Alert
Q3 Market Review and Outlook: S&P 500 Reaches New Highs Despite Volatility
It was a tumultuous summer as stocks experienced some of their best and worst days in years. For a time, it appeared the bull market was in jeopardy as investors contended with fears of recession, geopolitical unrest, and uncertainty about interest rates.
In early August, stocks plunged after a disappointing jobs report heightened recession concerns. This volatility was further exacerbated as a popular trade, the yen carry, began to rapidly unwind.
Markets quickly recovered from the downturn. Stocks were further lifted in September as the Federal Reserve (Fed) surprised investors by cutting interest rates by 50 basis points (bps), exceeding the widely expected 25 bps reduction.
The S&P 500 ended the third quarter up 5.5%, bringing the index's year-to-date gain to nearly 21%. This marks the strongest start to a year since 1997.
Bonds also performed well during the quarter, benefiting from declining inflation and, at long last, a Fed rate cut.
View insights on markets and economic trends below to help inform your investment strategy.
Moss Adams Wealth Advisors Market View
Below are our key takeaways on the economy and markets.
- The Fed now has confidence inflation is trending toward its 2% target and has shifted into rate-cutting mode.
- Though moderating, continued economic growth and labor market trends support our base case scenario for a soft-landing, meaning the US economy avoided the feared recession.
- While the labor market has shown signs of softening, resilience remains in the labor-intensive services sector, which we expect to hold up through the end of the year.
- In the medium- to long-term, we maintain a constructive outlook on both stocks and bonds as the economy normalizes, deflationary trends persist, and the Fed continues easing monetary policy.
- Key risks to equities include a potential upward reversal in inflation and long-term yields, a sharper than expected downturn in economic activity, or an escalation in global macro stresses.
- Labor market resiliency is key to our soft-landing narrative.
The Fed Lowers Rates
Investors entered the third quarter looking for a clear signal the Fed would soon be able to lower interest rates. Economic data supported this outlook, with softer readings on employment and inflation suggesting that price pressures were finally easing.
At the Jackson Hole Economic Symposium in August, Fed chair Jerome Powell emphasized the Federal Open Market Committee (FOMC) doesn’t seek or welcome further cooling in labor market conditions.
As inflation moderated toward the Fed’s 2% target, the FOMC surprised markets at its September meeting by cutting rates by 50 bps—more than expected—signaling a shift in priority toward supporting economic growth. This brought the federal funds rate to a range of 4.75% to 5.00%.
While some viewed the larger-than-anticipated rate cut as an indication of concerns about the economy, the Fed’s updated projections continued to point toward a soft-landing. Powell maintained a consistent message, stating during the post-meeting press conference, "We aren’t seeing anything in the economy right now that suggests the likelihood of a downturn is elevated." He portrayed the economy as stable, adding, "The US economy is in a good place, and our decision is designed to keep it there."
According to the Fed’s Dot Plot, the committee expects steady economic growth of 2% over the next four years. Although unemployment rate forecasts were adjusted upward by 40 bps for 2024 and by 20 bps for 2025, inflation forecasts for the same periods were revised downward. Additionally, the Summary of Economic Projections indicates two more rate cuts by year-end and four additional cuts in 2025.
The Job Market
The Fed’s decision was influenced by weaker data from the labor market, including a disappointing July jobs report and a subsequent revision by the Labor Department. The revised data revealed the US added 818,000 fewer jobs in the 12 months ending in March 2024 than initially reported.
Although the job market is not experiencing the heightened hiring activity seen during the post pandemic reopening, Powell highlighted the current unemployment rate of 4.2% remains historically low. He noted that, while hiring is slowing, the labor market remains relatively strong.
"Anything in the low fours is really a good labor market," Powell stated. "Participation is at high levels."
Despite a slight uptick in the unemployment rate, wage growth remained positive at 3.9%. Real wages—wage growth exceeding inflation—are expected to continue supporting consumer spending.
The Economy
The US economy in the third quarter exhibited mixed yet fundamentally sound characteristics. Most US consumers—the backbone of the economy—remained resilient in their spending, supported by solid real incomes and healthy balance sheets.
However, lower-income households face challenges due to the inflated costs of certain goods, elevated borrowing rates, and fewer employment opportunities. Additionally, corporate purchasing managers reported diminished conditions in the manufacturing sector, even as the service side of the economy continues to expand.
