By: Darren W. King | Wealth Management
Equity markets continued pushing through all-time highs in the third quarter, as economic growth remained resilient, and the Fed began their normalization of interest rates. The S&P 500 gained 5.89% in the 3rd quarter, and 22.08% for the year. Markets moved higher, despite some signs of slowing in hiring and consumer spending. The Technology-heavy NASDAQ was up 21.84% ytd., while the DOW Jones Industrial Average was up only 13.51%. The Russell 2000 Small Cap Index finished the third quarter of the year up 11.16% over the same period. International developed market equities, as measured by the Morgan Stanley Capital International Europe, Australasia, and Far East Index (MSCI EAFE), closed the third quarter up 13.55% in US dollar terms and up 10.72% in local currency. The MSCI Emerging Markets Share Price Index closed 3Q 2024 up 17.13% in US dollar terms.
The third quarter witnessed technology shares underperform as interest rate sensitive sectors rallied after the Fed lowered short term rates. S&P 500 sector results through 9/30/24: Utilities 30.63%, Technology 30.31%, Communication Services 28.81%, S&P 500 22.08%, Financials 21.89%, Industrials 20.20%, Consumer Staples 18.74%, Health Care 14.35%, Real Estate 14.30%, Materials 14.14%, Consumer Discretionary 13.90%, and Energy 8.36%. Value, defensive, and interest-rate sensitive stocks were the story of the third quarter as money moved out of high performing technology shares and into areas of the market that had underperformed during the past several years. Utilities have now surpassed Technology for the best performing sector in 2024, as investors have focused on the increasing need for power grid investment to support increasing power demand.
Based on current consensus earnings forecasts, the forward 12-month P/E ratio for the S&P 500 is 21.6X, more expensive than the five-year average P/E of about 19.5X. Currently, the market is estimating 10% earnings growth on 5.1% revenue growth in 2024. S&P 500 earnings growth is also forecasted to accelerate to 15.1% in 2025. Profitability remains high for S&P constituents, with net profit margins currently at 12.2%, compared to 5-year average profit margins at 11.5%. Average equity strategists’ bottom-up price targets for the S&P 500 in 2024 are at 6,287.88, 10% higher than current trading levels. We are expecting a more normalized return environment for equities for the remainder of 2024 with valuations needing to also normalize after the strong rally over the past 3 quarters. However, we do see a continued broadening of equity returns out of technology and into other areas of the market that have not participated as dramatically in the equity rally. Strategic moves out of domestic large capitalization investing into small cap and international stocks proved to be a wise decision as small cap and international equities were up between 7% to 9% for the third quarter, while the S&P 500 returned 6%. Most notable was the 14% rally in the Shanghai Composite in the third quarter, following stimulus packages to boost the struggling Chinese economy.
During their September 2024 meeting, the Federal Reserve initiated a policy pivot, cutting interest rates 50 basis points to 5%. After 11 hikes and 13 months at the upper bound of 5.5%; Fed communication now forecasts the fed funds rate at 4.5% by the end of 2024 and falling to 3.5% by the end of 2025. The Fed also indicates a neutral rate around 2.9%. Latest economic projections show an economy that is growing at much higher levels than late 2023 projections, but with slightly higher inflation remaining and a labor market that is losing momentum. The Fed estimates Real GDP to be 2.0% in 2024, revised up from 1.4% GDP growth estimates that were forecasted in December. As measured by the Fed’s preferred inflation gauge, the Core Personal Consumption Expenditures Index, inflation is estimated to end 2024 at 2.4%, slightly lower than earlier projections at 2.6%. As of October 7, the fixed income markets still see slightly more rate cuts by year end 2025 beyond what the fed is indicating. This suggests short and intermediate duration fixed income might be offering too low of yields at this time. While equity markets rallied in the third quarter on signs of improving economic and earnings growth, the bond market sent interest rates lower and rallied strongly on the feds 50 basis point cut. As of quarter-end, 10-year treasuries now yield 3.83%, down from 3.88% at the end of 2023. With the 10-year treasury yield drastically lower than the 4.5% yield offered at the end of May of this year.
The 10-year treasury staged a rally through September of 2024, starting the year at 3.88% and ending the quarter at 3.78%. Longest duration bonds underperformed shorter duration issues as yields fell more for short duration assets than longer dated issues following the fed’s rate cut. 20+ year treasuries were up 1.58% in the first three quarters of the year, while intermediate treasuries were up 4.19%. In a risk-on trade, higher credit quality underperformed the lowest credit quality issues. Aaa rated bonds within the Barclays U.S. Aggregate Index were up 4.96% in the first three quarters of 2024, while Baa rated bonds returned 5.65% during the same period.
