Quarterly Newsletter

Investors with a stake in the stock market were rewarded in July and August of this quarter as the S&P 500® Index moved higher by 2.4% and 0.6%, respectively. Bond investors were also pleased as medium and long-term interest rates dropped. Concerns over potential economic weakness, a cautious Federal Reserve, and some profit taking in the big tech names, which have driven the market in 2024, turned stocks sharply negative in the first part of September, with some bounce back toward mid-month. Investors should brace themselves for the possibility of more of this kind of volatility through the ups and downs of the upcoming presidential election. One notable stock market trend was how, unlike much of the trailing year, stock returns were broad during the quarter, outperforming results for the recently market-leading “Magnificent 7” stocks. This broadening reflects how resilient corporate earnings have remained despite challenges.

Once again, all eyes were on the Fed, with expectations that, at last, the restrictive rates would ease. Stocks received a boost from the dovish rumblings at the Federal Reserve’s Jackson Hole meeting in late August, where Fed Chairman Jerome Powell basically announced a pivot to lower rates beginning in September as he described the Board’s focus shifting from controlling inflation to concern over softening employment numbers. While a quarter-point cut seemed likely, odds for a half-point cut rose among the most optimistic. A good part of the September slump in stocks could be attributed to the dimming of the prospect of a larger rate cut. The Consumer Price Index report issued by the Department of Labor on September 11 revealed a slight surprise upward in core consumer prices, dampening expectations. However, overall inflation returned to levels not seen since early 2021, on track towards the Fed’s target of 2%. This has allowed the Board to focus more on the employment side of their dual mandate. The employment picture is worsening slightly, and their desire to achieve a soft landing may be the major driver in upcoming actions.

While the positive stock returns, especially the broadening of the market, were welcome turns, we couldn’t help but feel a bit of skepticism as the major stock indices toyed with new highs. A hint of this skepticism was seen in The Conference Board’s consumer confidence surveys, where optimism was tinged with concern over the labor market. The September data confirms this sentiment with a slowdown in job growth, but not near the level associated with recession.

As we’ve noted in the past, the resilience of the economy in the face of the Fed’s record-setting rate increases has been largely a function of a strong consumer. Early in the tightening cycle, this strength was bolstered by fiscal stimulus and Covid checks. Lately, it’s been fueled by rising credit card debt and the potentially fickle wealth effect of the rising stock market among higher net worth households, with a record number of 401(k) millionaires. This has helped to hide the damage the trailing inflationary period has wrought on American households with below-median incomes. If an extended market downturn puts a brake on the upper earners’ spending spree, the prospect for a deeper economic slowdown rises.

The surprising presidential candidate switch in August can serve as a harbinger of how quickly political and, by extension, economic situations can shift. The futures markets were predicting a 2% drop in Fed Rates by mid-2025, which, if realized, could be a real boost for future stock returns. However, in the past, such precipitous dips have only occurred in the midst of recessions. All around us are signs of economic slowdown as manufacturing measures for both demand and output dropped in August, the Labor Department revised trailing job growth down by 818,000, discount retailers reported sales and earnings declines, and even the hype over AI showed some slackening. While monthly or quarterly results do not always portend long-term trends, they can suggest shifts.

Through mid-September, the top-performing sectors for the quarter were Utilities and Real Estate, sectors whose attraction increased as bond yields fell. The long-leading Technology and Communication Services Sectors not only trailed the overall market (which was still solidly positive for the quarter as of this writing) but were negative, while the more defensive Healthcare and Consumer Staples outperformed.

These shifting fortunes highlighted our belief that the prospect of a more challenging economic period ahead doesn’t require a sharp shift in asset allocation. Instead, it highlights the importance of the constitution of an equity allocation. In fixed income, we believe in being open and opportunistic with what the market is offering. Even though interest rates have fallen slightly, investors can still own a high-quality fixed income portfolio and lock in yields above what money markets will likely produce over the next year. In stock portfolios we continue to emphasize solid businesses that we believe are reasonably valued and well-situated for success through the inevitable ups and downs of a modern economy. The broadening of the market this quarter bodes well for the kind of diversified portfolios we have long emphasized.