Third Quarter Market Review and Outlook

By Osborn Williams & Donohoe on October 21, 2024

Stocks are Resilient

Markets continue to climb higher despite many crosscurrents. The U.S. presidential election is just weeks away, along with a devastating hurricane in the southeast, tensions in the Middle East, and a still-ongoing Russia/Ukraine war. Global central banks are amid mass easing cycles in hopes that their respective economies steer away from a recession, and the three-day U.S. port strike recently came to an agreement that will last until January 2025.¹

That said, the S&P 500 had its strongest year-to-date gain through three quarters since 1997, rising 20.8%. The stock market is a leading indication and has shown much resiliency this year. The strength of the U.S. economy is a big reason for this, with strong corporate profits, lower inflation, a stable labor market, and healthy consumers. This year inflation has fallen from 3.35% to 2.53%, and the labor market is near 10-year averages for unemployment, jobless claims, and monthly job gains. On top of this, the Federal Reserve is embarking on a new easing cycle to further support the U.S. economy. Lower interest rates should help bring down mortgage rates and auto loans, and provide cheaper borrowing costs for consumers and corporations. Together, the U.S. market is in a solid position for further expansion. U.S. GDP growth is tracking between 2-3% this year, with earnings expected to grow 8-10%.

The S&P 500 Had its Best Gain Through Three Quarters in 27 Years²

China Stimulus

China released the most extensive stimulus package since the pandemic. The country has faced many difficulties in recovering from Covid-induced shutdowns and following the start of the Federal Reserve’s new easing cycle, China has decided to embark on its own liquidity program to bolster the economy. Global markets surged on the news. Many companies that were once highly favored in China have underperformed due to weak demand in the region. Investors are hopeful that the policy changes will improve consumer sentiment and demand and turn the country’s troubles around. Our preference is to own U.S. multinational companies with exposure to China rather than Chinese pure plays because U.S. companies have better transparency and less political risk.

What Worked and What Did Not in the Third Quarter?

From a high level, the S&P 500 gained 5.9% while the tech heavy Nasdaq 2.8% in the third quarter. Utilities were the best performing sector, up 19.3%. Real Estate, Industrials, and Financials all gained over 10%, and Technology was the second worst-performer, up a mere 1.6%. Energy lagged the most at -2.3%.

After an over 14-month Federal Reserve pause in interest rate policy, the September Federal Open Market Committee (FOMC) meeting brought a deduction in the Fed Funds Rate of 50 basis points (bps). The yield curve un-inverted for the first time in two years ahead of the Federal Reserve decision in early September. Treasury yields have anticipated the rate-cutting cycle most of this year by proactively tightening.

Investors learned that the market could appreciate without the help of the Magnificent 7 and Technology. Although a 31% weighting in the S&P 500, Technology only contributed 9.5% to the index’s total return in the quarter. Since the beginning of July, the Magnificent 7 has only accounted for 2.9% of the S&P 500’s total gain. The four stocks with the largest negative contribution to the S&P 500 in the quarter were Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), and Nvidia (NVDA); all four names had negative returns and held a combined 20% weighting of the index. The broadening and rotation we have discussed over the last few months was realized in the third quarter, which was ultimately a benefit to our portfolios.

What Changed?

The rotation was much awaited after technology accounted for 95% of the S&P 500’s return in the second quarter. Markets sold off heavily from mid-July to early August following June’s cooler-than-expected inflation report; the S&P 500 went from +3% quarter-to-date (QTD) to – 5.2% in just a few weeks. The Technology sector bottomed at -13% in the quarter near early August but made up all the losses by quarter-end and closed flat.

The markets experienced a sharp sell-off in early August, but quickly rebounded throughout the second half of the month. Seasonality was felt in the first week of September when stocks fell 4%. August’s weaker-than-expected jobs report convinced investors that the Fed would cut 50 bps during September’s meeting, thus bringing easier financial conditions. Markets rallied there on out and gained 5.6% in the last three weeks of September.

A Big Quarter Awaits

The fourth quarter will likely be the most important quarter of this year with the U.S. presidential election and two FOMC meetings awaiting investors. We focus on what we know, which is the U.S. economy is growing at or above 2% with solid corporate profits. Third quarter earnings season is underway, and we are listening for comments on the consumer, capital markets, and net interest margins. Looking forward, we will be attentive to any uptick in inflation as a byproduct of continued growth, consumer health, and lower interest rates.

We believe that dividend payers with more reasonable valuations are well positioned to participate in a broadening market. Historically, dividends have accounted for nearly 60% of the overall total return for the S&P 500 going back to 1930. Similar to the 2010s, the majority of returns so far this decade has been from price returns as opposed to dividends with a payout ratio in the low 30s (below historical average of 47.8).³ Question is whether this trend can continue given the different inflation and interest rate environments we find ourselves in today. To the extent to which valuations are elevated and interest rates are trending lower, it stands to reason that dividends are likely to make up a greater portion of total returns in the future.

Return for Selected Indices⁴

All of us at Osborn Williams and Donohoe thank you for your continued trust and confidence. We welcome any opportunity to be of assistance to you and your family members.

¹ Source: Reuters. As of October 4, 2024.
² Source: Bespoke Investment Group. As of September 30, 2024.
³ Source: Strategas. As of August 31, 2024.
⁴ Source: Bloomberg. As of October 14, 2024.