The Bloomberg Dollar Spot Index finished September with the dollar having strengthened .82% compared to our trading partners for the year. However, the dollar weakened almost 4% during the quarter as global markets now see around 200 basis points of interest rate easing in 2024 and 2025. Light crude oil futures fell 1% in 2024, with WTI oil futures falling to $70.92 from $71.65 at the end of 2023. 30-year mortgage rates fell from 6.99% at the end of 2023 to 6.68% by the end of September, while 30-year treasuries rose 9 basis points from 4.03% at year-end 2023 to 4.12% at the end of the third quarter.
According to the Bureau of Labor Statistics, the September employment report showed 254K jobs gained during the month, well above estimates, and with numbers for the prior two months revised higher by 72,000 jobs. The September jobs report alleviated concerns that the labor market is deteriorating and showed improvement in the labor market after several weak numbers at the beginning of the summer. The September jobs number reported unemployment at 4.1%, falling from 4.3% in July, but well off the cycle low unemployment rate at 3.5% in March or 2023. The labor force participation rate in September was 62.7%, up from the pandemic trough of 60.2% in April of 2020. For September, average hourly earnings rose 3.9%, below the recent wage inflation numbers that were averaging greater than 5% for most of 2023. The latest jobs numbers indicate a slower trend in wage inflation and signs that the restrictive monetary policy is finally working its way through the economy. Additionally, the prospect for an impending recession are not in the numbers and market sentiment is moving more towards the soft-landing scenario.
Retail sales in August increased .1% from the prior month, surprising economists who had predicted a .2% decline. Annualized retail sales were up 2.1% over the past year, compared to the consumer price index’s measure of inflation up 2.5%. After some soft numbers at the beginning of the summer, the economy appears to have stabilized over the course of the late summer months. Gasoline station sales were down 6.8% from the prior year as energy prices moved lower in 2024, providing a boost to consumer discretionary spending on other items. Department store sales were down 2.1% from the prior year. Building materials and supplies were down .1%. E-commerce and mail-order houses ended the 12-month period with a 10.7% sales gain. Auto sales were up 1.3% from the prior year. Restaurant spending was up 2.7%, furniture store sales were down .7%, health care spending was up 3.5% and clothing and accessories were up 1.0%. On a positive note, food costs were only up 1.6% from the prior year, well below current year over year inflation numbers as supply chains are recovering from the pandemic. With consumer spending two-thirds of our economy, we are seeing consumption growth remaining resilient. With wage growth up 3.8% over the prior year and real disposable income also up 3.3%; the income side of the equation is helping to defray some of the inflationary and higher financing pressures. Worse case scenarios of a collapse in consumer spending are thankfully not materializing.
We are expecting a more normalized return environment for equities for the remainder of 2024 with valuations needing to also normalize after the strong rally over the past nine months. However, we do see a continued broadening of equity returns out of technology and AI themes and into other areas of the market that have not participated. The first Fed rate cut has already functioned as the catalyst for some outperformance for underperforming sectors over the past several years. Small capitalization and international equity valuations remain attractive compared to large capitalization peers. Current S&P 500 earnings estimates for 2025 are forecasted to grow by 15% and remain above trend. We do not see a Democrat or Republican win in the presidential election changing fiscal policy. Whether looser regulation, tariffs, ending green energy initiatives, continued direct entitlement spending, or continued infrastructure spending; we see a higher level of inflation and a free spending economy over the longer term. Equity markets believe economic growth is strong enough and inflation is falling fast enough for the Fed to rescue lofty equity valuations. An orderly return to a more normalized rate environment could prove to be a powerful catalyst for equities to avoid any major market correction in the near term.
Within the fixed income markets, interest rate, fed policy, and market traders see two more twenty-five basis point interest rate cuts this year, following some slowing in hiring and inflation moving closer to the fed’s 2% target. Ten-year treasury rates are currently at 4.02% as of October 7, up twenty-seven basis points from the end of the third quarter, but down substantially from earlier this summer. The corporate bond market is still offering yields north of 4.5% for intermediate to longer maturities. We see rates moving lower over the intermediate term, and we see current interest rate levels as an opportune period to extend portfolio duration, invest excess cash in fixed income markets, or take some profits from equity portfolios to add to fixed income exposure.
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Click here to read the Q3 2024 Market Summary.
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Data Sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Dept. of Commerce (GDP, retail sales, housing); Institute for Supply Management (manufacturing/services). Factset (S&P 500 statistics); Performance: based on data reported in Bloomberg (indexes, oil spot prices, foreign exchange); News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources, such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied upon as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.