Global Market Review and Outlook

Total Returns
Sources: Factset, William Blair

The summer and early fall proved actioned-packed with a change in the Democratic presidential nominee from Joe Biden to Kamala Harris, two assassination attempts on Republican presidential candidate Donald Trump, a sharp escalation in the conflict in the Middle East, and a “bazooka” of monetary support announced to help China’s ailing economy. In what was a dramatic quarter on multiple fronts, the tailwinds of dovish monetary policy prevailed, allowing for strong performance across the board in financial markets. The S&P 500 ended the quarter up 6%, and international indices realized slightly higher returns in the period. Core fixed-income returns were up 5% on the backs of higher bond prices as interest rates fell.

Evidence of tamer inflation (2.5% CPI in August) paved the way for the Federal Reserve to pare interest rates in September for the first time in over four years. The Fed started with a 50-basis-point cut, the high end of market expectations, and signals are for about 150 basis points of gradual additional cuts through 2025. Resilient GDP growth and solid employment numbers bolster the likelihood that a recession will be avoided in the near term, which we believe is the most likely scenario. With inflation almost entirely concentrated in the services sector, and goods, food, and energy inflation either contracting or negligible, inflation appears to be a less pressing problem at this time. Inflation levels are now within range of the Fed’s 2% target. One point of emphasis is that while inflation has come off the front burner, the compounding rate of inflation over the past several years weighs more on lower-income families who have had their rent and food prices increase faster than their compensation, and do not have the benefit of rising home values or investment appreciation. For this reason, despite still low unemployment, we are seeing weak consumer confidence numbers, and credit card delinquencies and auto loan defaults are ticking up. These data points warrant close monitoring.

U.S. Y/Y CPI Breakdown

From a market perspective, we anticipated lower interest rates would be a catalyst to improve the performance of more rate-dependent areas of the economy that rely on lending for growth. This hypothesis played out last quarter as returns finally moved beyond the Magnificent 7 after two years of a concentrated market. In the third quarter, real estate and small-capitalization stocks were the best-performing areas of the market, up 16% and 9%, respectively. With central banks easing globally and massive monetary stimulus in China, developed international markets and emerging markets also fared well. It is too early to call a change in trend, but with more reasonable valuations as compared to history in smaller companies and in the international realm, opportunity can be found outside the largest companies in the S&P 500. In addition, small-cap companies are set to grow earnings faster than their large-cap brethren starting in the fourth quarter of this year, which they have not done since 2022. The dominant mega cap companies are still in an enviable position, growing more quickly than the market with high levels of profitability and cash generation. However, antitrust concerns and impacts from potential future tariffs and geopolitics may weigh more heavily on companies that are more exposed to the international marketplace.

Earnings Growth

Pro-forma EPS, Y/Y

It is our belief that the longer-term path of asset prices closely tracks growth in corporate profits. U.S. corporate profits as measured by S&P 500 earnings per share are expected to grow approximately 10% this year and close to 15% in 2025. This growth is remarkable, especially in the context of 2%-3% increases in GDP. While we would not be surprised for earnings expectations next year to degrade over time, as is typical for forward projections, 2024 is very close to baked. Continued strong earnings growth is a positive sign for stock prices, which are once again making all-time highs. It is also worth noting that asset valuations are higher than long-term averages. The S&P 500 is trading at 22x earnings, compared with the long-term average of 17x. The top 10 stocks in the index are trading at 30x earnings. Some may say that the market is “priced to perfection.” If earnings prove too optimistic, market valuations and prices would likely have to adjust.

For fixed-income instruments, while near-term rates may have peaked on money market and other short-term instruments, yields across the bond market remain above the rate of inflation, allowing investors to earn a positive real return. Further rate cuts should have a positive impact on bond prices. Credit spreads (the additional yield investors get to take on risk above the risk-free rate) have been narrow for a couple of years, reflecting strong corporate and local government balance sheets. We favor high-quality municipal and corporate bonds and believe fixed income can serve an important role in portfolios, providing both stability and income generation.

With the presidential election very much upon us—who isn’t getting bombarded with emails, texts, and television ads?—we should not be surprised by heightened equity market volatility as we head into November 5, Election Day. Typically, September and October going into an election are weak months for the stock market as uncertainty is high. Even with a near dead heat in the current election and very different policies expected from Harris and Trump, the market has been remarkably steady recently and gained ground since September 1. Perhaps the timing of Fed easing in September provided buoyancy? Whatever the case, it is important to remember that historically markets have performed very similarly on average under both Republican and Democratic administrations. Structural growth in the economy drives markets over time.

Last, as we approach year-end, the past several years of strong market returns have us reviewing portfolios with an eye on trimming holdings that have appreciated meaningfully and may have grown beyond their appropriate size. We view this pruning process as an important part of overall portfolio risk control, like tending a garden, and while we will remain prudent and thoughtful when realizing gains, we want to keep portfolios fresh and evolving.

We wish everyone peace and good health. Our thoughts are with those who have faced loss and destruction from the recent hurricanes.