3rd Quarter 2024: Market and Economy

As I start my commentary, I am aware of how the upbeat tone regarding markets and the economy overall contrasts the tragedy that has befallen our great state. Sitting at my desk in Charlotte reading the devastating news reports, I cannot imagine the loss and heartbreak families are facing right now in western North Carolina. The thoughts and prayers of everyone at Bragg Financial are with those dealing with the effects of Hurricane Helene.

Tech Giants Take a Backseat to Everything Rally

Markets took investors for a ride in the third quarter. The S&P overcame declines of nearly 10% in early August and another 4% in September to finish on a high note, adding another 5.9% on top of solid first half gains. The real story, though, was not that stocks rose but which stocks led the way.

Since the 2022 lows, the “Magnificent Seven”—a group of mega-cap tech titans—have been the driving force behind stock market gains, far outpacing the other 493 names in the S&P 500, as well as small caps and international stocks. They weren’t so magnificent this quarter, though. The seven companies ended the quarter about where they started, while only Meta Platforms (Facebook) made new highs since June.

Meanwhile, nearly every other sliver of the stock market shined. This led to a major shift as value stocks outperformed growth and smaller and international stocks outpaced US large caps.

Even fixed income, which had been dragging earlier in the year, rebounded this quarter on falling interest rates. Conversely, cash might be the only asset class that didn’t fare so well. Money market funds, which had been offering enticing yields of up to 5%, saw yields drop as interest rates fell. When this happens, we tend to see money flow out of money market funds and into bonds to lock in higher yields before rates potentially fall even further.

It has been a long time since we’ve seen nearly everything in a diversified portfolio rise across the board. It’s too soon to tell if this trend will continue but if so, it could be a healthy indicator of a sustainable bull market.

Fed Shift Changes the Game

The major factor tied to market rotation is the Federal Reserve’s change in policy. In 2022 and 2023, the Fed aggressively raised the Fed Funds rate, the interest rate at which banks lend to each other, by a hefty five percentage points, pushing all borrowing costs higher. While doing so, Fed Chairman Jerome Powell stated that he expected higher rates to inflict “pain” on the economy in order to tame the worst inflation our country has seen in over 40 years.

Fast forward to today, and inflation has cooled off significantly. Over the 12 months through August, the Consumer Price Index shows inflation at just 2.5%, and if you look at the trend over the last three months, it’s even below 2%.

Despite the rate hikes, the economy kept growing. U.S. GDP increased by 2.5% last year and is projected to grow at a similar rate in 2024. That’s not quite the “pain” Powell was talking about.

There are, however, some signs of weakening. GDP growth is expected to fall below 2% in 2025. On the jobs front, unemployment has crept up from 3.4% in April 2023 to 4.2% in August. While well below the 50-year average of 6.2%, the trend is headed the wrong way. Pair that with declining job openings and the labor market is showing some potential cracks.

With inflation seemingly under control and unemployment rising, the Fed decided to ease up on the brakes by making an initial rate cut of 0.50% in September—marking a major turning point for both the economy and markets. Historically, the Fed has never made an initial cut this large when the economy wasn’t teetering on the brink of a recession, so we are in uncharted waters here because thankfully the overall economy is still broadly headed in the right direction.

Fed Cuts Create Opportunity

So what does this mean for us? This is just the first in a series of cuts to lower borrowing costs across the economy. For consumers, this could make big-ticket items like homes and cars more affordable. Mortgage rates have already dropped from over 7% to below 6% for many borrowers. Mortgage refinancing has more than doubled since June and is nearly triple that of a year ago. That means extra money in people’s pockets, which they tend to spend on other things.

For businesses, lower financing costs can free up capital for growth. Companies might decide to hire new workers and invest in expansion projects. This shift could explain why the tech giants lagged recently, because they’re less dependent on borrowing. Meanwhile, other companies, especially smaller ones, stand to benefit significantly from falling rates.

Election Hype vs. Market Reality

With election season in full swing, it’s hard to ignore the constant chatter. There might be quick reactions to news items, but markets aren’t impacted by elections as much as you might think. We have taken deeper dives into this topic before. Candidates make big promises on the campaign trail but the policies that are ultimately implemented often look quite different once they’re in office. In reality, the Federal Reserve’s monetary policy usually has a bigger influence on the economy and markets than anything coming out of Washington.

That’s not to say elections don’t matter, because they absolutely do and I hope everyone does their part and votes. Elections usually just don’t significantly affect long-term investments. The S&P 500 has historically trended upward over the long run, regardless of who’s sitting in the Oval Office.

So, we’re not planning any major investment shifts based on election results. I know I’m not going to change my spending habits after November 5, and I doubt many of the 300+ million consumers in the U.S. that power our economy will either. Likewise, businesses will continue to focus on growth and profitability, regardless of any regulatory or tax changes.

The Road Ahead: Balancing Optimism and Uncertainty

All in all, the third quarter brought some welcome changes. The Fed has pivoted and the bull market expanded beyond just a few stocks. For investors, it’s been a strong year so far with every asset class contributing positively to balanced portfolios, which is just what we hope for.

Looking ahead, there are several tailwinds that give us optimism:

• Stable Economy: GDP growth puts us on solid footing.
• Federal Reserve Actions: Rates are expected to continue falling, stimulating economic activity.
• Corporate Earnings: Profit margins are up and S&P 500 earnings are on track to grow by 10% this year and another 15% in 2025, according to FactSet.
• Cooling Inflation: More predicable prices add stability for consumers and businesses.
• Innovation: Advancements in artificial intelligence are driving efficiency and opening up new opportunities across industries.

That doesn’t mean we can sit back and relax. There are always potential risks to watch out for. The Fed might shock the market by not moving as quickly as the market expects and more worrisome, the growing conflict in the Middle East could inject volatility into global markets.

History shows recessions don’t just occur gradually. Just look at the causes of last six recessions: A global pandemic, the housing bust, the dot-com bubble, the first Gulf War, and two separate Volcker recessions. We’re not predicting a recession anytime soon, but in each of those cases, a major outside force pulled the entire economy down with it, and we need to stay vigilant. So while we are cautiously optimistic for the fourth quarter and beyond, we will continue taking some of the gains off the table when rebalancing our portfolios to build up ballast for an uncertain future.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.