ARQ Wealth Advisors – Q3 2024 Commentary: The Fed & Election Edition
Authored by Richard Siegel, CFP® and Justin Rivera, CFA, CFP®
Finally! The Fed made its move, a bold 50 basis point rate cut: the first drop in the Fed Funds rate in four years. Remember…the Fed has a dual mandate: price stability and full employment. With inflation finally getting down towards the Fed’s target of 2% and the unemployment rate moving up from all time low levels in the 3.4% range into the low 4% range (still considered full employment), the Fed took the opportunity to reverse their restrictive monetary policy regime and begin an easing cycle. What does this mean?
- Savings rates, CDs, money markets will start paying less interest/dividends
- Borrowing costs and lending costs will come down
- Financing costs for the U.S. Government and for public and private companies will ease.
The 3rd quarter of 2024 posted strong returns for the capital markets. Not only did equity markets perform well, but bonds delivered in three months what would normally be seen as an impressive result for a full year. These outsized bond returns are directly attributed to interest rates coming down based on recent inflation and employment data and the corresponding shift in fed policy.
Most impressive, was the long-awaited broadening out of the stock market. The powerful rise in the “Magnificent-7” technology stocks took a back seat, while foreign, small-cap and value stocks played catch-up.
Every four years around this time, the Presidential election grabs the spotlight. Investors from both sides of the aisle start to worry about the potential impact on the stock market and the economy if their preferred candidate doesn’t come out on top.
At the end of the day, we all understand the policy positions of these two candidates, and personal beliefs aside, we also know what really moves the markets is monetary policy and corporate profitability. Policy positions could positively or negatively impact economic growth and the markets, therefore mixed control of government, which puts checks and balances in place, is usually the most successful. Bottom line…free market capitalism thrives in gridlock. As we always stress during election cycles, try not to let your emotions and personal beliefs impact your ability to follow your investment plan. The outcome of doing so is almost always counterproductive.
Economic Overview
As we close the third quarter of 2024, the U.S. economy is exhibiting signs of what many experts are calling a “soft landing.” This term refers to the ideal scenario where the Federal Reserve’s aggressive monetary tightening — designed to curb inflation — succeeds in cooling the economy without triggering a deep recession. For much of the past two years, the primary concern was that the Fed’s interest rate hikes would plunge the economy into a downturn. However, recent data suggests that we may be avoiding that outcome, with inflation slowing down and economic activity holding steady, albeit at a moderated pace.
A soft landing implies a scenario where inflation is tamed without the drastic job losses that usually accompany economic slowdowns. Through the third quarter, inflation has shown clear signs of cooling, with the Consumer Price Index (CPI) dropping to 2.6%, down from a high of over 9% in 2022. This decline in inflation is largely due to the Fed’s aggressive stance on interest rates throughout the previous year, which is bringing inflation closer to the Fed’s eventual target.
However, the job market is beginning to show signs of softening as well. While unemployment remains low at 4.1%, the number of job openings has fallen drastically over the last two years. Hiring is slowing, and companies are becoming more cautious, which suggests that the economy is entering a period of moderation. Still, with inflationary pressures easing, it seems plausible that we are on track for a soft landing rather than a deep recession.
In a move that surprised some but was anticipated by many in the financial world, the Federal Reserve cut interest rates by 50 basis points this quarter, marking the first rate cut in four years. After a prolonged period of rate hikes, the Fed appears to be shifting to a more accommodative stance as inflation cools and growth moderates. The rate cut is seen as a preemptive measure to ensure the economy doesn’t slow down too drastically as the effects of previous rate hikes take hold.
Looking ahead, the Fed is expected to continue with measured rate cuts through the remainder of the year and into 2025, with market estimates suggesting another 50 basis points in 2024 and 100 basis points of cuts next year. This easing in monetary policy could provide a tailwind for the stock market, which historically performs well in the early stages of a rate-cutting cycle. Lower interest rates generally make borrowing cheaper, which can stimulate economic activity and provide support to both consumers and businesses.
For stock markets, the shift in the Fed’s stance is typically positive. Rate cuts can boost investor confidence, as they lower the cost of capital and make stocks relatively more attractive compared to
bonds. Historically, equity markets have performed well in the six to twelve months following the first rate cut after a hiking cycle. That said, much depends on the Fed’s ability to balance cutting rates without reigniting inflation, as well as global economic conditions that could affect market sentiment.
Overall, the economic outlook remains cautiously optimistic. While risks of a recession have not fully disappeared, the combination of slowing inflation, a still-resilient labor market, and the Fed’s shift to rate cuts suggest that the U.S. economy may be “threading the needle.” Investors should remain mindful of potential market volatility but also recognize the opportunities as we transition into year-end.
