Here is What We Are Seeing for Q4 2024

I hope you are doing well.? This week our research partners at Aptus Capital Advisors came out with a quarterly market update.? Here are some of the highlights.?

The Market Hit New highs, From Different “Whys”:

The character of the market changed in the third quarter, but the direction remained the same with strong breadth. Many have asked if this is a less powerful rally, but the data suggests otherwise: this is still a bull market and it has broadened. The equal-weight S&P (+9.48%) has outperformed its cap-weighted counterpart by 3.59%. The rate-cutting cycle has officially begun, as the market witnessed above trend growth and the absence of market trauma. The S&P 500 rose +5.89% during Q3 2024 to all-time highs as the economy expanded, and the Fed implemented a 50 bps cut. The soft-landing narrative continues.

The Burden of Proof Remains with the Bears:

Put simply, while the economy is slowing, the news has not been bad enough yet to cause a sustainable decline in stocks. The Fed’s easing cycle, coupled with “OK” macroeconomic data, has kept earnings forecasts steady.

? What Bears are Saying: Rising unemployment, weak ISM Manufacturing PMI, and negative earnings guidance hint at challenges ahead. Concerns also include political uncertainty (domestic and global) and geopolitical risks (Russia/Ukraine, Israel/Hamas).

? What Bulls are Saying: 1) Still "ok" economic data—slowing, but not alarmingly so, 2) The initial market rally due to anticipated Fed rate cuts, 3) Earnings growth, still strong at over 10% year-over-year, and 4) Optimism around AI advancements.

To Chase or Not to Chase:

Inflation around 3% isn’t inherently threatening to the market or economy, but the Fed’s approach to how it handles slowing growth could be the lynchpin to the market moving forward. Emerging cracks in the labor market, combined with the “higher for longer” environment could increase the likelihood of an economic slowdown, posing a real risk to the current rally. The bottom line is that growth remains a focus and will be the ultimate driver of this rally.

While the 2024 EPS Growth looks strong, the market valuations can change depending on many factors as shown in the chart below:

You can see how incredible the net income growth has been for the Magnificent 7 stocks, and how lackluster the growth has been for the remainder of the market.? This seems to be “normalizing” a bit with the expected growth of the Mag 7 coming back to reality while the rest of the market recovers.?

Volatility Has Occurred But Has Been Short-Lived

Even though the market was positive in Q3, it did witness a bit more volatility than what investors experienced in the prior twelve months. The market has witnessed three pullbacks in ’24:

???????????? Market Mis-pricing the Number of Rate Cuts this Year in April:-5.40%

???????????? Yen Carry Trade Unwind of Early August:-8.45%

???????????? Slowing Macro Data &Weak AI Results of September:-4.22%

Historically, the market experiences three 5%+ pullbacks per year on average. These corrections are healthy and should not be alarming. The data below shows that these pullbacks are common rather than extraordinary. Since 1928, the largest annual drawdown averages-16.0%, yet year-end returns typically remain positive. The message here is clear: it pays to stay patient, not reactive. Market pullbacks are healthy and normal.

During the Quarter, Market Participation Broadened

???????????? More stocks are participating in the S&P 500’s latest march to record highs (43 new all-time-highs in 2024), easing concerns over a rally that has been concentrated in a handful of giant technology names for much of 2024.

???????????? More than 60% of S&P 500 components have outperformed the index in Q3, compared to around 25% in the first half of the year. The equal-weight version of the S&P 500- a proxy for the average index stock- has gained almost 9.5% in the quarter, outperforming the S&P 500, which is more influenced by the heavily weighted shares of mega caps (NVDA, AAPL, MSFT, META, etc.)

???????????? The broadening rally is an encouraging sign for stocks, following concerns that the market could be vulnerable to a reversal if the cluster of tech names propping it up fell out of favor. This as a healthy development for risk assets.

???????????? Specifically, the rate sensitive areas of the market has started to perform well.

The Fed’s New Phase of Policy Administration

?In September, the Fed announced a 50bp rate cut, with Powell emphasizing a shift towards supporting employment more than fighting inflation. This indicates a more flexible approach to managing the dual mandate.

The 50bp Opening Salvo for This Cutting Cycle Sent a Message

We had expected that the Fed would be extremely cautious in lowering rates due to concerns that they may spark a renewed bout of inflation. However, the big cut and the communication following show that Powell meant what he said at Jackson Hole, that they “do not seek or welcome further cooling in labor market conditions.” We no longer see the same degree of caution on inflation, but rather an increased confidence that inflation is heading to 2% on a sustained basis (rightly or wrongly).

The Economy May Slow, But it Won’t Stop

Economic growth has been impressive since the middle of 2023, despite high interest rates and price-level fatigue among consumers. We see some signs that growth will moderate late in 2024 and perhaps into early 2025, but are optimistic about the potential for growth to accelerate later in 2025 and beyond to around 2.5% on trend (GDP) given recent Fed action.

“It's a Myth That Expansions Die of Old Age"

As Janet Yellen said in 2016, the US economy does not go into a recession without an outside catalyst. We had expected that the “catalyst” would be tight monetary policy leading to a change in consumer behavior, but the data suggests that monetary policy isn’t as tight or restrictive as we thought it would be at these interest rate levels. Even more importantly, the US consumer behavior has not changed much. They still love to spend.

Strong Equity Markets Post Cuts at All-Time Highs

???????????? The last twenty times that the FOMC cut policy rates when the S&P 500 was within 2% of all-time highs, the index performed well over the following twelve months. During Q3 ’24, the Fed cut rates when the market was at all-time highs, marking the 21st time this occurrence has happened.

???????????? Historically, the market has been higher on every single occasion, resulting in an average return of 13.9% during the period.

That’s all for this week.? As always, please DM me if you have any questions or want to book an appointment.