Global Market Review and Outlook

Source: FactSet. Data are as of September 30, 2024

This past quarter provided further proof that politics, the economy, and financial markets have not lost their power to surprise, and a lot can happen in just three months.

The economy has so far remained incredibly resilient against Federal Reserve rate increases spanning the past few years. Economic data has shown evidence of a slowing economy; however, no major red flags have appeared as signs of a looming deep recession. After an uncomfortable bump up in inflation during the first quarter of this year, many economists scaled back their expectations for further progress on inflation and the Federal Reserve’s ability to lower interest rates going forward. Fast forward to the third quarter, the Consumer Price Index did in fact resume its downward trend, falling from 3.3% in May (reported mid-June) to the current 2.5% (for August), now in line with the Fed’s long term target.

The Federal Reserve’s second mandate, “full employment,” has been a focus of late. The unemployment rate over the last few quarters ticked up from an April low of 3.4% to 4.3% in July. This uptick triggered the Sahm rule, which states that whenever the three-month average of the unemployment rate has risen more than 50 basis points above the 12-month low, the economy has been in recession. About half of this increase in unemployment has been the result of an increase in supply, with workers going back into the labor force as a result of high demand (i.e., new entrants or reentrants), as opposed to a reduction in demand, where more workers are moving from employment to unemployment. We should be mindful of the Sahm rule, however, September’s unemployment reading fell back to 4.1% is another sign that the economy remains incredibly resilient in the face of the tighter monetary backdrop we have witnessed over the past few years.

Early August was marked by a sharp spike in volatility, as investors worried about the economy’s prospects for stability and growth, given a lower-than-expected increase in employment for July (released August 2), and by fears that the market was experiencing a massive “yen carry-trade unwind.” With the Bank of Japan raising rates and the Fed about to lower them, a key source of market liquidity over the past few years started to become unstuck. Investors for years have been profitably borrowing in yen, investing the proceeds in higher-yielding assets elsewhere (e.g., Treasury bills), before converting back and capitalizing on a depreciated exchange rate. Pivots by central banks are often precarious; specifically following the employment report and fears about a reduction in liquidity, investors panicked that the Fed had raised rates too high, had missed the opportunity to start lowering them in July, and was now behind the curve.

At last, the Fed started to lower rates in September with a surprise cut of 50 basis points, rather than the much-anticipated 25 basis points. This cut was fortunately not in response to any stress-related events unfolding in the banking system or the financial markets; rather, the Fed knew that the prevailing fed funds rate of 5.25%-5.5% was set to balance the much higher inflation rates seen in 2023. With inflation now effectively back to target, and risks of weaker employment growth starting to increase, it was time to pivot back toward a more neutral setting. The Fed’s latest estimate of the neutral rate is 2.9%, or roughly 250 basis points lower than the September peak in the fed funds rate.

The stock market has taken the Fed’s action as a good sign. The S&P 500 in the first three quarters of this year increased by 20.9% (see index table), the fastest three-quarter start to the year since the 27.9% increase over the first three quarters of 1997. More encouraging for most investors is that the S&P 500 has finally seen a tangible increase in market breadth over the last quarter, following two years fully dominated by the Magnificent 7 stocks. The aggregate S&P 500 index increased by 5.5% in the third quarter, against a much larger 9.1% jump in the equally weighted index (a much better measure of the health of the broader market).

During the Fed tightening cycle over the past few years, there has also been continuing strength in the corporate debt market. High-yield credit spreads have remained exceptionally compressed, despite pain in other areas of the financial markets (see credit spread table, source Bloomberg). As the Fed moves toward lowering rates and easing monetary conditions, the markets hope that this will help ensure a soft landing. This is timely for sure, as the expected decline in rates over the next two years coincides with longer-duration corporate debt starting to approach maturity walls.

High Yield Credit Spread

BofA High Yield Corporate Bond Yield Minus 10-Year U.S. T-Note Yield, %

One of the most notable developments this past quarter was the Democrats’ decision to change presidential candidates midstream, as President Biden stepped aside to support Vice President Kamala Harris as the Democrat nominee. According to many election measuring resources, Harris is now neck and neck in the polls with former President Trump. She also has the benefit of a substantial campaign war chest nearing $1 billion, compared with Trump’s $692 million, much of which is being deployed in America’s seven major swing states. We may witness heightened equity market volatility in the coming weeks (see VIX chart, source Bloomberg), as is normally the case as elections draw near without certainty of a landslide victory by either party. A look at past market performance around elections shows that while the White House occupant may impact very short-term market action, over the longer term, structural growth in the economy matters much more. One factor that is being discussed and top of mind for investors and voters alike is concern about our country’s debt sustainability and the fact that neither candidate has discussed this head on during this campaign cycle but will be forced to tackle this when in the White House.

VIX Volatility Index

During Election Years 1992-2024

On the international front, China’s deflating property bubble prompted the government to unleash a series of monetary policy measures to help ease the country’s woes. While the moves caused the equity market to surge in the short term, the changes do not address the fundamental structural issue the economy faces—one where growth is still being driven by exports and investment, as opposed to consumer spending. Without measures to empower the Chinese consumer, the economy will continue to suffer from overproduction and downward pressure on asset prices, in turn placing greater pressure on foreign economies to absorb the slack. This is something the U.S. is countering with tariff protection, but the EU is struggling to address, and, at present, the euro area’s growth strategy is seemingly nonexistent. In addition, an ongoing hot war in Russia-Ukraine has impacted energy supplies, and it is facing stiff competition from an innovation, industrial policy, and energy-independent-led U.S.

As highlighted, there are many moving parts impacting both U.S. and global economies and markets as we move into the last quarter of the year. We are energized by the innovation and growth initiatives of companies, as we remain focused on owning these high-quality investments across asset classes. Even more important, we remain focused on the objectives for your capital to help meet your short- and longer-term financial goals. As always, we look forward to our meetings and conversations together as we move into year-end and 2025.

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