Q3 2024 Market & Economic Outlook

 

Current Economic Views

U.S. economic growth remained steady in the year’s first half as job gains continued and inflation moderated. The Federal Reserve has held interest rates steady for approximately a year. To justify future interest rate cuts, improvements in inflation will need to continue.

 

The labor market has remained a bright spot, as job gains averaged 177,000 during the second quarter, and unemployment remains low at 4.1%. Labor demand normalized after the robust 2023, with 1.22 job openings for each job seeker. That figure is approaching the pre-pandemic figure of 1.20 and near a balanced market of 1.0. Given the ongoing job gains, consumption continued, albeit slower from 2023. During the quarter, household net worth reached record highs, which can further boost spending.

 

At the June meeting, the Federal Reserve maintained its projection for growth (Gross Domestic Product) of 2.1% for 2024, followed by 2% for 2025. The Fed’s Summary of Economic Projections signaled one rate cut this year. The Fed’s preferred measure of inflation, core PCE, was 2.6% annually in May, but still above the 2% target after some earlier reports showed inflation remaining stubborn.

 

Economic growth overseas remains sluggish relative to the U.S. Geopolitics could weigh on the global economy for the remainder of the year. In addition to the ongoing wars, the U.S. and Europe will hold elections, contributing to some near-term uncertainty. The potential outcomes can impact changes in economic policy, such as the tax code, environmental and safety regulations, and foreign policy, including trade agreements.

Looking ahead

We expect growth to continue at a slower but steady pace relative to 2023. Household balance sheets remain in reasonable shape, job growth should continue at a moderate pace, and as inflation continues to move in the right direction, the Fed can lower rates later in the year.

 

At the beginning of July, Bloomberg pegged the chance of a recession in the coming 12 months at 30%. The market expects two rate cuts by the end of the year, but that estimate can fluctuate.

 

Inflation will remain front and center for the rest of the year. The current "higher for longer" interest rate environment could continue if wages and inflation remain sticky. Conversely, if progress continues, the Fed can lower rates, which will lower borrowing costs across the economy.

 

We continue to monitor areas of concern in the U.S. economy. At lower income levels, delinquencies (credit cards, auto loans, etc.) are rising as excess savings have diminished.

 

In the near term, housing data could continue to disappoint. However, the housing market is very interest rate-sensitive, so the industry could benefit once the Fed cuts rates. 

Current Investment Views: Equities

Equities posted another positive quarter, with the S&P 500 achieving a 4.3% total return; however, the artificial intelligence growth theme dominated market internals. Nearly everything directly tied to AI performed well, while stocks with little exposure or tangential benefits from AI lagged the broader market.

 

Not only was the market thematically concentrated, but breadth also remained lackluster, with S&P 500 returns driven by a handful of stocks. Without Nvidia (up 36.7%), Apple (up 23%), Broadcomm (up 21.5%), Alphabet (up 20.8%), and Microsoft (up 6.4%), the S&P 500 would have posted a negative return in the second quarter. Remove Nvidia, Apple, and Alphabet reduces S&P 500 returns to 0.4% from 4.3%. The S&P 500 Equal Weighted index was down 2.6%. Six of the eleven sectors posted negative returns (Financials, Energy, Materials, Industrials, Health Care, and Real Estate).

 

Apple is the most recent addition to the “AI-beneficiary” list after unveiling a new version of Siri at its Worldwide Developers Conference. This version features generative AI as part of its underlying tech and processes most requests directly on users’ phones rather than routing through data centers. While likely limiting some capabilities, the structure allows for improved privacy and reduced costs. AI will only be available on newer iPhone models, which should drive a meaningful upgrade cycle.

 

The utilities sector (up 4.7%) was one of the few non-growth sectors to catch a bid in the quarter. Still, that was associated with improving AI-related sentiment as investors focused on the capacity growth needed to support the rapidly expanding power generation needs of data centers processing AI workloads.

Looking ahead

The key item to watch in the third quarter is whether market returns can broaden beyond large-cap growth stocks. We suspect that for that to occur, continued progress on disinflation, durable economic activity, and a resilient consumer — a backdrop that remains our base case — will be required.

 

Projections have S&P 500’s sales increasing 4.5% year over year in the second quarter. Expectations have earnings per share growing 9.1%, a slight deceleration from the second-quarter estimate coming into the quarter but the highest earnings growth rate since 2021’s fourth quarter. Estimates peg Communication Services and Information Technology as the largest growth contributors, with earnings advancing roughly 18.7% and 15.7%, respectively.

 

Much like the performance contributors, expected earnings growth contributors are also highly concentrated. The six largest stocks in the S&P 500 (Amazon, Apple, Google, Meta, Microsoft, and Nvidia) are expected to grow EPS by 30% annually, while the other 494 are expected to grow only 5%.

 

We are somewhat concerned by the narrow market participation and believe it exacerbates fragility in both earnings estimates and index levels; however, up to this point, the secular growers have shown an ongoing ability to deliver on their lofty forward guidance.

