Q3 2024 Summary – Election Tension

Macroeconomic Environment

The markets were stellar in 3Q24, generating strong returns across asset classes and reflecting a positive outlook that strength remains in the economy despite signs of cooling. The Fed’s move to ease monetary policy to help the economy navigate a soft landing was no surprise, but the size of the move was debated in the weeks leading up to the decision. The election is now the focal point for the next month, and with it comes uncertainty on how either party’s fiscal policy will address the growing deficit and myriad other issues that could impact the economy (trade, immigration, geopolitics).

The Fed delivered on the widely anticipated rate cut at the September Federal Open Market Committee (FOMC) meeting. The committee voted 11-1 to lower the overnight borrowing rate by 50 bps to 4.75% – 5.00%. It was a significant shift from three months prior, when the Fed unanimously voted to hold policy rates and projected only one rate cut (25 bps) for the year. For historical reference, the last time the Fed cut by 50 bps was in 2020 during the pandemic and 2008 during the Global Financial Crisis. The “dot plot” indicates that the median projection by year-end is 4.25% – 4.50% (two rate cuts of 25 bps) and the 2025 median projection for year-end is 3.25% – 3.50% (four cuts). As of quarter-end, the markets were slightly more dovish, reflecting a high likelihood of three rate cuts by year-end, according to the CME FedWatch tool.

The committee emphasized its dual mandate, highlighting that inflation has made progress toward its 2% target and that unemployment, while ticking up, remains low. The Personal Consumption Expenditures (PCE) price index, the Fed’s preferred measure, increased 2.2% year-over-year in August, down from 3.3% a year ago. Excluding food and energy, it rose 2.7% YOY. The Consumer Price Index (CPI) increased 2.5% YOY in August, and Core CPI increased 3.2%. Housing inflation remains stubborn (although it has eased since early 2023) and was one of the largest drivers in both inflation measures—Core CPI excluding housing rose 1.8%. The White House issued a blog post in September highlighting the housing supply shortfall as the culprit.

The labor market continued to soften as job gains and wage growth trended downward as of August. The Job Openings and Labor Turnover report highlighted a decline in job openings over the last 12 months, reflecting that it may be getting harder to get hired. The 4.2% unemployment level in August was up from 3.8% a year ago, though it remains at a level that is still considered full employment. Jobless claims may see some volatility in the near-term with Boeing’s massive strike, the East and Gulf Coast ports strike, and the fallout from Hurricane Helene. The Summary of Economic Projections have a median projection for 4.4% unemployment by year-end.

GDP in 2Q grew by 3.0% in real terms, ahead of 1Q’s 1.6% growth, driven by an increase in inventories and consumer spending. Estimates for 3Q GDP are lower; the Atlanta Fed’s GDPNow publication has an average estimate of 2.5%, and the Philadelphia Fed’s Survey of Professional Forecasters was less rosy at a 1.9% estimate. Manufacturing data (PMI) has been under 50 over the last six months indicating a contraction in the sector. Consumer spending was modest in August with services spending offset by a decline in goods spending; new car sales declined heavily. That followed a period of solid retail sales in July, which aligns with the seasonal Amazon Prime Day bonanza. Household net wealth remains high relative to historical levels, with an increase in 2Q from gains in real estate and the equity market. Consumer savings was revised upward (5.2% in 2Q from 3.3% previously reported) showing better growth in real disposable income in recent quarters.

The Conference Board Consumer Confidence Index fell in September to 98.7 from 105.6 in August, reflecting the largest decline since August 2021. Data on household debt is now showing small signs of cracks. The New York Fed’s Quarterly Report on Household Debt reported an increase of $109 billion in 2Q across mortgage, credit card, and auto loan balances. It also highlighted a minor increase in loans that transitioned to 90+ days delinquent; that figure was most evident in credit card debt. Despite the growing challenges among some consumers, applications for new home purchases increased 4.4% in August compared to July, which was flat, according to the Mortgage Bankers Association Survey. The decline in mortgage rates has spurred activity with estimated new home sales increasing roughly 15% in August, a similar level to February 2022.

The economy and politics are as intertwined as ever with the U.S. approaching the end of the current election cycle. In September, Congress averted a government shutdown by kicking the can down the road and passing a stopgap bill. In December, the House and the Senate will have to agree on a spending package for 2025, and the outcome will likely be influenced by the results of the election. The federal budget deficit has swelled to approximately $1.9 trillion, roughly $370 billion more than the same period last year, according to the CBO. Outlays continued to outpace revenues as there has been a substantial increase in interest payments on public debt.

Both presidential candidates’ fiscal policy proposals have been cited by economists as potentially increasing the deficit if they get full support from Congress. Tax policy stands to be reshaped with provisions of the Tax Cuts and Jobs Act (TCJA) set to expire in 2025. According to former President Donald Trump, he favors extending all the TCJA provisions and proposes further tax cuts, while Vice President Kamala Harris proposes higher taxes on corporations and on the wealthy coupled with an increase in entitlements. Trump’s tariff proposals (60% tariff on China and 10% universal tariff) could somewhat offset the revenue shortfall from tax cuts but remain contentious with concerns around sparking a trade war and reigniting inflation. Some worry his protectionist policies in the current geopolitical environment could potentially throw fire to the flames.

Overseas, euro zone GDP increased 0.2% in 2Q year-over-year but was down relative to 1Q. Growth was lowest among the largest economies including France, Italy, and Germany (which contracted 0.1%). In September, the European Central Bank (ECB) cut its policy rate for the second time this year by 25 bps to 3.50% – 3.75%. Inflation among EU members fell to 2.2% in August, down from the 10.5% peak in 2022. The ECB’s Governing Council’s assessment of the inflation outlook projected headline inflation to average 2.5% in 2024 and decline toward 1.9% in 2026.

