Economic Overview
The U.S. Federal Reserve cut the short-term Federal Funds rate by .50% in September, lowering the rate that banks use for borrowing overnight money down to 4.75-5.00%. Although widely expected, risk assets rallied following the move, with further interest rate cuts priced in over the coming year. Giving the Fed air cover for rate cuts is steadily rising unemployment, softening inflation, and weakening GDP growth. Despite that backdrop, there are few calls for a so-called “hard-landing” for the U.S. economy, which remains fairly robust by most measures.
Nonfarm payrolls rose by 142k in August, below expectations for a gain of 165k, while July’s gain were revised down from 114k to 89k. The Unemployment Rate dropped from 4.3% to 4.2%, while the Underemployment Rate rose from 7.8% to 7.9%. Labor Force Participation held steady at 62.7%, while Average Hourly Earnings rose higher than expected in August, up +0.4% MoM, and have climbed +3.8% YoY. The JOLTS Job Openings number fell from 7,910k to 7,673k, suggesting a further softening in the demand for labor.
Consumer price inflation data came in about as expected in September, with the August CPI report showing a +0.2% MoM rise in prices, and ex-food & gas, a +0.3% gain. Year over year, CPI is up just +2.5%, while core CPI has risen by +3.2%. At the wholesale level, PPI was up +0.2% MoM and 1.7% YoY, while core PPI rose +0.3% MoM and +2.4% YoY. The Core PCE Price Index ticked up by +0.1% in August, and has risen +2.7% YoY.
The 3rd reading for Q2 GDP showed a U.S. economy growing at a 3% rate, although recently released ISM figures for September suggest an economic contraction may be coming. The S&P Global US Manufacturing PMI came in at 47.3, while the ISM Manufacturing PMI number was 47.2. The ISM Prices Paid reading came in below expectations (48.3 versus estimates for 53.5), while the ISM New Orders index beat expectations at 46.1 (versus 45.0).
All in all, the Fed felt the time was right to begin cutting interest rates. Whether the U.S. economy falls into recession, hard or soft, is anyone’s guess. There remains ample fiscal stimulus to potentially offset a decline in the private domain. Market volatility should spike around election time, although we’ll remain focused on corporate earnings. EPS expectations are high, as are equity markets. It will be important for S&P 500 companies to meet expectations in order to keep this great bull market moving in the right direction.
Domestic Equity
Domestic equities continued their stellar year last month. U.S. stocks rallied in September, with the benchmark S&P
500 Index gaining +2.1% on the month, bringing its YTD return to +22.1% and one year performance to +36.3%. Consumer Discretionary, Utilities, and Communication Services were the biggest winners of the month, notching gains of +7.1%, +6.6%, and +4.6% respectively. The only sectors to exhibit negative returns on the month were Energy, Healthcare, and Financials, down -2.7%, -1.7%, and -0.6% respectively.
Small- and Mid-Caps also caught a bid, posting positive returns of +0.8% and +l.2% respectively. This puts both Small- and Mid-Caps ahead of Large-Caps in terms of QTD performance. Small-Caps were up +10.1% and Mid-Caps were up +6.9% QTD. Large-Caps relative under performance is partially explained by the concentration of technology stocks in the S&P 500. Tech stocks make up over 30% of the S&P 500 sector allocation and a majority of the Tech allocation is concentrated in just a few companies (Apple, Microsoft, Nvidia, Amazon, Meta). The QQQ's which tracks the NASDAQ 100 composite technology index, was up only +2% on the quarter, dragging down the S&P 500 performance to only +5.9% during the quarter. Eight of eleven sectors outperformed the S&P
500 on a QTD basis, showing signs that the market continues to broaden out.
Contributing to positive equity returns this month was the federal reserves decision to cut rates by 50 basis points, marking the first reduction in four years. This move aimed to stimulate economic growth and signaled a potential shift towards a prolonged rate-cutting cycle, which historically has led to strong equity returns. Following this announcement, major indexes reached record highs as investor sentiment improved.
Overall, September was characterized by positive returns in U.S. equity markets driven by a combination of favorable monetary policy shifts and market broadening, despite underlying challenges in certain sectors.
International Equity
International Emerging Markets (EM) had a strong month as the MSCI EM Index returned +6.7%. Developed Markets (DM), as measured by the MSCI EAFE index trailed, gaining +1.0%. For Q3, EM (+8.8%) and DM C+ 7.3%) both outperformed U.S. markets.
On September 24th the Chinese central bank announced a broad package of monetary easing measures including: a lowering of its benchmark policy rate and bank reserve requirement as well as lowering interest rates on mortgages. Policymakers hope to energize consumers who have been under pressure from high unemployment and a downturn in the real-estate market.
The MSCI China Index, which closely tracked the broader EM index prior to the announcement, rallied to finish September up +23.4% and +23.0% for Q3, both in USD.
September was a busy month for global central banking activity. In addition to the Fed cutting rates, the European Central Bank, Bank of Canada, and the Swiss National Bank all lowered policy rates while the Bank of England left rates unchanged.
Real Estate, which typically performs well in falling rate environments was the best performing ACWI Ex U.S. Sector for Q3, returning +17.0%. Other top performing sectors for the quarter include Utilities (+16.9%), Consumer Discretionary (+11.5%), Financials (+11.5%).
European equities struggled in September with concerns over economic growth becoming a headwind to stock performance. Final numbers for Q2 GDP released recently showed YoY GDP in Germany expanding just +0.3%, the UK growing +0.9%, and France +l.1%. In USD terms, the DAX (Germany) returned +1.8%, the FTSE 100 (UK) managed +0.2%, and the CAC 40 (France) contracted -0.5%.
Fixed Income
Chairperson Jerome Powell's Federal Reserve found it appropriate to lower the Federal Funds Rate by 50 basis points at the September meeting. Cutting the rate by roughly ten percent would seem to be a reactionary move, an attempt to battle some near-term economic difficulties. Not so, claimed Powell in his press conference following the announcement of the rate cut. He claims to see no economic troubles on the horizon and is confident that a very soft landing has been achieved. Of course, this begs the question of why the Fed needed to cut 50 basis points, instead of the more customary 25 bps?
The bond market has priced in continued large interest rate reductions. Significantly more rate cuts than the Fed dot plot (rate projections) would suggest are likely. This has de-inverted the Treasury yield curve between the 2 year Treasury (3.63%) and the 10 year Treasury (3.77). Historically, as the yield curve de-inverts, economic troubles soon follow. There are no signs of such worries in today's markets. Stocks are up and corporate bonds are historically expensive. The unemployment rate has moved higher, but is broadly expected to stabilize, rather than to rise significantly from here.
The stock market has regularly touched all-time highs, and corporate bond issuance is near record levels. China has even responded to its flagging economy by rolling out multiple forms of stimulus to keep growth from imploding. The U.S. election is a month away, and both candidates promise plenty of spending while the country runs the largest deficit outside of depression, war-time, or pandemic. The punch bowl is full, and no one wants to take it away.
Across the Treasury yield curve, interest rates moved lower again in September, and again, this move was most pronounced at the front-end of the curve. The continued decline in rates boosted bond prices, allowing all indices tracked to report strong performance for the month.
Investment Grade (IG) and High Yield (HY) corporate bonds led the way as credit spread tightening added a tailwind to their performance.
Tax-free Municipal bonds also had a strong showing in September. Valuations are currently much more reasonable than where the began the year, with the longest maturity bonds offering the most value.
Alternative Investments
Alternative investment performance was mainly positive in September. Broad commodities, as measured by the Bloomberg Commodity Index, were up +4.4% for the month but were down -0.6% in 03.
Gold continued its strong run of performance, returning +5.2% in September and +13.2% in 03. It may be surprising to investors that in a risk-on environment partially fueled by Al hype, Gold's YTD return of +27.7% has outperformed almost all major asset classes, including the S&P 500 Index. The precious metal can be a useful portfolio diversifier in times of inflation, deflation, war, and market turbulence. However, demand from central banks and Chinese consumers have likely been the primary driver of its strong gains in 2024.
Oil was one of the few negative performing commodities during the month, with WTI Crude Oil falling -7.3% to close at $68.17 per barrel. Bearish factors such as weak demand from China (despite government stimulus measures) and OPEC+ signaling a ramp up in supply by year end contributed to the price decline. However, we begin 04 with Israel's attacks on Hezbollah potentially triggering a wider war and a retaliation by Iran. These geopolitical risks may counteract possible downside price pressure from the suspected increased supply from OPEC+.
Real Estate, as measured by the FTSE NAREIT Index returned +16.8% for the quarter, a sharp rebound after its return of -2.2% through the first 6 months of the year. REITs are relatively sensitive to interest rates so the broad decline in rates in 03 drove the performance. Focusing on the U.S. housing market, the average for a 30-year fixed loan mortgage rate recently hit a 2 year low. This may bring in more potential buyers from the sidelines and cause an uptick in refinance activity from existing owners.
Originally published at Nottingham Advisors
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