As inflation continued to slow, there was extensive speculation that the Fed would finally start reducing interest rates. There was significant debate as to whether the Fed would cut 25 basis points or 50 basis points, and at the September meeting, the Fed reduced the Federal Funds rate by 50 basis points. For the third quarter, the Bloomberg 500 returned 5.76%[1]. When we look at the style indices, the Bloomberg 1000 Growth returned 4.87% and the Bloomberg 1000 Value Index returned 8.53% during the third quarter[1]. Value stocks benefitted from the expectation of lower inflation and the start of the Fed’s easing cycle. International equity, as represented by the Bloomberg World ex U.S., was up 8.41% and small cap market as represented by the Bloomberg 2000 Index, returned 9.95%[1]. Market segments other than growth had a strong showing during the third quarter.
Looking at fixed income, the Bloomberg Aggregate Bond Index returned 5.19% and the Bloomberg 1–3-year Government/Credit Index returned 2.96% during the third quarter[1]. The 10-year Treasury Note ended the second quarter with a yield of 4.40% and settled at 3.78% by the end of the third quarter[1]. The 2-year Treasury Note ended the second quarter with a yield of 4.75% and settled at 3.64% by the end of the third quarter[1]. The 62-basis point decline in the 10-year Treasury note is what helped drive returns in the Aggregate Bond Index and spreads were generally tighter at the end of the third quarter versus levels at the end of the second quarter.
The Fed stayed consistent with telegraphing their expected rate cut and delivered the consensus reduction in the Federal Funds Rate of 50-basis points at the September meeting. Equities performed well because the market is focused on the Fed’s ability to navigate the lessening of inflation, with a slower but not recessionary environment. The lessening of inflation saw interest rates rally and fixed income performed very well during the third quarter. The most recent reading of the Personal Consumption Expenditures Index was 2.2% and this is very close to the Fed’s 2.0% inflation target[1]. By holding rates at a higher level, the employment market has shown some cracks with unemployment up over 4%, and we also have witnessed slower job growth with significant negative revisions to previous new job creation reports[1]. Expectations are for at least 75 basis points of further cuts with the belief that the Fed sees inflation in a manageable range and is now focused on preserving economic activity to protect the job market.
The market is now very focused on the outcome of the Presidential election and by every measure, we expect this to be an extremely close race, and it is entirely possible it may take a day or two to declare a winner. The market is also closely watching the Senate and House races to try and decipher the ultimate construction of our next Congress. To be fair, both sides are equally uninspiring when it comes to being serious about the persistent Federal budget deficit and the mounting overall Federal debt. This is one of those problems that seems to not be a problem until it is. We believe this is one of those cases in that discipline will either be adopted by the government or forced upon it by the bond markets. Our current debt-to-GDP ratio has only been this high during World War II when we constructed the Arsenal of Democracy to fight Nazi Germany and Imperial Japan.
As we look through all the market statistics, it is apparent that the Fed has now pivoted from fighting inflation to supporting employment. Recall that the Fed has a dual mandate of promoting full employment and maintaining low inflation. It has been well chronicled that the Fed got it wrong with respect to “transitory” inflation and we believe the 50-basis point cut was a statement that they were not going to be late to protect employment. As consumer consumption represents over 70% of U.S. economic activity, keeping the consumer strong will be the best means of keeping the economy afloat.
We are seeing the first wave of refinancing activity as those with mortgage rates over 7% are seeing an ability to refinance. Household spending remains focused on staples because groceries, rent, and insurance remain quite costly. Consumers have enjoyed some relief as fuel prices have declined.
The geopolitical landscape is still quite concerning. The world is growing weary of the protractive conflict in Ukraine. The U.S. provided more military armaments to the Ukrainians, but we have not provided a green light to use missiles deeper into Russian territory. The Iranians are very close to achieving their ambition of nuclear weapons and the conflict in Gaza continues while the Israelis are fighting Houthis and Hezbollah. We also remain concerned that China will finally assess our resolve by taking more direct action with respect to Taiwan. Overall, the world is as fragmented as it has been since the fighting during World War II. While we do not believe we are on the precipice of a major global conflict, there are so many conflicts occurring, it is not too hard to paint a picture where these smaller conflicts conflate into something much larger.
We continue to focus on portfolio rebalancing because equity valuations are getting stretched and fixed income yields are still attractive enough to provide strong return input in a well-diversified, multi-asset portfolio.
The market’s wall of worry remains tall, and we will start to see some resolution during the fourth quarter as we elect a new President and seat a new Congress. We will be watching for a second bout of inflation that has many times been an echo of any period of inflation. We are always available to discuss your portfolio’s structure during these very tumultuous times.
[1] Source: Bloomberg
Market Insights October 2024 | KoCAA (kofcassetadvisors.org)