour tighter monetary policy. Elsewhere the European equity returns were more subdued, with the UK and Europe excluding the UK returning 2.3% and 1.6%, respectively. Economic data highlighted the sluggish recovery of the eurozone this year, with Germany’s dependence on manufacturing proving to be a significant drag due to weak demand from China and increased competition from cheaper Chinese exports. The Composite PMI, contracted in September for the first time since the start of the year. UK activity momentum continued, though inflation there was firmer: headline inflation was unchanged at 2.2%, but core inflation rose to 3.6%. Inflation on the continent remained muted: eurozone headline inflation fell below 2%.
Other Asset Classes:
demand-side pushing crude below $70. While Saudi Arabia is reportedly preparing to restore some production to regain market share, while a worrisome demand outlook from top importer China also weighed on prices. Gold (+5.3%) hit a fresh high on the back of soft dollar conditions and the decline in treasury yields that boosted the appeal of the non-interest-bearing precious metal. Copper (+9.8%) rallied strongly towards month-end after Chinese authorities surprised investors with a major economic rescue package aimed at shoring up the world’s top consumer of the metal. Measures were put in place to rejuvenate the slumping property market, a pillar of metals demand.
The US dollar (-0.9%) extended its losing streak on expectations the Federal Reserve is still on track for more rate cuts in the coming months. The greenback was weaker versus most of its major peers, with the euro (+0.8%), pound (+1.9%), and yen (+1.8%) all appreciating last month.
Outlook:
As we step into the last quarter of the financial year, assets in many segments of the financial markets are sitting pretty with double digit year-to-date returns. Given the strong performance in the first three quarters, any near-term price corrections wouldn’t be surprising and could actually be healthy for the medium to long term. The elevated risks that markets face include increasing geopolitical tensions in the Middle East, political uncertainty leading up to the upcoming US presidential election, the high valuation of the S&P 500—currently trading at approximately 21.5 times forward 12-month earnings. However, the positives in the equation are factors such as low energy costs, stimulus from China, easing by global central banks, corporate earnings growth, and a Federal Reserve committed to keeping the economy in “solid shape” which should be favorable for markets.
October is also a crucial month for corporate earnings, with about one-third of S&P 500 Index companies reporting third quarter earnings. If analysts are correct with their projected 4.6% year-over-year growth rate, the third quarter will mark the fifth consecutive quarter of positive earnings growth. For the fourth quarter, the S&P 500 Index earnings are estimated to grow 14.9%, taking the full-year growth rate to 10.0%. The overall outlook is positive, but some caution is warranted.
There are always uncertainties and always reasons for optimism. Diversification and Asset allocation although cliché are the primary toolsto balance these risks and rewards. Clients with multi-asset portfolios have experienced this over the summers where the right balance between the asset classes and appropriate diversification helped to create resilient portfolios that stood the test of the volatile times.
Cash:
As Central banks start cutting interest rates, reduce cash/cash equivalents and hold cash only as “dry powder” in the portfolio to take advantage of any potential pull back in the markets.
Fixed income:
Equities:
Alternatives:
