“Market forecasters aren’t paid to be right, they’re paid to be interesting.” — Old Market Adage
Third Quarter Review
Financial markets continued their upward trend throughout the summer, but not without some volatility. After a sharp three-week correction culminating in August, equities roared back with leadership rotating from the Magnificent Seven and AI-related stocks to smaller cap and cyclical sectors. Foreign bourses rallied. Bonds also did well, with 10-year Treasury yields dropping from 4.40% to 3.61% before closing the quarter at 3.78%.
Most commodities fell during this period. Oil dropped over 8.5% due to weaker than expected demand growth, particularly from China. Precious metals, meanwhile, were the stars of the summer, led by gold. The yellow metal benefitted from foreign central bank buying, a lack of fiscal policy solutions and continued geopolitical unrest.
A Significant Recalibration by the Federal Reserve
Continued moderation in economic growth, especially in the job market, prompted the Fed to begin aggressively lowering the short-term Federal Funds rate. A weak Nonfarm Payroll number for July seemed to confirm that action and Chair Jerome Powell acknowledged the slowdown in his annual Jackson Hole Symposium address in late August. This led to a 50-basis point (0.50%) reduction in the Fed Funds rate to 5.00% at the Federal Open Market Committee (FOMC) meeting a month later.
However, the weak July jobs report was complicated by Hurricane Beryl, whose effects impacted subsequent months. This was substantiated by relatively low weekly jobless claim reports, as well as similar data supporting the case for a durable economic expansion. Recent upward revisions to Gross Domestic Income include improvement in the savings rate, indicating consumers still have capacity to spend. Economic surprise indices from Bloomberg, Citibank, Goldman Sachs and others also show a marked pickup in US economic activity since midyear.
Climbing a Wall of Worry
Chief concerns among market strategists and investors include high valuations, the uncertainty of the U.S. presidential election and geopolitical developments. These worries have been troubling for some time now but continue to be discounted in prices at least to some degree. Equity valuations that are expensive relative to history have relevance for periods of a decade or more but have proven to be poor indicators of returns over shorter periods, especially if the economy avoids a recession. Corporate profits and margins are estimated to be moderately higher over the next year, and this should help the market continue to trend higher.
The consequential results of the upcoming general election will not only determine which party controls the White House, but both chambers of Congress as well. Currently, polls are anticipating close races for all three, which augurs that Washington might end up with a divided government when the smoke clears. Many political pundits have noted voter “election fatigue,” and that is being reflected in subdued consumer confidence surveys. To a significant extent, corporate spending decisions have also been put on hold until after the election. It is likely that both consumer confidence and corporate spending plans will rebound after November, a pattern seen in most of the last few election cycles.
Geopolitical trends have, unfortunately, proven to be more intractable than earlier thought. In particular, the Middle East situation continues to fester, with Israel and Iran inching closer to direct conflict. The main risk globally is that the supply of oil could be cut off from the Persian Gulf for a protracted period of time We assign an outside chance of this happening. To hedge the risk, our current portfolio positioning considers this possibility, with holdings in domestic oil and defense stocks along with gold.
The Outlook for the Fourth Quarter and 2025
In spite of these concerns, the economy and the stock market have done well this year. Post-election, things should continue to trend higher.
- Economic reports are generally constructive, the Fed is easing, market liquidity is abundant, and corporate bond spreads remain tight.
- We anticipate that the Federal Reserve will cut the Fed Funds rate in 25-basis point increments for the next few meetings.
- Longer-term rates, such as the 10-year Treasury, have already fallen from their highs this year and may offer limited declines going forward due to lingering inflation expectations and the lack of progress regarding the fiscal deficit.
- Though some volatility may persist, a year-end rally in equities should commence by Thanksgiving.