Japan’s inflation climbed 3% on an annualized basis in September following solid GDP growth in 2Q. The increase gave emphasis to why the Bank of Japan (BOJ) has worked toward policy normalization this year. In March, it shifted from its negative interest rate policy to 0% and in July it hiked its benchmark rate to 0.25%, reaching its highest level since 2008. In early August following the rate hikes, global markets were shaken as the yen strengthened and yen-funded carry trades began to unwind, leading to an aggressive sell-off across markets. The BOJ paused its hiking cycle in September amid a change in political leadership. Japan selected ex-Defense Minister Shigeru Ishiba as its new prime minister as Prime Minister Fumio Kishida announced he would not run for another term.

In September China revealed extensive stimulus measures to tackle weakening economic activity, deflation, and its deteriorating property market. The economic supportive measures include monetary policy easing through interest rate cuts, stimulus for the property market, and support for the stock market as well as banks. The Politburo called for controls on property construction, a greater focus on employment, and increasing consumption among low-income groups. The major announcement conveyed a sense of urgency as China’s growth has slowed, creating concerns whether it can reach its 5% GDP target.

Global Equity

U.S. stocks posted solid gains in 3Q, extending the strong performance for the year. The S&P 500 gained 5.9%, outperforming the tech-heavy Nasdaq Composite, which returned 2.1%. Year-to-date the S&P 500 (+22.1%) remains ahead of the Nasdaq (+20.0%). Within the S&P 500, Utilities (+19.4%) and Real Estate (+17.2%) led the sectors while Energy (-2.3%), Technology (+1.6%), and Communication Services (+1.7%) were the worst performers. Small cap stocks outperformed large cap stocks (Russell 2000: +9.3% vs. Russell 1000: +6.1%). Value beat growth (Russell 3000 Value: +9.5% vs. Russell 3000 Growth: +3.4%), but growth remained ahead year-to-date. The Magnificent Seven were up 35% year-to-date and represented 45% of the S&P 500’s return this year (top three were Nvidia: +136%, Meta: +63%, and Amazon: +22%).

Global ex-U.S. equities (MSCI ACWI ex USA: +8.1%) also finished the quarter strong, boosting returns year-to-date (+14.2%). Within developed markets, Value (MSCI World ex-USA Value: +9.7%) outperformed growth (MSCI World ex-USA Growth Index: +5.9%) by a wide margin. Real Estate (MSCI EAFE Real Estate: +17.4%) and Utilities (MSCI EAFE Utilities: +15.6%) were the strongest-performing developed market sectors. Japan (MSCI Japan: +5.7%) was up for the quarter, but stocks declined in September following the election of a new prime minister known for pushing fiscal discipline and being a China hawk.

Emerging markets (MSCI Emerging Markets: +8.7%) outperformed developed markets (MSCI EAFE: +7.3%).  Asia was the strongest region (+9.5%) with Thailand (+28.9%), China (+23.5%), and Malaysia (+20.5%) leading the way. EM Europe (-2.5%) declined in 3Q, led by Turkey (-12.6%). Consumer Discretionary (+23.3%) and Health Care (+19.7%) were the strongest-performing sectors for the quarter. Energy (-2.5%) declined as oil prices have sunk this year.

Global Fixed Income

The Bloomberg US Aggregate Bond Index soared 5.2% after producing flat returns in the previous quarter. Year-to-date, the Aggregate Index is up 4.9%. The 10-year Treasury yield sank 55 bps during the quarter, closing at 3.8% as markets priced in a higher probability of a deeper economic slowdown and more aggressive cuts. In early September, the 2-year and 10-year Treasury yields steepened and un-inverted for the first time since July 2022. All the Aggregate sectors outperformed Treasuries on a like-duration basis, led by agency mortgage-backed securities. Investment grade corporates (+5.8%) outperformed High Yield (+5.3%) for the quarter. Spreads broadly remained flat over the quarter despite intra-quarter volatility and remained tight relative to historical averages. Both investment grade and high yield issuance was robust in 3Q.

The Bloomberg Global Aggregate Index rose 7.0% (+4.2% hedged) propelled by dollar weakness as the U.S. Dollar Index declined. The story was similar within the emerging markets with the local currency JPM GBI-EM Global Diversified Index (+9.0%) outperforming the hard currency-denominated EMBI Global Diversified Index (+6.2%).

Municipal bonds posted gains in 3Q (Bloomberg Municipal Bond Index: +2.7%) with lower quality outperforming (Bloomberg Muni High Yield: +3.2%). The municipal bond yield curve steepened with the front end of the curve declining more than the long end. Ample supply for the quarter was met with strong demand.

Closing Thoughts

The sea of green depicted by rock-solid performance across markets this year may stand at odds with the U.S.’s historic political crossroads, an inflating deficit, and geopolitical risks (war spilling over from the Middle East, Eastern Europe). Are the markets acting rational? Some may say no, but those risks can be very hard to price. What we do know is that the U.S. economy and labor market, though softening at a steady pace, have remained resilient and the Fed has made progress toward reaching its policy target, and plans to ease further. The next month leading to the election results will feel like an eternity, but the outcome should help relieve some of the pent-up uncertainty related to bigger picture risks. As ever, we recommend adhering to a disciplined investment process that includes a well-defined long-term asset-allocation policy.

For market index data, click here.