Market Review
The benchmark S&P 500 index closed the 3rd quarter up 5.5%, following on a 3.9% gain the prior three months and leaving the benchmark tantalizingly close to a second-consecutive year of 20+% gains. The index has hit over 40 new all-time closing highs this year after passing the previous record from January, 2022, in January of this year. Second-quarter corporate earnings beat analyst forecasts by 4%, growing slightly over 10% year-over-year. Revenues surprised to the upside by slightly under 1%, growing over 5% versus the prior year. Analysts project that earnings grew around 5% during the 3rd quarter and will grow roughly 10% in the 4th quarter. Projections for 2025 point to double-digit earnings growth each quarter and full-year growth of 15%. The Federal Reserve (the Fed) cut their policy rate by a larger than expected 0.50% at their September meeting after leaving it at a cycle-high 5.25%-5.50% range for seven consecutive meetings. The stock market greeted the central bank’s policy shift enthusiastically, as Fed Chair Powell characterized the move as a “recalibration” and the beginning of policy normalization from a restrictive stance.
The Economy
The U.S. economy expanded at an above-trend pace of 3.0% during the 2nd quarter, after consensus began the quarter calling for a below-trend 1.4% growth rate. Per the Federal Reserve Bank of Atlanta’s GDPNow model estimate, 3rd quarter growth is tracking at around 3%, which is a good bit above economist projections that haven’t changed much over the course of the quarter. Third-quarter inflation readings on the central bank’s preferred Core Personal Consumption Expenditures Deflator continued to trend toward the stated 2% target, providing policymakers confidence that positive development will continue. The Fed’s post-meeting statement after easing policy in September indicates they feel risks are balanced in their dual mandate to support full employment and keep inflation under control. Economists anticipate the US economy will grow 2.5% during 2024, which would be exactly in line with 2023. The unemployment rate has ticked up slightly this year in spite of solid job growth, as previously discouraged workers return to the labor market looking for work.
Equity Markets
The S&P 500 beat only three of 11 sectors during the 3rd quarter, which is highly unusual, but serves to illustrate the enormous weighting Tech (+1.4)holds in the index. In spite of that paltry return, Tech still tops all sectors year-to-date. It’s also unusual for typically stodgy Utilities (+18.5%) to top Tech by double-digits during a quarter that saw largely positive returns. Investors see non-regulated power producers in the Utilities sector benefitting from the race to feed an increasing horde of data centers that are hosting the artificial intelligence (A.I.) revolution. Real Estate (+16.3%) trailed only Utilities and out-distanced 3rd-place Industrials (+11.1%) by over five percentage points. With longer-term interest rates dropping to factor in an anticipated 2+% cut in the Fed’s policy rate, dividend yields available in the Real Estate sector look increasingly attractive versus bond yields.
In addition, companies in the Real Estate sector own many of those aforementioned data centers and now find it less expensive to finance property purchases at lower interest rates. Industrials, too, benefit from the data center buildout, as they provide everything from construction equipment, to wiring, to building the infrastructure that carries electricity to data centers. Materials (+9.2%) stocks fit into that same data center narrative, as they provide the building materials for those projects in addition to large-scale infrastructure projects funded by the federal government. Investors see Financials (+10.2%) benefiting from lower interest rates on having to pay less on deposits and those lower rates potentially increasing loan demand. Mortgage rates fell almost a full 1% during the quarter. The still-healthy job market has made for a resilient US consumer, as Americans who are working tend to keep spending. Healthcare performed roughly in-line with the S&P 500, as the campaign trail hasn’t produced any particular policy proposal that looms over the sector. Old-school Energy stocks were the only sector in the red, as increased production has meant supply has grown more quickly than demand.
Long-Term View
Management teams continued to report strong results, as evidenced by topping analyst forecasts yet again on earnings and revenue. Given the relatively high bar set by investor expectations, however, topping those forecasts provided comparatively little oomph to share prices in the immediate aftermath of earnings announcements versus historical norms. Earnings and revenue misses saw share prices penalized, as usual. It’s probably a fair read on market reactions to say that companies that missed on 2nd quarter results saw their shares punished a good bit more than companies who topped expectations saw their shares rewarded. The election season dominates current news flows, and investors are understandably interested in the candidates and their respective platforms. Whoever is elected president, voters who supported the opponent will likely be disappointed. The question that arises every four years is how the election will impact stocks. As the graphic to the left indicates, it hasn’t tended to matter to stock market returns which party holds the presidency. Since 1981, every administration but one has seen annual returns average in double-digits during their tenure. At the end of the day, earnings drive stock market returns. Broad economic trends and management teams drive earnings. Elections matter, but well-run companies improvise and adapt to overcome challenges that arise.
