The Everything Rally
There was a lot for investors to like in the third quarter as most asset classes aside from oil and oil related equities put up positive returns. And for once, the big market capitalization companies didn’t dominate everything else. The Magnificent Seven stocks performed well (+5.7% for the quarter), but many other equity sectors did even better.
In the third quarter, various areas of the stock market, from utilities to industrials to financials outperformed the seemingly dominant technology sector. Value stocks beat growth and small capitalization stocks beat their large capitalization peers.
Declining interest rates helped propel parts of the stock market that are often thought to have a high level of correlation with bond returns due to their large dividend payments. According to The Wall Street Journal, the utilities sector ended the quarter as the S&P 500’s top performer with a 18% gain, while the real estate group climbed 16%.
The key driver for the markets broadly has been interest rates. The Federal Reserve cut the overnight policy rate on September 18th by half a percentage point. This not only helped bond investors but also fed through into the pricing of other asset classes including precious metals.
Although the yield curve is still inverted from money market rates out to about the three year point, the highly followed relationship between the two year and ten year treasury has normalized. That is, the U.S. government is now issuing debt for two years at a lower interest rate than it is for ten years. An inverted yield curve sometimes returns to its normal positively sloped shape ahead of economic slowdowns, as investors bet on interest rate cuts from the Federal Reserve.
According to Barron’s, the Federal Reserve’s larger than anticipated interest rate cut led to the biggest jump in investor optimism since June 2020, as measured by Bank of America’s global fund manager survey. Money managers’ allocation to stocks surged while allocations to bonds and cash decreased.
With that said, many investment managers and advisers, including yours truly remain a bit more cautious. In addition to the lagged effect of monetary policy from the past hiking cycle, retailers, restaurant chains, existing home sales, manufacturing activity and employment are all flashing signals of economic caution. As equity markets march higher, we still have not seen a deterioration of growth factored in yet.
How The Markets Did Last Quarter?
Despite geopolitical uncertainty and the upcoming election, it was a strong quarter for equity investors. Specifically, the S&P 500 was up +5.9%, Russell 2000 Small Cap Index was up +9.3%, Developed International (EAFE) was up +6.8%, and Emerging Markets were up +9.3%.
It was also a good quarter for fixed income investors given lower bond yields. Using U.S Treasuries as our benchmark, the short end of the yield curve was up +1.8%, intermediate maturities finished up +4.8% while long-term maturities finished up +6.9%, reflecting their greater price sensitivity to changes in interest rates.
Similar to last quarter, the wild card on many investors’ minds is the upcoming presidential election and with it the evolving political uncertainty. According to J.P. Morgan Asset Management, fourth quarter seasonality around presidential elections drops equity returns for the quarter on average from +3.5% to +1.7% during election years while financial markets exhibit greater overall volatility.
Market volatility could stay elevated until a candidate is declared the winner. After that, markets should go back to focusing on growth, inflation, interest rates and various policy decisions as the main drivers of returns.
While tactical analysis can be useful for short term positioning, it is best to observe financial markets and manage investment portfolios over a longer time horizon. In general, corporate earnings growth drives equity markets higher, bonds can provide diversification and a hedge to slower growth, and thoughtfully constructed portfolios are the main factor to achieving one’s investment goals.
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Enclosed are your investment reports for the last quarter. Please feel free to contact me if you would like to discuss our investment strategy for the upcoming quarter. Thank you for your continued trust and confidence.
Sincerely,
Justin Kobe, CFA
Founder, Portfolio Manager & Adviser
Pacificus Capital Management
A referral is the best compliment.
Feel free to forward this email to friends and colleagues.
Sources:
The Wall Street Journal: https://www.wsj.com/market-data?mod=nav_top_subsection
J.P. Morgan Asset Management: https://www.jpmorgan.com/insights/markets/top-market-takeaways/tmt-fourth-quarter-forecast-three-things-that-could-affect-markets
International índices: https://www.msci.com/real-time-index-data-search
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
__________________________________________________________________________________Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Cambridge and Pacificus Capital Management are not affiliated.
Material discussed is meant for general illustration and/or informational purposes only, and it is not to be construed as investment, tax, or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. These are the opinions of Justin Kobe and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.
Investing in the bond market is subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification and asset allocation strategies do not assure profit or protect against loss.
Indices mentioned are unmanaged and cannot be invested into directly. The S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. The Russell 2000 Index is a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index. The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 21 countries. The MSCI Emerging Markets Index is a market capitalization weighted index comprised of over 800 companies’ representative of the market structure of the emerging countries in Europe, Latin America, Africa, Middle East, and Asia. Prior to January 1, 2002, the returns of the MSCI Emerging Markets Index were presented before application of withholding taxes.
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