Occasional Daily Thought October 28, 2024

By LaRue Gibson on October 29, 2024

The third quarter of 2024 offered no shortage of market-moving news, yet the outcomes were surprisingly mild, defying expectations. This may reflect a new investment environment where investors, awash in information from 24-hour news cycles and social media, have become desensitized to events that would have rattled markets in years past. Perhaps modern technology has enabled market participants to discount shocks with unprecedented speed, or perhaps the vast liquidity injected by central banks since the 2008 financial crisis has fundamentally altered market dynamics. One cannot truly know, but what is past is prologue. Ignore history at one’s peril.

The quarter was packed with geopolitical and domestic surprises. In Late July, the sitting President of the United States abruptly terminated his run for a second term and endorsed his Vice President, Kamala Harris, to succeed him. And if that was not enough, there were two assassination attempts on Donald Trump, the former and possibly future President of these United States.

Additionally, early August saw a sharp rise in the Japanese yen, triggering an unwinding of leveraged trades and a temporary, but sharp sell-off in equity markets.

Despite these headlines, financial markets displayed remarkable resilience, except for three or four white knuckle trading days in early August, driven largely by central bank actions and fiscal policy interventions. The Federal Reserve cut its benchmark interest rate by fifty basis points and signaled further easing ahead. China launched a massive stimulus package, comparable in scale to the efforts deployed during the global financial crisis. On the commodities front, U.S. oil production hit record highs, and despite geopolitical tensions in the Middle East, weak Chinese demand contributed to a decline in energy prices, providing relief to consumers.

The overarching theme for the third quarter of 2024 was the return of liquidity. With inflation pressures cooling, both central banks and investors bet on increasingly accommodative monetary policies. Although valuations remain high across many asset classes, few wish to bet against the ongoing rally proving liquidity reigns supreme!

We note though that despite a longer than expected regime of higher interest rates by the Federal Reserve, economic growth and corporate earnings have stayed solid, long-term interest rates remain low, and credit spreads are tight, indicating little stress in the business economy.

In a significant shift, market leadership broadened beyond the dominant stocks popularly referred to as the Magnificent Seven while ten-year treasury yields dropped by over one-half of one percent during the quarter, contributing to renewed investor confidence. Furthermore, the market’s breadth reflects healthier sentiment, providing a more stable foundation for future gains.

As we move into the fourth quarter, several key themes may shape market performance. Lower fuel prices, supported by falling energy costs and robust U.S. oil output, will likely boost consumer spending, especially in this election season. While geopolitical risks persist, they are being met with fiscal and monetary support on multiple fronts.

However, the central question persists: How long can markets rally on the back of liquidity before the bill comes due?

Central banks may continue to loosen monetary policy, but such actions may pose longer-term risks. Investors should stay alert to shifts in inflation expectations as well as any unexpected economic shocks that could alter the course of monetary policy.

For now, we maintain an optimistic stance for the rest of 2024. The combination of slowing inflation, accommodative policy, and solid economic fundamentals provides a favorable environment for equities and credit markets. However, as always, we monitor data as well as exogenous events closely —particularly geopolitical developments, energy markets, and central bank actions—as they could disrupt the delicate balance the markets have struck.

In conclusion, while few assets can be considered cheap today, the market appears determined to ride the wave of liquidity. We remain bullish heading into the fourth quarter, but with a watchful eye on any signals that suggest a shift in market dynamics.

Frequent consumers as well as recent readers of our research content will recognize this important graphic.

The fourth quarter’s seasonal bias underpins our bullish positioning for the remainder of 2024, and when one considers the three quarters of momentum the U.S. benchmark indexes have enjoyed, an absence in exposure to stocks may prove costly.

Upon reviewing historical years with exceptionally impressive performance in the first three quarters, we found that while Octobers in these years tend to experience choppiness and increased volatility, aligning with broader seasonal trends, October often serves as a transitional month for equity markets. Despite this turbulence, the long-term takeaway remains encouraging:

• Stock markets typically regain momentum following these choppy Octobers, leading to robust performance in the final quarter of the year. The historical record reinforces the importance of seasonality in driving equity returns. November and December have consistently ranked among the top-performing months for equities.

As the fourth quarter commences, we review the three graphics that tell us most of what we need to know to quickly assess the health of the economy and risk markets. We do not claim it works perfectly, but in a world full of things to read, to see, to hear, and to do, having pithy snapshots helps.

We remind you that, in a complex world, three indicators can simplify our understanding of the economy and risk markets:

1. The Relative Performance of the Consumer Discretionary Sector to the Consumer Staples Sector
2. The Yield Spread Between High Yield and Investment Grade Corporate Bonds
3. The Trend and Momentum of the S&P 500 Stock Index

This slide depicts the relative performance of Consumer Discretionary Stocks versus Consumer Staples Stocks. It gives us an indication of the risk markets’ view on economic activity and the appetite for risk in the marketplace. When Consumer Discretionary issues outperform Consumer Staples, we interpret this situation bullishly for the economy and conclude that the markets appetite for risk is robust. We do not expect you to understand the intricacies of charts, but the picture shows a strong uptrend [notice the upward slope] in this crucial ratio since June of 2022. Since the Federal Reserve reduced interest rates at their September 2024 confab, this relationship has reaccelerated bullishly indicating the markets are confident in the economy and, thus willing to accept a greater risk appetite.

We will continue to monitor this relationship for clues regarding the economy and risk positioning in equity markets going forward.

Our next slide shows an indicator that assesses how the bond markets feel about the economy. If yield spreads between High Yield Corporate Bonds and Investment Grade Corporate Bonds narrow, we believe that bond investors have confidence in economic growth as they have not abandoned non-investment grade debt obligations which provide greater security compared to their high-yield cousins.

The graph clearly demonstrates that the spread between Non-Investment Grade Debt and Investment Grade Debt has continued its trend towards narrowing. Again, confidence has risen since the Fed trimmed interest rates. In fact, one could argue the process has accelerated further since the October jobs report has surprised to the upside.

In our opinion, this corroborates the message from the relative performance of the Consumer Discretionary to Consumer Staples complex. Let us show that graphic again.

Finally, to assess the health of the equity markets, we offer this matrix. It evaluates the trend of a benchmark index and the momentum it displays. We utilize the Standard and Poor’s 500 Stock Index. When more than half of the index participants trade at a higher price than the average price of the past 250 days, we say that the market exhibits a positive trend. Furthermore, when more than half of index participants trade at a higher price than the average price of the past 50 days, we say that the market demonstrates strong momentum. A healthy market exhibits a positive trend and strong momentum. Given the robust trend and momentum characteristics of the U.S. benchmark indexes as demonstrated by the clustering of the major U.S. stock indexes in the upper right-hand quadrant, we view the equity markets positively as 2024 concludes.

As an aside, we included the Shanghai Shenzhen CSI 300 Index that represents the broad Chinese equity markets in our Tend and Momentum Matrix. The Chinese government has aggressively moved to stimulate the world’s second largest economy. Stock markets have responded as this graphic indicates. This bears watching as a stronger Chinese economy may imply global economic growth acceleration and renewed inflationary pressures. Stay tuned.

Join the running of the bulls up Wall Street! We believe that the final two months of 2024 may offer growth opportunities to those investors who focus on data and successfully navigate the noise our 24-hour news cycle and endless social media postings create.