Third Quarter 2024 Investment Commentary

By Published On: October 15th, 2024

Executive Summary:

  • Thayer Portfolios Build on 2024 Gains in the Third Quarter, Benefitting from Strength Across and Within Asset Groups
  • Taking Negative Job Surprise in Stride, Fed Pivots Policy Toward Neutrality
  • U.S. Economy Continues to Stem Recession Angst While Employment Remains Crucial
  • Election Will be Compelling, While Offering Relatively Little Fiscal Clarity or Reform
  • Thayer Portfolio Move: Swap Gold for Short Term Treasuries

Commentary:

What happened in financial markets in the third quarter?

Financial markets enjoyed a robust quarter, across and within asset classes. For the first time in 2024 both bonds and stocks rose solidly, as the inflation headwind finally stood down, leading the way to an aggressive first rate cut by the Federal Reserve in September. The AGG bond index gained 5.3%, bringing its year-to-date return to 4.7%. The all-inclusive ACWI stock index, meanwhile, tacked on 6.4%, upping its year-to-date gain to 18.5%, while the S&P 500 gained 5.5% and 20.8%, respectively.  With both bonds and stocks rising, balanced portfolios benefitted. Thayer client accounts participated well, enhanced further by a strong gold investment.

The strength in stocks became broader in the recent quarter, as the Fab names and the NASDAQ took a breather. Value stocks and dividend payers outperformed their growth counterparts for the first time this year. The older-economy Dow Jones index rose 8.2% while the NASDAQ was up a more modest 2.6%, bringing respective year to date gains to 12.3% and 21.7%. Small-mid capitalization names also performed well, and we even saw a later quarter surge in emerging market names driven by an aggressive Chinese stimulus campaign. New measures, including allowing homeowners to refinance mortgages, helped investor spirits, and the Shanghai index jumped more than 20% in late September.

Readings on inflation have provided evidence that the problem has been sufficiently disarmed, with a twelve-month rate in the mid-2%s and the last six months around the 2% preferred target.  Inflation accelerants including supply chain constraints around the COVID reopening and heavy Federal spending tied to COVID relief, which contributed to a 9.1% CPI peak in June 2022, have run their course. This powered bonds as they continue to recover from sharp 2022 losses in an around the inflation peak.

What is the Fed’s path now that it has pivoted to monetary ease?

The Fed’s long-anticipated pivot to monetary easing took place on September 18th, with a .50% cut in the policy funds rate to 4.75-5.00%. The expectation had long been for a quieter .25% cut, and in the previous Fed meeting on July 31st Jay Powell waved off the possibility of .50%, but this changed two days later following a surprisingly weak jobs reading for July. Markets dropped quickly amid fears the Fed was late to act, missing the grimmer tea leaves on employment and the economy overall. Within the Fed’s dual mandate – full employment and price stability (inflation) – the focus in financial markets shifted decidedly from the second to the first.

Now that rate cutting has begun, the Fed will have to weigh both jobs and inflation over the next sequence of policy meetings, including November and December this year and the usual eight sessions next year. Based on consensus projections from Fed officials at the September meeting, another .50% in cuts is seen this year, followed by an additional 1.00% over the course of 2025. This would bring the policy rate down to 3.25-3.50%, a full two percentage points of easing from the restrictive peak, and a level regarded as essentially neutral.  All of this of course is subject to change, and it seems possible the Fed may have to move more aggressively if we see further deterioration in employment and/or negative surprises.

What is the state of U.S. employment and its impact on the GDP outlook?

Does the Fed now see stronger headwinds for workers and the economy than the general investing public? There are plainly visible signs, including erosion in job openings from about 12 million in 2022 to 8 million today, and an uptick in the unemployment rate – it stands at 4.2% today, having been as low as 3.4% in 2023 and 3.7% early this year. The latter in fact triggers the Sahm Rule Recession Indicator, in which half point or more upticks in unemployment within twelve months point to an upcoming economic downturn.  

But even at the higher unemployment rate and lower job opening level, American labor is still considered healthy and wage growth is hovering around 4%, solidly outpacing inflation. Retail sales’ most recent report, particularly on-line sales, was indicative of robust consumption. Consumer spending more broadly has appeared to remain strong. These indicators are always important as consumption accounts for roughly two-thirds of our economic output.   

Overall, we seem to have sidestepped imminent recession and managed some employment deterioration. GDP growth came in at 3.0% in the second quarter, following 1.4% in the first. In the wake of the strong recent consumer spending reports, the Atlanta Fed just raised its third quarter estimate from 2.5% to 3.0%. Generally, more subdued growth is seen for 2025, but still short of recession. The Fed likewise sees overall economic health and labor sector equilibrium, as reiterated by Powell in his September 30th comments to the National Association for Business Economics.

What are key issues around this year’s U.S. election?

The upcoming U.S. presidential election at this writing appears very close, and this will keep investors on edge. Our sense is that markets will begin to consider the fiscal side of the fiscal/monetary policy mix for the first time in years, after focusing on the monetary (Fed) side over the course of the recent inflation story. Fiscal conservatism and reform may be desirable with annual budget deficits, the national debt and annual debt service costs at unsustainable levels, but this is not on offer from either Donald Trump or Kamala Harris.  And in today’s electorate, as detailed by The Wall Street Journal, traditional fiscal rectitude no longer comports with the Republican base, as it has become overwhelmingly more reliant on Federal assistance than its Democratic counterpart.

Trump has ruled out cuts in entitlements (Social Security, Medicare, and Medicaid) and would like to eliminate taxes on Social Security benefits. Harris wants to provide $25,000 of assistance to first-time home buyers, expand the Earned Income Tax Credit and renew expiring ACA subsidies. Trump is counting on higher tariff income to enhance revenues, but this could come out of consumer pockets and effectively rekindle inflation. Harris would like to reverse Trump’s 2017 corporate tax cut halfway from 21% to 28% (not to the pre-2017 35%), but this could incentivize companies to charge higher end-market prices, also pushing up inflation.

Whoever wins the White House, financial markets tend to prefer divided government, with at least one of the branches of Congress on the other side of the aisle from the President. This lowers the prospect of major legislative change which could have a dislocating effect. Bill Clinton raised eyebrows at the DNC with the statistic that 50 million jobs have been created under Democratic presidents since the Cold War ended in 1989, versus only one million under Republicans, but the best results usually were achieved under divided rule, including in his own administration.

Are there any recent changes in Thayer portfolios, and why?

We are generally maintaining Thayer’s portfolio positioning as we move into the fourth quarter. Our only move has been to sell our gold position. It has been the single strongest performer in 2024, and gold is at or close to an all-time high, thus leading to a decision to book the gain. Proceeds have been redeployed into 1-3 year Treasuries, which still offer an attractive yield. 

Along with enhancing portfolio yield, as gold is a non-yielder, the move also reduces overall volatility. We feel this is appealing during the upcoming period, including a very high-profile election and ongoing geopolitical strife. 

We wish you all the best and will be back with a fresh update later in the quarter.

David Beckwith, Chief Investment Officer