Q3 2024 Market Commentary

Global markets continued their upward trajectory in the third quarter of 2024, as both stocks and bonds gained. In the US market, all eyes were on the Federal Reserve as they prepared to make the first cut to the federal-funds rate since 2020. The Fed’s cut, which came following their regular meeting on September 18th, was for a half a percentage point – at the higher end of investor expectations.

Historically, the stock market tends to perform well in periods of declining interest rates as long as there is not a recession (in other words, as long as the Fed is able to cut rates far enough ahead of time to avoid a recession). The markets fell sharply in late July/early August due to exactly this concern. Hiring fell, unemployment rose, and investors feared a recession was imminent. “Things are deteriorating quickly” said one pundit. Fortunately, August and September jobs numbers came in stronger, the Fed cut rates in September, and the crisis seemed to be averted – for now.

In hindsight, market fluctuations are often easy to explain. Looking ahead, however, if you listen to the market prognosticators, we always seem to be at some sort of an “inflection point”. At the moment, we are supposedly at yet another “inflection point” between a soft landing or a hard landing – either inflation cools and the Fed gradually lowers interest rates, or the Fed doesn’t thread the needle between inflation and lower rates quite right and we risk a recession (if rates fall too slowly) or a return to inflation (if rates fall too quickly).

The truth is, the present can always be described as the “inflection point” between different potential future scenarios. It just means we don’t really know what comes next. For now, let’s be happy with the 21.2% return to the Russell 1000 index of large US stocks so far in 2024 (and the 27.7% return to gold, and the 4.5% return to the Bloomberg US Aggregate Index of US bonds).

As the Fed cuts rates, smaller companies (“small caps”) that typically have more debt stand to benefit most. And, indeed, it was small caps that outperformed large caps in the third quarter as expectations have grown for a coming period of significant rate cuts. The Russell 2000 Index of US small cap stocks gained 9.3%, while the Russell 1000 Index of large caps gained 6.1%. For the year, large caps still retain a healthy lead, with the Russell 1000 up 21.2% versus the Russell 2000’s gain of 11.2%.

The recent outperformance of small caps is a change from recent experience, when large tech stocks have been leading the market, but it is not a change from the long-term trend, where over the past century or so

(1927-2023), US small cap stocks have outperformed large caps 2/3rd of the time, by 2.85% per year on average.

International markets slightly outperformed the US this quarter, with the MSCI EAFE index of developed international countries gaining 7.3% in the third quarter, and the MSCI Emerging Markets index of developing countries rising 8.7%. For the year to date, however, US markets still hold the lead.

Interest rates fell in the third quarter along the entire yield curve. On the short end, the Federal Reserve cut rates to the federal-funds target rate, from a range of 5.25% to 5.50% down to 4.75% to 5.00%. This rate cut, in turn, helped reduce the prime rate, which is the reference rate for consumer loans from credit cards to Home Equity Lines of Credit, from 8.5% down to 8%.

30-year mortgage rates also fell – from 6.86% at the end of June to 6.08% at the end of September. Rates had been as high as 7.8% less than a year earlier, and the decline in rates ought to help the housing markets, which had slowed significantly as rates peaked. Although rates went back up a bit early in October, the trend remains downward this year.

The decline in rates also helped bond returns, with the Bloomberg US Aggregate Bond Index jumping 5.2% in the quarter.

Oil prices fell during the third quarter, with WTI crude oil prices starting the quarter at $83, but ending at just $69 per barrel. Gasoline prices declined in turn, ending the quarter at a national average of $3.18, down from $3.48 at the start of the quarter. However, due to escalation of the conflict in the Middle East, oil began to rise again during the early days of October.

Gold prices continued to spike, as discussed in last quarter’s commentary. Gold prices jumped 13.2% for the quarter, and have outperformed even large US growth stocks for the year, with a year-to-date return of 27.7%. Tailwinds for gold have included continued buying by the Chinese central bank as well as unrest in the Middle East (gold tends to be a safe haven asset during times of geopolitical crisis).

The list of potential risks to the economy is long for the remainder of the year. Transitions of political leadership, geopolitical conflict, a re-emergence of inflation, and changes in trade policy were among the threats identified in a recent McKinsey & Company survey of global executives.

In the US, national elections are less than a month away. The elections themselves are hard enough to forecast: the polls are quite close for the presidential election – one prominent forecaster (fivethirtyeight.com) gives a 55% probability to a Harris win and a 45% probability to a Trump win. Since Harris became the Democratic nominee, she has mostly led in the national polls, but a few polls, including a Quinnipiac University Poll in September, have called it a dead heat.

Predicting how the election results will impact markets is even more dubious. The overall market as measured by the S&P 500 was up over 50% for each of the last four presidential terms (through September 30th), and market returns often seem counterintuitive. For example, traditional energy (measured by the Energy Select Sector SPDR Fund) was down 29% during Trump’s pro-energy administration, but up 131% during Biden’s administration (so far).