Quarterly Update

From the perspective of stock and bond markets, the third quarter (Q3) of 2024 felt tied to the hip of Fed policy. The “Will they or won’t they” question about the Fed finally lowering interest rates seemed to pervade just about everything and even caused a short but nasty bout of volatility mid-quarter. Also due in large part to interest rates, sizeable shifts took place across styles and sectors in the stock market. However, the major indices still performed well during the quarter amid all the commotion, even the bond market!

Here’s a roundup of how major market indices performed during Q3 and so far this year through 9/30, respectively:

• US Large Cap Stocks: up 5.8%, up 21.7%
• US Small Cap Stocks: up 9.3%, up 10.2%
• US Core Bonds: up 5.2%, up 3.6%
• Developed Foreign Markets: up 6.8%, up 11.5%
• Emerging Markets: up 9.7%, up 17.2%

In the stock market, the top performing sectors during Q3 were rate-sensitive sectors like Utilities and Real Estate. Utilities have gained nearly 31% year-to-date, but 20% of that came during Q3. And Real Estate dug itself out of a hole by rising about 14% during the quarter to end the first half of the year with an 11% return. At the opposite end of the spectrum, high flying sectors like Technology and Communication Services lagged. The former lost a bit during Q3 but still gained 17% this year while the latter grew about 6% and is up 25% year-to-date as Q3 ended.

Our bull market remains intact, but there’s movement beneath the surface. For much of the last couple of years AI-related stocks, led by the so-called Magnificent Seven, drove the performance of major market indices. That’s been shifting and this kicked into higher gear during Q3. According to my research partners at Bespoke Investment Group, nearly all of the gains in the S&P 500 index so far this year have come from other companies. That’s heathier for investors longer-term but creates short-term pain for other investors. You were mostly insulated from this sector and style rotation if the stock portion of your portfolio was broadly diversified.

In international markets, China broke out of a long slump to return 39% but nearly all of those gains came in Q3 (and seem due to recent direct market intervention by the Chinese government). This pushed emerging market indices higher since most have a large amount of exposure to China.

In the bond market, core bonds finally broke out of their quagmire to return about 3.6% so far this year. Depending on the index and type of bonds you’re looking at, returns this year range from about flat for longer-term bonds to around 4% for inflation-protected bonds. The benchmark 10yr Treasury yield fell to about 3.6% as prices rose during the quarter, before flipping back to about 4% as Q3 ended.

Much of the movement in the stock market, and substantially all of the movement in bonds, was due to a sea change in Fed interest rate policy in Q3. After quickly raising interest rates to fight inflation following pandemic-related spending and other economic issues, the Fed left rates high for what many thought was too long. Inflation eventually came back to manageable levels perhaps well before Q3 and numerous voices, including from within the Fed, said that higher interest rates had become restrictive for the economy.

Months of waiting for the Fed to lower rates came to a head in September when the Fed’s Open Market Committee voted to reduce it’s short-term rate benchmark by half a percentage point. This had been expected by markets but the actual event was pivotal for returns during the quarter and for the rate outlook. Lower rates are a net-positive for the economy and the path seems clear for lower rates in the near-term, although that path isn’t predetermined. However, Q3 ended with markets pricing in a roughly 80% chance that the Fed lowers rates again at its November and December meetings. More reductions are expected into the new year, perhaps cumulatively shaving off 2% or more from the cost of borrowing money in the economy.

This resetting of Fed policy may also help the Fed achieve a so-called soft landing, where higher interest rates are used to slow an overheated economy and then reduced without causing a recession. This is very tricky to pull off given that changes in monetary policy work with a “long and variable lag” of months, even quarters. Traditional recession indicators, such as an inverted yield curve, have largely failed as predictive tools in recent years. However, analysts see a stable job market, solid consumption and strong personal balance sheets for many consumers. These and other indicators suggest our economy is in good shape, at least for the time being. Maybe this is what a soft landing looks like, but only time will tell.

Now we’re in the final quarter of the year. This is typically a volatile time, especially during October, but the quarter has historically been the best of the year in terms of market performance. So plan for more volatility in the weeks and months ahead – there’s always ample reason for it. But plan for good outcomes as well. If I’m responsible for managing your portfolio, know that I’m watching markets constantly and checking your allocation against your model frequently, and tweaking things as needed. Let me know of questions and any year-end concerns or considerations.

Have questions? Ask us. We can help.