Economic Highlights
In the month of September, the U.S. economy showed signs of stability and moderate growth despite some softer employment trends. The Personal Consumption Expenditure (PCE) price index, a key measure of inflation, rose by 2.2% year-over-year in August, down from 2.5% in July, indicating that inflation is moving closer to the Federal Reserve’s target of 2%. The unemployment rate decreased slightly to 4.2% in September, down from 4.3% in August, suggesting a slight uptick from August’s weaker trends. The latest revision for the second quarter of 2024 confirmed that the U.S. economy grew at an annual rate of 3.0%, driven by increases in consumer spending, private inventory investment, and nonresidential fixed investment. Despite the ongoing growth, the Federal Open Market Committee (FOMC) decided to lower the target range for the federal funds rate by 0.5 percentage points to 4.75%-5.00% in its September meeting, putting greater emphasis on progress in reducing inflation and balancing risks to the economic outlook. Clearly, the Fed is concerned about the highest real interest rate in many years and its potential to weaken economic growth going forward. At his press conference, Federal Reserve Chair Jerome Powell stated that the U.S. economy is in “solid shape” and hinted at the possibility of further rate cuts depending on economic developments, inflation easing, and the labor market remaining resilient. The Feds reaction function is firmly tilted towards super-sized rate cuts at any sign of labor market weakness. Until then, their ‘data dependent’ mantra will continue to guide the timing and magnitude of interest rate cuts.
Investment Highlights
Thanks to optimism surrounding a soft landing, encouraging inflation results, and recent Fed rate cuts, U.S. markets experienced a broadening of the rally in Q3. The S&P 500® continued to hit record highs, finishing the quarter up 6%. Despite the recent pullback in September, small-cap stocks outperformed their large- and mid-cap peers, up 10% in Q3. Internationally, emerging markets were the winners, up 7%, as China finally adopted long overdue economic and monetary stimulus.
The Federal Reserve’s decision to commence its easing cycle in September signals a strategic pivot toward accommodative monetary policy, aimed at fostering economic growth through reduced borrowing costs for both businesses and consumers. Historically, such policy shifts are associated with increased capital expenditures and consumer spending, offering a potential tailwind for the broader economy. For equity markets, this shift is generally supportive, lowering the cost of capital and enhancing corporate profitability, particularly in capital-intensive sectors such as technology and real estate. Growth stocks tend to outperform in these environments, though sustained easing risks inflating valuations, potentially setting the stage for future market corrections. But with the S&P 500 at a price-to-earnings multiple of 21 and the broader market at 17, we are not in bubble territory yet. In fixed income, lower yields buoy bond prices, especially at the long end of the curve, while narrowing credit spreads may reduce borrowing costs for corporations. However, inflation concerns could lead to heightened volatility across asset classes if the Fed’s actions are perceived to overshoot and risk overheating the economy.
Amidst these macro tailwinds, equity markets are navigating an environment of elevated valuations. The S&P 500’s year-to-date gain of 20% underscores the market’s resilience. Recent upside in the index has been achieved without the leadership of mega-cap technology stocks, evidenced by the equal-weighted S&P 500 up nearly 9% since June 30, the Nasdaq 100 up less than 2%, and the Magnificent 7 themselves eking out a gain of only 2.5%. This broadening out-of-market performance is a healthy sign for future gains in most bull markets. Treasury yields have edged higher post-Fed decision, a typical pattern following rate cuts, and reflect diminishing macroeconomic fears. Concurrently, China’s barrage of fiscal and monetary stimulus last week has added further momentum, particularly to Chinese equities, emerging market equities and commodities, demonstrating coordinated global efforts to sustain growth. However, concerns over stretched valuations remain. With the S&P 500 trading at a forward price-to-earnings multiple above 21, current levels leave little margin for adverse developments, heightening the market’s susceptibility to downside risks. Historical comparisons to the year 2000 underscore the caution warranted by such elevated valuations, though the potential for a 1995-style soft landing remains a more optimistic, albeit increasingly priced-in, scenario. As volatility rises amid geopolitical tensions and the approaching U.S. election, the market faces a delicate balance between further upside potential and vulnerability to exogenous shocks.ain.
Wealth Planning Highlights
Welcome to the fall harvest season, or, as we say in the investment industry, welcome to tax loss harvest season. Tax loss harvesting is an integral part of our overall portfolio strategy for you.
This means that we will be doing the following in relation to your portfolios:
- Looking for any unrealized losses to realize in order to reduce your calendar year realized capital gains.
Additionally, we will be analyzing mutual funds capital gains distribution notices to determine the potential tax impact on your portfolios. We have focused on mutual fund managers who have a long-term track record of managing their capital gain distributions, but sometimes, a mutual fund surprises us. If there is a capital gain distribution that is greater than your unrealized gain in this fund, we will sell out of the fund before the declared dividend date. This results in a smaller tax bite for you.
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