Q3 2024: Thoughts on the Investment Markets

In a year when the S&P 500 Index is up more than 20% year-to-date, it may be hard to appreciate the much-lower returns that bonds have delivered. We should remember that the trailing 10-year annualized return for the Bloomberg U.S. Aggregate Bond Index was a paltry 1.8% at the end of the quarter, making it difficult for investors to earn a positive real rate of return over the last decade, as interest rates hovered near zero for much of that time. The index returned 5.5% in 2023 and is up 4.5% thus far in 2024, significantly above what bond investors experienced in the recent past. Despite the recent decline in yields, interest rates remain above the rate of inflation, which provides a much more amenable environment for fixed income investors going forward.

Stock Market Review and Outlook

Return data provided by Morningstar Direct and Bloomberg

Market volatility reared its head in the third quarter. Equity markets sold off in late July before rallying back into positive territory in September. From July 16 to August 5, the S&P 500 dropped 8.5% from its high, sparking some concerns that we were entering a bear market. Much of this selling was centered in AI-themed information technology stocks, which were down -14.6% during the downturn. However, from August 5 through the end of the quarter, the S&P 500 was up 11.4%, finishing the quarter up 5.9%. This late-quarter rally brought the S&P 500’s year-to-date performance to a robust 22.1%. Equity market performance was less tech-centric than it had been for much of the year, with value stocks outperforming growth stocks in the quarter. The Russell 1000 Value returned 9.4% in the quarter, versus 3.2% for the Russell 1000 Growth. The best-performing sectors in the quarter were Real Estate at 17.2%, and Utilities at 19.4%. The worst-performing sectors were Energy at -2.3%, Communication Services at 1.7%, and Information Technology at 1.6%. Both small-cap stocks and international stocks outperformed U.S. large-cap stocks in the quarter, rewarding investors who held more broadly diversified portfolios.

Looking forward, an environment of falling interest rates may provide structural tailwinds that can be positive for both international and small-cap equities. Lower levels of interest rates in the U.S. are often bearish for the U.S. dollar. A depreciating dollar is typically a positive for investors in international stocks, since returns earned in foreign currencies can buy more dollars when they are returned to U.S.-dollar-denominated investors. Domestically, a decrease in interest rates may ease financing costs for companies reliant on floating rate debt. Lower debt servicing costs can be particularly impactful for small-cap companies as they typically have fewer financing options than larger companies. As a result, small-cap stocks have often performed well in periods of declining rates.

Conclusion

Against a rather benign economic backdrop, financial markets took investors on a bit of a rollercoaster ride in the third quarter. Equity markets sold off dramatically in late July and early August. The cause of the (thankfully brief) market panic could have been any number of things or some combination of all of them. Some of these causes include reaction to increasing unemployment stoking fears of a recession, the Bank of Japan raising interest rates and putting an end to the yen carry trade (borrowing in yen and using the proceeds to buy tech stocks), or simply a selloff in tech and AI-themed stocks that the market finally believed had become overvalued. The specific reason behind such market volatility is usually difficult, if not impossible, to fully ascertain. Such ongoing market volatility is normal and can be viewed as the cost of earning positive real returns over the long term.

Thus far in 2024, investors have been besieged by a wide range of variables that are challenging their investment discipline. As the economy has cooled, investors and policymakers have been forced to navigate an evolving economic backdrop, balancing the risks of a potential recession with a more-benign “economic soft landing” scenario. In addition, investors may have been distracted by the imminent presidential election, with all its unexpected twists and turns, that has competed for investor attention. All of these stressors (i.e., the uncertainty of a close presidential race, market volatility, a softening jobs market and two ongoing overseas wars) can lead investors to seek out a sense of security and certainty. At times like this, we must realize that uncertainty and doubt may be uncomfortable, but it is a price one pays when pursuing long-term investment success.

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