Market Overview | Third Quarter, 2024

Despite fears that the upcoming election season could cause an uptick in volatility, markets continued to push higher during the third quarter. Stocks experienced a sharp, rapid decline from mid-July into early August, but by quarter-end, that brief period was all but forgotten. As the illustration below shows, strength wasn’t restricted to equities. Stocks, bonds, and alternatives all enjoyed a solid quarter and, naturally, that translated to positive returns for most investors and a blended benchmark of stocks and bonds.

The primary driver of the broad market strength was rooted in expectations around what the Federal Reserve (the Fed) was likely to do with short-term interest rates at their September meeting. Market expectations for when the Fed would start lowering short-term rates had changed numerous times over the course of the past year, but as the summer progressed, it became increasingly clear that the time for rate cuts was fast approaching. The Fed remained non-committal publicly, but also did little to dispel the idea that the most likely timing for rate cuts would be at their September meeting. In fact, by the time the September meeting rolled around, the expectations had further shifted from “if” the Fed was going to cut to “by how much.”

Despite the expectations of a rate cut, the Fed still delivered a bit of a surprise with a larger than expected cut of 50 basis points or 0.5% (consensus expectations had been 25 basis points). While stocks and bonds had rallied in anticipation of a cut, the larger than expected rate cut was enough to allow both to maintain prior gains and momentum into quarter end. There would be no “buy on the rumor, sell on the news” this quarter.

Now that the Fed has begun cutting rates, the questions shift to the pace and size of future cuts. After holding short-term rates steady for roughly 14 months, the Fed has indicated that the September cut won’t be the last. Additional cuts are expected before year-end and, as our graphic shows, the Fed currently anticipates cutting rates over the next few years (green diamonds) with a “terminal” rate of just under 3% by the end of 2026.

While the rate cut was cheered by stock and bond investors, those holding dear to their money market funds were likely disappointed. We’ve likely seen the peak in money market yields for the foreseeable future and with stocks and bonds having already rallied meaningfully, those thinking they could time the move from cash to stocks or bonds may have missed their opportunity.

Equities

Through the first half of the year, global equity markets had been broadly positive, but with a significant amount of variance or dispersion. Growth stocks, and specifically U.S. large growth stocks, had been by far the biggest winner. That shifted during the past quarter. U.S. large growth stocks still advanced and remain the big winner year-to-date, but other market segments made significant moves to narrow the gap. Value, small and mid-sized company stocks, as well as international stocks, all enjoyed similarly strong quarters.

The differential in recent performance by market segment may have narrowed in the past few months, but a considerable gap still exists from a valuation standpoint. The most notable outlier remains U.S. large growth stocks. Many of these large growth-oriented companies are well-known and highly profitable, but they simply trade at expensive valuations that historically have portended mediocre (or worse) future returns. Using industry jargon, they fall into a category that securities analysts often describe as being “priced for perfection.”

Expensive assets can perform well and stay expensive for long periods, but we much prefer to invest in areas where valuations are more reasonable or in-line with historical levels. Fortunately, with the exception of U.S. large growth, opportunities exist to put capital to work. We wouldn’t necessarily describe most equity markets as cheap, but as our market valuations graph shows, they do appear fair or reasonable in most cases.

Fixed Income

Strong periods for financial markets and investor portfolios are typically headlined by returns from stocks, but bonds more than held their own during the past quarter. While global stocks returned an impressive 6.6% for the quarter, the benchmark U.S. bond index wasn’t far behind, with a return of 5.2%. Not all fixed income market segments enjoyed such strong returns, but returns were positive across the board.

Interestingly, much of that return occurred over a rather short period of time. In mid-July, with economic data pointing to a slowing economy, the market consensus view that the U.S. would enjoy an economic soft landing came under fresh scrutiny. As noted in our Market Overview, this shift in investor sentiment that lasted into early August resulted in a sharp, rapid decline in stocks. Bonds, however, enjoyed a relatively strong period. Between July 17th and August 5th, global equities fell nearly 8.3%%, but bonds pushed higher by 2.2%.

Bonds have a reputation as an asset class that produces consistent, modest, and perhaps even boring returns, but that clearly isn’t always the case. In fact, as we look at returns for fixed income over the past two years, the full calendar year return may match that consistent and modest description, but the quarterly results have been anything but consistent and modest. Returns last year and so far this year, have been driven by the results from a single quarterly period. Bonds may not have the same volatility or magnitude of ups and downs as compared to stocks, but that certainly doesn’t mean they have no volatility.

Again, cash investors thinking they’d be able to time when to get out of cash and into bonds (or stocks) but didn’t, appear to have missed the optimal time to make that shift. That doesn’t mean that it is too late. For investors still sitting on cash, the opportunity to lock-in similar (or even better) rates of return for longer periods of time still exists.

Commodities + Real Assets + Alternatives

A rising tide may tend to lift all boats in stocks and bonds, but that is rarely the case when it comes to alternative investing. Alternatives are not so much of an asset class as it is a collection of investment areas, types, and strategies that have unique characteristics and fall outside of traditional stocks and bonds. In keeping with that uniqueness, returns tend to be rather disparate or only loosely connected. That was certainly the case during the past quarter.

While all but Natural Gas has enjoyed gains on a year-to-date basis, the past quarter was much more mixed. Commodities broadly, including oil and gas, were down for the quarter. Precious metals, primarily comprised of gold, enjoyed strong gains. Energy Pipelines, often referred to as MLPs, and U.S. Real Estate Investment Trusts (REITs) also enjoyed strong gains. In the case of REITs, those gains make up all the gains on a year-to-date basis.

Given our allocations to strategies like global macro and trend-following managed futures, we’ve also included “Liquid Alternatives” as part of our returns in the space. Liquid Alternatives is the return for the Wilshire Liquid Alternative index and is designed to measure the performance of an index of daily traded mutual funds (hence the liquid description, since they can be bought or sold daily) that Wilshire has categorized as alternative. Strategies in the index tend to be what most investors would consider hedge fund-like strategies – equity long/short, global macro, relative value, multi-strategy, and event-driven. We don’t employ all of these strategies but thought it would be a good overall reference for how such strategies have performed.

For clarification purposes please note that our listing of alternatives and returns for the period shown is far from an exhaustive list. We’ve chosen the areas or strategies shown primarily because they tend to be areas of interest for investors and/or areas that we own in client portfolios.

Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.