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Pumpkin spice and Yankee candles abound! We hope you’re enjoying the transition to fall, even if the only change is ‘less hot.’ As with every quarter, we want to cut through the noise and provide perspective in closing out the year. The last few months brought the usual mix of fireworks as the Japanese Central Bank spooked some investors, and geopolitical tensions continued flaring. And of course, the next U.S. administration will be clear in less than a month’s time, after an abrupt change in Democratic candidates. There’s an old saying that stocks often ‘climb a wall of worry,’ and certainly any given year provides plenty of worry. And yet, markets ended Q3 on a positive note across the board, with the week following Japanese Central Bank pullback offering the best performance of the year thus far. Disciplined investors were rewarded, once again.
With less than three months left in the year, we are optimistic in light of earnings, gross domestic product (GDP) figures, historically low employment, and inflation mercifully below 3%. Various headwinds will always appear, some which haven’t even been revealed yet. For now though, the desirable soft landing remains on track. Consider the following data points consistent with our core themes for the year: the Fed’s dual mandate, Geopolitics and International Markets, the interest rate cycle, and markets during and around elections.
Smaller companies, international markets, and emerging markets outpaced as rate cuts were priced in throughout Q3.
Understatement of the day: geopolitical risks remain elevated. It is imperative to remember markets price-in information immediately, if not in advance, often resulting in surprises. Specific outcomes cannot be reliably predicted, especially in the face of crises. This past quarter is no different. International and emerging markets outpaced the broad U.S. market as a whole. International led the way from October 2022 until late June. Further, after Putin invaded Ukraine (already over two years ago), international companies were better than US on a relative basis the rest of the year by 6%!
The interest rate cycle ended with a rate cut of 0.50% last month. We’ve argued for two years that if inflation is below the historical average of 3.28%, (it’s now 2.55%), GDP estimates remain positive (the ATL Fednow model shows 3% for Q3), and unemployment softens a bit (it remains low 4.20%, but ticked up), the Fed will loosen interest rates. The rate hike cycle is over, for now. What’s most interesting is…
Markets already priced in the rate reduction, and the yield curve is no longer inverted. This is not a surprise, as the Federal Reserve has been as transparent as possible since the Greenspan era in the 90s, when it was a black box, until meeting day. This allowed markets to appropriately adjust through the quarter. What’s more, the yield curve is no longer inverted. Longer-term (10-year and 30-year) interest rates are now above short term rates (2-year). This implies a better functioning monetary system, as banks have a better incentive to lend to businesses and consumers (they can earn a higher rate on loans than they have to pay in deposits).
31% of the entire U.S. stock market value is held by seven companies, as of September 2024. This is an unusual anomaly. Compare this to the 2000s tech bubble, where 19% of the U.S. stock market was held by seven companies. We remain in a very top-heavy market, which means much of the day-to-day S&P 500® moves can be tied to seven stocks. This is not to predict any sort of ‘bubble’, as pundits and cocktail party advisors are apt to do, but merely to add context to this past quarter’s returns. These companies can be very strong, but the concept of diminishing returns (Freshman Year Econ shoutout!) eventually shows up in stock prices. We always emphasize profits, relative value, and relatively smaller cap firms with a global viewpoint to avoid the downfall of chasing the largest companies in an index, because they’re branded as ‘magnificent.’
The year following a U.S. election is historically the least volatile on average. For everyone saying, ‘if so and so wins, this will happen in markets,’ the data actually shows an average return of 9.4% per year in the S&P 500® since 1948, and volatility of 13.5%, well below the average of 16.5%. Vote the election; do not trade it.
As we close out another year together, we remain optimistic about economic development in spite of the inevitable crises of the day. Climbing the wall of worry is a difficult task. However, we steadfastly believe that controlling the things we can, and maintaining discipline around the things we cannot provides the best opportunity for success. Updating and executing your plan, focusing on your personal headlines, and sticking to our data driven philosophy and process are all things we can control. And, to that end, please reach out if any of your circumstances have changed, and if you have any questions.
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Sources: Ycharts, ATL Fednow, Fred.com, Zacks.com, First Trust
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.
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Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
Index Definitions:
The Consumer Price Index (CPI) is a measure of inflation compiled by the US Bureau of Labor Studies.
Barclays U.S. Aggregate Bond Index: The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index of fixed rate debt securities rated investment grade or higher by Moody’s, Standard & Poor’s, or Fitch rating services. All issues in the index have at least one year to maturity and an outstanding par value of at least $25 million to $1 billion based on the type of security. Indices are not available for direct investment and do not reflect any fees that may be charged.
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The Russell 2000 index is an unmanaged index of the 2000 smallest companies in the Russell 3000 index. The Russell 2000 Index is used as a representative sample of the small companies in the United States economy. The Russell 2000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.
The Russell 3000 index is an unmanaged index of 3000 companies in the United States. The Russell 3000 Index is used as a representative sample of the United States economy. The Russell 3000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.