The conflict, which began with a Hamas attack on Israel a year ago, escalated with the killing of Hamas's political chief in Tehran and recent airstrikes on Lebanon and Israel. Despite the humanitarian crisis, financial markets have been minimally affected so far. The main risk is from rising oil prices, though production hasn't been impacted yet, and China's softening demand has had a larger effect. Israel's tech-driven economy remains resilient, while other regional economies are too small to affect global growth significantly.
Measures include interest rate cuts and property market support through lower down payments. The Shanghai Composite Index jumped 23% in the week after, but many economists believe the stimulus will fall short of its goal.
Polls that had shown a meaningful lead for the Republicans in the presidential and congressional races have since swung much closer, making the outcome hard to predict. Markets remained mostly unchanged despite the headlines.
Despite inflation remaining above the 2% target, the Federal Reserve cut rates by 50 basis points in September. The September jobs report showed strength, with 254,000 jobs added, upward revisions to previous months, and a drop in unemployment to 4.1%.
Historically, when the Fed cuts rates without a subsequent recession, both stocks and bonds tend to perform well over the following 12 months, with stocks often outpacing bonds.
July was a busy month for headlines given the start of the Paris Olympics, Hurricane Beryl making landfall, the ongoing war in Gaza, and an assassination attempt on Donald Trump. With all of these events taking place, a change in market leadership may have gone unnoticed by many, as growth stocks within the Nasdaq fell. Despite declines for growth stocks, most equites were positive, with the Russell 2000 (U.S. small-caps) up over 10% for the month, and ex-U.S. international stocks outperforming the S&P 500.
Stocks saw a sharp selloff, with the S&P 500 dropping 8.5% from its July high, driven by weaker economic conditions and recession fears. The July jobs report showed only 114,000 new jobs and a rise in unemployment to 4.3%, the highest since 2021. On August 5th, the S&P 500 fell 3% after a surprise rate hike by Japan's central bank. However, the downturn was brief, as Fed Chair Jerome Powell signaled a rate cut at the Jackson Hole Symposium. By month's end, the S&P 500 was nearing new all-time highs.
The Federal Reserve cut interest rates by 50 basis points in response to a cooling labor market and significant progress in reducing inflation, with core inflation rising 2.7% year-over-year in August. While Powell acknowledged improvement, he expressed concerns about housing costs, noting that "housing services inflation continues to decline, but sluggishly." The rate cut also seeks to prevent further deterioration in the labor market as it normalizes post-COVID. Powell emphasized policy flexibility, stating decisions will be made on a meeting-by-meeting basis and affirmed the economy's overall strength.
Economic indicators continue to show a resilient and growing economy as inflation measured by the Consumer Prince Index (CPI) has moderated. The most recent labor market report shows that unemployment remains low and that most workers that want a job can still find one, though employers are confronted with a need to pay higher wages as the wage growth rate remains 4% Y/Y. According to both the Purchasing Managers' Manufacturing Index (PMI) and the Institute for Supply Management (ISM) reports, the service sector continues to grow. However, data has somewhat clashed with other reports as employment appears soft and selling prices are higher. On a less positive note, manufacturing still has not rebounded as employment remains soft there too, and businesses are uncertain about what to do next, given the upcoming election. Consumer Confidence shows that there is skepticism around the economy as respondents are still concerned about inflation and the job market. On the other hand, Consumer Sentiment is a bit improved, as lower rates and borrowing costs are helping. Overall, the economy still looks promising heading into the end of the year, though the recent strong employment report may lead the Fed to cut rates at a more measured pace. Given that we have seemingly embarked on a rate cutting cycle, it will be important to monitor if inflation picks up again as a result.
The third quarter brought about a reversal from the past few years as diversification finally worked. Despite the Fed commencing a rate-cutting cycle, growth stocks measured by the Nasdaq 100 were the laggards. Lower rates may have granted some respite from burdensome floating rate debt, which helped U.S. small-cap stocks lead the way for the U.S. market over the last 3 months. Despite this reversal with large growth underperforming, large growth still appears relatively expensive from a valuation perspective, while small-caps are still near historical low valuations.
