Insights

Quarterly Commentary

3Q 2024

Stocks encountered some turbulence before the third quarter closed on a high note. Inflation continued to trend lower and company earnings were generally positive, but markets were on edge over the health of the economy, particularly in July as weaker jobs reports and deteriorating consumer and business confidence indicators factored into a 10% downdraft for US stocks. Skepticism about the Artificial Intelligence craze contributed to a welcome change in market leadership, with large tech giving way to smaller company and foreign stocks.

Over the last two years we have discussed the “Fed pivot” – the moment when the Federal Reserve would shift from hiking short-term interest rates to dropping them as a key (pivotal?) development for markets of all kinds. The speculation ended on September 18th at 2pm when the Fed cut the benchmark rate by 0.50%. With all the anticipation, it shouldn’t be a surprise that markets reacted with little more than a shrug. After a brief spike, US stocks have flatlined since the announcement.

Bonds are a different story. While interest rates on short-term instruments declined, longer yields have risen since the Fed cut. The 10-year Treasury yield increased from about 3.7% to 4%, reflecting recent robust employment numbers that point to continuing economic strength. While this is good news overall, the higher rates are a disappointment to those who hoped the Fed pivot would lead to lower rates on mortgages and other loans, which would have provided a boost for consumers, real estate investors, etc.

For perspective, the average difference between inflation (as measured by the CPI) and the 10-year Treasury yield since 1960 is 2%. The spread has often been higher following periods of elevated inflation (most notably in the 1980s) and lower when deflation was an issue (the spread was low or negative for most of the period between 2012 and 2022). If inflation does reach the Fed’s 2% target, then a 4% yield for the 10-year would be historically “normal”, although we all know that markets are typically anything but.

Looking ahead

While we will still hear plenty about the timing and size of future rate cuts, we expect investors’ attention to increasingly shift to the elections now only a month away. Commentators naturally dwell on perceived differences in the candidates’ tax and economic policies. Despite the rhetoric, there is significant overlap on fiscal issues. Both candidates appear to favor substantial tariffs and US manufacturing incentives, for example, and given the similarities in enacted measures over the last eight years, there is no reason to doubt they would continue down this road.

Of the many differences between the candidates, we are focused on taxes because important elements of today’s policies are set to expire at the end of 2025. While it’s not a hot topic currently, we wouldn’t be surprised if the US fiscal situation (taxes, spending and the national debt) gets significantly more attention in 2025 as the new president and congress begin to shape actual policy.

We note that, on average, stocks tend to pause before an election and rise after, regardless of the results, but every time is different. While we sympathize with the view that either party sweeping control could present a risk to stocks - markets generally don’t like the potential for large-scale change - we also observe:

• In the US, stocks tend to rise over time, regardless of the party in power.
• Expectations often confound – renewable energy stocks soared while Trump was in office and have suffered during Biden’s tenure, while conventional energy stocks did the opposite. Go figure!

Staying the course

Whether it is the election, geopolitics, or earnings seasons, we expect stocks to be volatile. The way we position for the ride is to understand your ability and willingness to tolerate the unexpected. We’re here to help you understand how much risk you can take based on your resources and your goals and how much risk you want to take based on your preferences. Please don’t hesitate to contact us if you’d like to discuss your positioning or refresh your plan.