The unemployment rate, currently at a historically low 4.2%, has slightly increased from its 18-month low, primarily due to a rise in the supply of workers rather than an increase in layoffs. Furthermore, historically low corporate bond spreads reflect the ongoing strength of balance sheets and the reliability of corporate earnings.
US Gross Domestic Product
The economic expansion that began in mid-2020 is now entering its fourth year, showing some signs of moderation. Real gross domestic product (GDP) declined from an annualized rate of 3.3% in the fourth quarter of 2023 to 3% in the second quarter of 2024. The Atlanta Fed’s GDP now estimate the third quarter stands at 2.5%.
One explanation for the modest softening of the economy has been the consumer. An extended period of inflation above the trend has adversely affected consumer sentiment, which has surprised to the downside despite reasonably strong economic data.
On the corporate side, investment spending has remained robust, particularly in developing advanced infrastructure around intellectual property and margin-enhancing technologies, such as artificial intelligence (AI).
Outside the US
Markets outside the US have shown resilience, despite some pockets of weakness. Emerging markets, particularly India, have demonstrated strong growth. Developed markets have had a mixed performance; Europe, with its focus on manufacturing, has faced challenges.
In China, the ongoing real estate downturn is affecting growth, inflation is hovering around zero, and domestic demand remains low. However, recent government interventions and stimulus measures may boost sentiment and stabilize growth.
In other parts of Asia, Taiwan and South Korea have experienced renewed growth in the electronics sector, while India's favorable demographics and business strategies are anticipated to support its growth path. Overall, this year is shaping up to be better than expected for the global economy, which has so far avoided a recession.
As global central banks continue to normalize their policies and inflation trends back to more manageable levels without significantly slowing economic activity, global risk assets are likely to continue their upward trajectory.
Recap and Looking Forward
In the third quarter, stocks successfully climbed a wall of macro worries, even as concerns over a softening labor market rattled nerves in late summer.
As stocks rebounded from the August swoon, under the surface there was a notable broadening of market breadth.
The shift involved a rotation away from the major technology companies that had previously driven the bull market, with segments that had underperformed—such as small-cap stocks and value equities—now exhibiting improved performance. As the Fed continues to ease financial conditions, we anticipate this broadening will extend to more economically sensitive sectors of the market, including industrials, materials, financials, and small caps, as well as technology.
For the remainder of the year, we expect sustained growth, albeit at a moderating pace, aligning with the Fed’s objectives. Favorable inflation data and economic indicators in the coming months should enable the Fed to persist in its rate-cutting cycle.
We believe the historical trend of a strong start to the year, coupled with what is likely to be peak interest rates, continued modest economic expansion, and positive earnings guidance, positions risk assets favorably for the remainder of 2024.
Opportunities
There’s an opportunity cost in holding too much cash, and investors should consider putting long-term money in long-term assets.
US and global economies continue to grow as inflation wanes. Broadly, central banks around the world are in easing mode which bodes well for stocks and bonds.
Secular tailwinds should continue to be supportive, such as the prospects for AI, both for the companies who produce the infrastructure as well as for the companies who will benefit from its potential productivity enhancements.
We believe risk appetite will continue to broaden out beyond technology as more sectors adopt AI, and as market confidence is buoyed by declining interest rates.
Outside of public assets, alternatives still offer investors an opportunity to enhance portfolio performance through alpha, diversification, and income.
- With central bank rate cuts kicking off in many parts of the world, falling rates should create a tailwind for high quality private real estate, bringing down borrowing costs and bringing up valuations..
- Private infrastructure’s low downside capture can help buffer portfolios during periods of volatility. Additionally, we are bullish on infrastructure energy assets as AI’s rapid expansion is creating immense demand. Data centers and AI technologies need consistent and reliable power.
- Yields on private credit remain attractive; however, elevated macro uncertainty suggests that choosing private credit funds with robust asset management capabilities remains critical.
While it’s impossible to predict what will happen to markets in the short-term, markets have historically done well following a peak in inflation, the conclusion of a Fed tightening cycle, and a trough in consumer confidence.
We’re constructive on both stocks and bonds as the economy normalizes and deflationary tailwinds continue.
We’re Here to Help
For more information about the economic landscape and what it means for investors, reach out to your Moss Adams professional.