Further, outside of the U.S., foreign stocks according to the MSCI World ex-USA index outperformed the S&P 500. This was primarily driven by emerging markets being the top performing region. China's aggressive stimulus plan helped performance and led to the MSCI China Index rallying to a 23.6% return for the quarter and bringing them to nearly +30% year to date. Overall, corporate earnings along with lower rates assisted stocks across the board.
In the third quarter of 2024, the bond market saw solid performance. The Bloomberg U.S. Aggregate Bond Index (commonly known as the "Agg") gained a strong 5.20% , bringing its year-to-date return to 4.45%. Earlier in the year, the index had been in negative territory for most of the first six months.
However, the impressive gains in the third quarter not only erased those losses but also highlighted a key factor that contributed to the performance: decreasing interest rates, since bond prices rise when interest rates fall. Other segments of the U.S. bond market also benefitted.
Investment-grade and high-yield corporate bonds performed slightly better than the broader Agg index, and international bonds - from both developed and emerging markets - also posted positive returns. In the municipal space we had a very similar story, with the broad municipal index spending essentially half the year in negative territory only to erase all the losses with a strong 2.71% quarterly performance, bringing its year-to-date return to 2.30%.
Impact on Alternatives
Inflation stuck at higher-than-normal historical rates and the Fed backing down on its fight against inflation, adding protection to portfolios can help insulate against the negative implications of high inflation. De-globalization in bringing critical manufacturing back to U.S. shores, an ongoing housing shortage, and geopolitical unrest are all contributing to structurally higher inflation than we have experienced over the past several decades.
Commodities, such as energy, precious metals and food, can help protect against unexpected inflation but can also lag broader markets when inflation doesn't surprise to the upside. Another disadvantage to commodity exposure is that rather than taking possession of physical oil, gas, corn, etc., investors gain exposure through future contracts traded on commodity exchanges. These futures lose value over time and need to be rolled over to longer maturities, meaning that the investment can still lose value while the value of the underlying commodity is rising.
A safer way to protect against inflation is to own the commodity producers, which provide consistent cash flows through the sale of commodities. Direct ownership of farmland has demonstrated a history of strong inflation protection and diversification of traditional stock and bond portfolios. Since 1991, farmland's 65% correlation with inflation measured by the Consumer Price Index (CPI) is stronger than gold, with volatility below 10-year government bonds. Although purchasing a farm is not an option for most individuals, farmland investment through a comingled private fund is a much easier way to access the asset class.
Private infrastructure assets also exhibit good inflation protection with their strong correlation to CPI. Private infrastructure includes assets such as power generation and distribution, logistical infrastructure such as shipping ports, trucking terminals and airports, and even data centers. Contracts are long-term and include price escalators tied to CPI. As with farmland, most investors own infrastructure through investment in a pooled fund.
Although there are numerous distractions with war in Ukraine, an escalating conflict in the Middle East, a contentious election in the U.S. and continued economic uncertainty as we unwind from a global pandemic that shut the economy down and closed supply chains, it is important to focus on the big picture. Stock prices are driven by earnings, and throughout history, the private sector has continued to innovate and deliver products and services that consumers and businesses want regardless of distractions caused by global events. Throughout history, we have contended with world wars, regional wars, civil and political unrest, runaway inflation and numerous recessions. Despite all this, the only decade for negative total returns on an absolute basis was through the Great Depression in the 1930's. With new technologies such as Artificial Intelligence that can improve productivity there is no shortage of ability for public and private businesses to grow. Volatility will not go away, but staying invested has proven to be the best way to keep pace with inflation and grow wealth.
TMG has and will continue to deploy its sophisticated technology and trading systems to add value during periods of market volatility by conducting tax loss harvesting, strategic rebalancing, and accelerating Roth conversions, when appropriate. We appreciate your trust and confidence in managing your investments. Our team remains committed to monitoring the markets and making informed decisions to ensure your portfolios are well-positioned for future opportunities.
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