Third Quarter 2024 Market and Economic Review

For the first time since the first quarter of 2022, there’s a different economic story to tell than counter-inflationary tactics – mostly raised or steadied interest rates by the Federal Reserve. On the contrary, following the Fed’s September meeting, Chair Jerome Powell announced the Fed’s first rate reduction in years, acknowledging that the inflationary rate is comfortably heading towards their target of 2.0 percent.

Though a rate reduction was very much expected, the Fed’s decision to shave the rate by a ½-point (when most expected a ¼-point change) did create some buzz across all the media channels. It marked just the fourth period in the past 24 years the Fed cut its rate by that margin. The others occurred in 2001-2003 (during the dot-com bust and 9/11), 2007-2008 (during the financial crisis and housing market crash), and 2020 (triggered by the global covid pandemic). While the media may have reacted a little wide-eyed at the ½-point reduction, the markets took the news in stride and continued a fairly steady growth pattern for the quarter, with an exception in early August, which we’ll discuss in more detail shortly.

For the most part, there wasn’t much second-guessing from the markets and economists on the ½-point reduction because many have called for the Fed to ease up on its inflationary brake handle for months. And, on the global stage, the U.S. monetary policy has been a little more reserved compared to what some other countries have already done, particularly in Europe where many of the larger economies are reporting inflation in the range of 2.2% and have started cutting rates months ago. U.S. job reports have been healthy for much of the year, and consumer spending and retail sales were also positive, closing out the quarter.

As mentioned above, there was a blip in the markets at the start of August that most people didn’t even notice because of how quickly it resolved itself. On August 5, the Tokyo Stock Exchange (Nikkei) plummeted close to 13% and created shockwaves in markets worldwide. Within hours, Japan’s markets began course-correcting and were mostly recovered within a week. While economic talking heads kept the story alive for the rest of the week, mainstream media mostly ignored the entire incident. However, the event left global markets looking like a seismograph registering a brief earthquake that no one felt. It was an unusual episode worth discussing as an example of why short-term trading can have painful outcomes.

In the U.S., some of the impact was coincidental in timing. At the tail-end of the prior week, The U.S. Department of Labor and Statistics released a softer-than-expected jobs report. Additionally, news was circulating that Warren Buffett was selling off a significant portion of his Apple holdings, which helped position our markets for an overreaction to virtually any added negative news.

The more global element to the August market nosedive was due to a trading practice called Carry Trades. Essentially, these are large banks, financial institutions, hedge funds, etc., borrowing money in a currency with very low interest rates and then investing those funds in currencies with larger yields. It’s a practice that’s been around for many years but gains popularity when volatility is relatively steady. In this case, Japan’s economy had been battling deflation for many years with essentially a 0.0-percent interest rate (and even negative interest rates earlier this year), making it a favored currency for borrowers. When Japan announced a ¼-point rate increase (an effort to boost the declining yen) at the same time the U.S. was releasing news that made our economy appear weaker than expected, these Carry Trade holders suddenly had cause for alarm. Subsequently, they began rapidly unwinding their Carry Trades and sent the Nikkei index into its most significant nosedive since 1987. The impact was much less significant in other countries but still left a noticeable imprint on virtually everyone’s charts.

What Does A ½-Point Interest Rate Drop Mean?

For individuals, a ½-point change in interest doesn’t really mean that much. Mortgages and car loans get a little easier to handle, but not significantly so. And interest changes on credit card debt are even less affected. But in the business world, there can be a genuine benefit for companies borrowing large sums of money with incremental interest reductions, especially when the consensus is that those rates will continue to come down over the next few quarters.

Additionally, for companies that have cash available, those CFOs are facing new decisions to make. As interest rates rose over the past couple of years, cash and bonds made a lot of sense to get a decent return with low risk. It also provided security if the economy dipped into recession.

With interest rates dropping, those same CFOs must now decide where their best investments are. Do you buy bonds with locked-in rates? Do you buy back stocks of your own company? Do you make other capital expenditure investments? Effectively, the Fed’s decision to lower rates is a signal to cash-infused companies to start planning new strategies.

A Shift For Markets

Generally speaking, U.S. markets experienced growth for the third quarter, but not without some turbulence. Both small (Russell 2000 index) and large (S&P 500) company indexes posted positive numbers, but the paths were quite different than prior quarters this year. The past few months experienced much more volatility, highlighted by the events experienced in the first week of August discussed above.

For much of the past couple of years, as we’ve fought through a very stubborn inflationary environment, investors have been cautious, and the very largest stocks have been the primary beneficiaries. The ‘Magnificent 7’ stocks, which dominate the S&P 500, saw much less growth for the quarter as most were either flat or slightly down by the end of September. Meta was the only member of the group to see significant gains. However, the index still grew by over 4.5% for the quarter, meaning the smaller companies that make up the remainder of the directory captured much more interest from investors.

Similarly, the Russell 2000, which was mostly flat for the first 6 months of the year, is now up 11.02 percent through three quarters; all of that growth coming in the past 3 months.

Perspective

The past quarter has served up some excellent reminders that the best path to investment success is through a well-diversified strategy with long-term goals in mind. All investment opportunities come with risk, and all stock markets experience volatility. At times, that volatility seems to come out of left field.

At Slaughter Associates, we are diligent at making sure every portfolio carries the right mix of investment types – from stocks to bonds to alternative investments – to meet the goals assigned by the client.