Global Market Review and Outlook

Capital markets continued to march higher in the third quarter despite noticeable volatility in the period. In the U.S., tamer inflation paved the way for the Federal Reserve to lower interest rates for the first time since March 2020. This policy-easing action helped support U.S. equities, and the S&P 500 advanced 5.9% in the quarter. Smaller companies fared even better as the Russell 2000 (small cap) gained 9.3%. Fixed income also benefited from the interest rate cut as prices rallied on the resulting lower yields. U.S. bonds were up over 5% in the quarter, while municipal bonds rose almost 3%.

Source: Factset

The quarter ended well in most regards, but the trip throughout was not entirely smooth. In July, questions over the durability of growth of the Magnificent Seven large-cap tech stocks and specifically Nvidia troubled markets. Higher unemployment in August stoked fears of a recession or hard economic landing. In September, uncertainty about the Fed’s interest rate cut intentions roiled investors. In each case, a swift drawdown in the markets was followed by an equally impressive rebound, and the quarter ended with markets near all-time highs.

We would not be surprised by further spikes in volatility as we move through the fall. Peak election season is upon us, and while history suggests that long-term market returns are healthy—and virtually identical—under each party, it does not eliminate the possibility of near-term uncertainty. In addition, geopolitical tensions in several areas continue to percolate. A flare-up could destabilize markets.

Volatility, while unsettling in the moment, is not necessarily a negative. In fact, it is a normal and often healthy part of our market environment. In 7 of the last 10 years, the U.S. equity market has declined by more than 10% at some point during the year, yet the S&P 500 has tripled during that same 10-year time span. Staying the course and taking advantage of the volatility during drawdowns continues to pay dividends over longer periods.

While markets can fluctuate in the near term, the ultimate longer-term path of asset prices is determined by economic growth and resulting corporate profits. In that regard, we continue to view the U.S. economy in good standing for now and consistent with the Fed’s much-desired soft landing. Second-quarter GDP growth annualized at a healthy 3%. Revisions to income levels suggest that consumer disposable income and savings are better than expected, and unemployment and layoffs are still at historically low levels. The job market will be our key indicator going forward given its connection to consumer spending, which ultimately is the largest contributor to GDP growth. If individuals are employed, spending typically remains healthy, reinforcing economic growth.

A relatively stable economic outlook and a lower interest rate environment provides a favorable backdrop for both stocks and bonds. The interest rate cut in September is expected to be the first of a broader easing cycle over the next 12 to 18 months as inflation subsides further. Typically, equity markets perform well in these environments. The average return of the S&P 500 one year following the first rate cut in a series (in a non-recessionary environment, comparable to today) is 13%. However, while the setup is favorable, we have to be mindful of relatively lofty expectations. Current valuations remain anchored on forecasts of double-digit corporate earnings growth for both 2024 and 2025. This would be a welcome but rare accomplishment if achieved. If it ultimately proves too optimistic, market valuations and prices would likely have to adjust.

For fixed income, further rate cuts should have a positive impact on bond prices, and while near-term rates may have peaked on money market and other short-term instruments, yields in many parts of the bond markets remain above the rate of inflation, allowing investors to earn real returns. Consequently, we still believe fixed income, where appropriate, can serve an important role in portfolios, providing both stability and income generation.

Last, as we approach year-end, this current string of strong market returns has us reviewing portfolio positions with an eye on trimming holdings that have appreciated meaningfully to appropriately manage concentration risk. We view this process as an important part of overall portfolio risk control and will remain prudent and thoughtful when realizing gains. We will, of course, try to manage tax consequences of asset sales with the need to keep accounts fresh and vibrant.

Enjoy the fall, and please reach out with any questions or comments.

Regards,

John, Cam, Lauren, and team