What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were up about 5.9% in Q3.
- The developed market of Japan was down about 4.9%.
- Europe and the U.K. were up about 1.6% and up about 2.3% respectively.
- Emerging Markets and Asia (Ex-Japan) were up about 8.9% and up about 10.6% respectively.
- Global fixed income returns ended the quarter positive from +5.2% (Italy) to +1.5% (Japan).
Where Do We Stand?
- The market rally advanced further in Q3 in spite of a bout of volatility in August .
- Valuations remain elevated versus historic averages yet earnings have shown some strength to support this.
- The markets will likely shift focus from the Federal Reserve to the coming Election cycle in Q4.
- We remain in a position to weather any volatility with client holdings in Gold and Cash while looking to be more active in opportunities when they present themselves.
With another quarter of healthy returns under investor’s belts the spectre of a soft landing for the U.S. (and Global) economies is now closer to reality. However, this soft landing scenario has not and will not come without extended bouts of volatility. Much like the bout we saw in Q3 this year. Currently, inflation has returned to tolerable levels while corporate earnings have been able to sustain and grow profits. This has allowed the Federal Reserve to begin cutting interest rates for the first time in four years.
Corrections come
The market began the quarter with a correction driven by a soft jobs report and Japan’s surprise decision to raise rates. By early August the S&P 500 was down by about 8% from recent highs. However, much of the losses had been recovered by the time the Federal Reserve met in mid-September, deciding to cut interest rates by 0.50%. The rate cuts and a less hawkish stance in Japan along with a round of Chinese stimulus calmed investors concerns. The net result for the quarter was another almost 6% added to an already very strong year for stock market returns.
Corrections go
The Federal Reserve has made it clear that any more weak data in the economy will spurn further interest rate cuts. Expectations at the beginning of the quarter for the rate level by the middle of 2025 was 4.4%. Today it stands closer to 3.2%. With a current level of 4.83% that means the market is expecting rates to be cut by 1.6% over the next 6 Fed meetings. That would be a significant move by a Fed that is probably still gun shy from inflation. Furthermore, I would not expect the Federal Reserve to act aggressively at the November meeting with a Presidential Election just two days beforehand. So really, there’s 5 meetings before the end of June 2025 to cut rates further. Unless something drastic happens between now and then the truth probably lies somewhere in between the current 4.83% and the expected 3.2%. Let’s call it 4%.
Inflation lingers
Driving a lot of these Federal Reserve moves will be the expectations on inflation. It has certainly cooled dramatically from its high of around 8% in 2022. However, we may not be done with the lingering effects of higher inflation. In fact, looking at the drivers of CPI (Consumer Price Index, a measure of inflation) any person on the street likely wouldn’t believe that inflation has “cooled”. Shelter (rent, mortgage, etc), food and transportation make up almost 60% of the index. All three of those items have moved higher and not cooled much. At least it still feels that way. If these items remain sticky and a shock on energy prices were to occur (See “Geopolitics below) then the Federal Reserve would have a much harder time continuing their interest rate cut cycle.
Geopolitics contained?
We have entered a different world as it pertains to geopolitics. The United Nations has been weakening with every new conflict and seems incapable of monitoring or controlling the rogue actors under its purview. This has led to a leadership vacuum around the world. Regional actors are now beholden to expand their borders (Russia, China) and/or act in their own interests with no deference to global stability (Middle East, Africa). The United States still stands as the “Global Police Force” but can’t be everywhere at once. For now, the conflicts around the world seem to be regionally contained so as to avoid any major economic or market ramifications. However, when it comes to conflicts that can change in an instant.
The U.S. Election
The largest short-term catalyst for the markets right now is the U.S. Presidential Election. At this stage we do not know who will win. Nor do we know how each candidate will affect markets in the longer term. We also have no idea if the winning candidate will have full control of Congress to act on their policy platforms. One can assume a Trump victory would mean lower taxes, lower immigration, higher tariffs, more disputes around global defense costs and higher overall volatility. A Harris victory likely means the opposite. Some of these policy stances are positive for markets, others are negative. On both sides of the political spectrum. The best way to play it is to remain diversified and conservative during the election, which we are.
The Patience Game
The conclusion is that we are in a bit of a waiting game right now. Stocks have done a miraculous job of fending off any negative sentiment that has come their way. Bonds have also done well in their recovery from a tough few years. Furthermore, the correlations between stocks and bonds (how they perform relative to one another) have now returned to the negative correlation that usually prevails in markets. Meaning, when stocks go down, bonds go up and vice-versa. This has positive implications for portfolio construction and portfolio behavior going forward. As always we remain prepared in client portfolios to weather any downturns and take advantage of opportunities as they present themselves.
If you have any questions or have experienced any changes in your financial situation please do not hesitate to Contact Me.
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