Current Investment Views: Fixed Income

The theme of the fixed-income market in the second quarter was elevated volatility despite little overall movement.

 

The 10-Year U.S. Treasury Yield rose 20 basis points in the quarter, ending at 4.4%, but its path was full of ups and downs.

 

Reasons for this volatility include:

• Investors grappled with inconsistent monthly inflation reports ranging from unsustainably high to in line with the Federal Reserve’s target.
• Other economic data painted a similarly messy picture. Several measures pointed to a resilient economy, with only a few consumers beginning to feel the pressure of high interest rates. In contrast, other measures suggested a cooling labor market that should slow the economy.
• Fed members reiterated their desire to cut rates eventually, but many expressed hesitancies about when they would occur and how restrictive monetary policy is.

 

On the other hand, credit spreads (the excess yield investors demand for holding a corporate bond instead of a similar treasury) were mainly steady throughout the quarter. The average U.S. Investment Grade spread finished the quarter up three basis points to 96 basis points. The average U.S. High Yield spread widened six basis points to 318 basis points.

 

Overall, the fixed-income market remains in wait-and-see mode as investors hope new economic data will begin to tell a clearer story about the future of rate cuts. Inflation is taking longer to come down than market participants expected, but recent data is encouraging.

Looking ahead

In the Fed’s latest economic projections, the median unemployment projection for the end of 2024 was steady at 4%. Like the market, the Fed sees a serious near-term economic slowdown as unlikely. The Fed’s median core PCE inflation projection for the end of the year was pushed higher from 2.6% to 2.8% following poor first-quarter inflation.

 

With few risks forecasted for the labor market and a worse inflation outlook, the median projection for three quarter-point rate cuts in 2024 was lowered to just one. Also, the longer-run median Fed-funds rate projection was adjusted higher, suggesting that some Fed members believe the long-run neutral rate has increased.

 

Although inflation has improved in recent months, it remains too high.

 

The labor market remains tight despite recent data. Lower-income households are struggling under the weight of high interest rates, but higher-income households still seem mostly unfazed. Despite insisting that its policy is restrictive, Fed members are questioning how restrictive it is.

 

The lagged effects of the Fed’s tightening cycle may still be making their way through the economy and a shallow recession is still possible. The Fed has noted that its dual mandate has recently moved into better balance.

 

The growing national debt, international conflicts, and the political uncertainty of a presidential election year also create more unknowns.

Asset Spotlight: Commodities

Commodity prices rose during the pandemic partly because of supply chain issues and increasing shipping costs. Now, the worldwide transition to green energy is the leading cause of commodity price increases. Control over the commodity supply is becoming a global issue, with the U.S. and China competing against each other. 

 

Supply and demand fundamentals are not the only reason for this year’s rally in commodity prices. The prospect of Federal Reserve rate cuts at some point, even if later and fewer than previously anticipated, encouraged investment.

 

Two of the G7’s central banks (European Central Bank and Canadian Central Bank) recently cut interest rates, and other nations could do the same soon. However, China is the big question mark regarding the global demand for industrial metals (more on China later).

 

Geopolitical issues also led to higher commodity prices. There is also concern that a Cold War is developing, in which regional producers need to choose between investors with Western values or dictatorship.

Some of the most notable commodity price increases include:

• Copper/precious metals – peaked at 28% this year and are up 11% to date. Electric vehicle batteries and data centers for the AI revolution need precious metals. These metals are also tricky/expensive to mine.
• Gold – peaked at 18% this year and is up 13% to date. The U.S. economy remains resilient, but consumer sentiment is soft. Investors and central banks are flocking to gold in part because of economic and geopolitical uncertainty.

Oil – peaked at 20% this year and is up 12% to date. Global demand remains strong, and OPEC+ announced plans to leave production levels flat. 

Looking ahead

Strong commodity prices usually mean China, the world's second-largest economy, has strong consumption and demand levels. This time is different, however. Recent data showed weak demand, and its stock market is down roughly 8% year to date, in a year when most regional indices are up. There is growing concern that the country’s companies will flood the global market with discounted products to foster growth.

 

However, it seems unlikely other developed economies will welcome the move. President Joe Biden recently announced $18 billion of tariffs on Chinese goods. Biden has staked his legacy on the U.S. beating China with its own government investments in factories to make advanced technologies. The bipartisan CHIPS act stated that national security is a reason for the increase in domestic technological goods production.

 

The European Union also levied tariffs against Chinese goods. The old playbook where China spreads its cheap goods around the globe seems unlikely.

 

Copper and other industrial metals recently retreated partly due to signs of weakness in China. (Lithium has fallen as electric vehicle sales growth has dropped and supply exceeds demand.) Commodities have also come under pressure as the Federal Reserve dialed back rate-cut expectations.

 

But there are fresh tailwinds, including the buildout of green energy infrastructure and a rising need for artificial intelligence data centers.