Equity Overview
The US stock market tends to exhibit distinct patterns during presidential election years. Historically, volatility increases as uncertainty around election outcomes weighs on investor sentiment. According to historical data, the S&P 500 has posted an average return in the 6% range in the 12 months following Presidential elections. Interestingly, the market tends to perform better when an incumbent party wins, as it reduces the uncertainty associated with significant policy changes. Following elections, the market typically stabilizes as investors gain clarity on fiscal and regulatory policies. Looking ahead to the remainder of 2024, we expect heightened market sensitivity to economic and geopolitical developments as election rhetoric heats up, especially regarding fiscal policies and interest rates.
In an unexpected move, China’s government introduced substantial fiscal and monetary stimulus measures this quarter, aiming to counteract weakening economic growth. These policies included interest rate cuts, government spending initiatives, and support for real estate markets. This stimulus package has had ripple effects on international equity markets, with Chinese stocks initially rallying in response to the announcement.
However, the broader impact on global equities has been mixed. Emerging markets, particularly those heavily tied to Chinese trade, saw short-term gains, but uncertainty about the sustainability of China’s economic recovery remains a concern. Additionally, sectors like commodities, which are closely linked to China’s industrial demand, experienced increased volatility. For international investors, China’s efforts to stimulate its economy could present selective opportunities in the short term, but caution is warranted as global supply chains and demand metrics remain in flux and performance in China after past interventions has proven to be short-lived. While we do have Chinese equity exposure in client portfolios, we decided to underweight this market earlier in the year for structural and ethical reasons.
For much of the past few years, US stock market performance has been driven by a narrow group of technology stocks—primarily the “Magnificent-7” stocks and similar high growth companies. These few large-cap companies accounted for a disproportionate share of market gains, creating a concentration risk for many portfolios. However, this quarter saw signs of a broadening in market leadership, as other sectors like value, small-caps, healthcare, and industrials started to outperform.
The Russell 2000, a benchmark for small-cap stocks, gained approximately 9.27% in the third quarter, outpacing the broader S&P 500 by around 3.4%. This shift indicates that investors are increasingly seeking diversification beyond high-growth tech names. As market breadth improves, it may reduce some of the concentration risk and offer more balanced opportunities for investors. Looking ahead, sectors that were previously underappreciated and still undervalued may continue to catch up, presenting opportunities in areas such as cyclical stocks and value-oriented investments, for example.
Entering the final quarter of the year, the market’s direction will be shaped by several factors, including election outcomes, central bank policies, and global economic trends. While volatility is expected, the broadening of market leadership and potential stabilization in international markets, driven in part by monetary stimulus in multiple foreign countries, provide reasons for cautious optimism. As always, maintaining a well-diversified portfolio and will be critical for navigating these dynamic conditions.
Bond Market Overview
The 3rd quarter performance for bonds was quite strong, especially as measured by the intermediate term (7 – 10 year) U.S. Aggregate Bond Index. This benchmark is comprised of U.S. Treasuries, mortgage-backed securities and high-quality corporate bonds. The index is very sensitive to movements in interest rates, so as rates pulled back last quarter, longer-term, high-quality bonds were the beneficiary. The opposite is also true and is the same reason why this benchmark index got so beat up in 2022 as rates rose quickly off anemically low levels. Historically, the bond market has delivered returns in the 4.5% range while, cash has returned about 2% less on an annualized basis. With the Fed beginning to lower rates, we believe cash investments (money markets, CDs, T-Bills) soon will no longer be a viable investment, while the bond market is poised to deliver returns in and around their historical averages.
We prefer a more tactical approach to bond investing, meaning our strategies will adjust to take advantage of price dislocations, interest rate opportunities and the use of low-risk alternatives as bond substitutes in order to lower our strategies’ sensitivity to moves in interest rates.
The most noteworthy development that occurred during the 3rd quarter was the normalization of the yield curve. This was the first time since July 2022 that the yield curve was positively sloped, meaning 10-year Treasury yields are now above 2-year Treasury yields. An inverted yield curve, where short-term rates are higher than long-term rates, typically signals a recession is on the horizon. The curve hit its highest level of inversion (1.1%) in July 2023 just before the Fed hiked interest rates for the final time in this tightening cycle. Following that last rate hike, the spread gradually closed as inflation metrics improved and markets gained confidence that the Fed wouldn’t raise rates any higher.
The final three months of 2024 promise to be volatile with plenty of uncertainty and speculation. Some of the factors that are sure to keep investors on edge include the escalation of the Israeli/Palestinian & Iran conflict, the build-up and outcome of the Presidential election, and the Fed’s rate policy decisions in response to the final few months of jobs and inflation data. We’re also entering Q3 S&P earnings season in mid-October; It is important that companies can deliver good news and a positive earnings outlook to justify the stock market’s lofty valuations. If the rest of 2024 rhymes with history, October is very volatile, while cooler heads prevail in November and December with strong market returns. Regardless of short-term volatility associated with elections, the market has moved up from the bottom left to the top right over time, regardless of political party.