What a difference three months can make on Wall Street. Following the previous quarter in which a vast majority of stocks declined while a literal handful of mega-sized technology stocks carried the S&P 500 index higher, the 3rd quarter saw a radical shift in market leadership that coincided with a sharp policy pivot by the Federal Reserve.
Decelerating inflation readings and a softening labor market emboldened the Fed to begin cutting the federal funds rate in September. As the bond market anticipated the Fed’s policy shift, interest rates across the term spectrum declined and by the end of Q3 the yield curve was no longer inverted. Not surprisingly, the US bond market enjoyed its strongest quarter in four years as the Bloomberg U.S. Aggregate Bond Index gained 5.21%. An expected byproduct of the Fed’s course of action going forward will be a dramatic drop in CD and money market interest rates.
The US equity market had a decidedly bullish response to the central bank's dovish pivot, overwhelming any bearish sentiment voiced over the weakening body of economic data as hopes remained alive that the Fed will successfully engineer a “soft landing” – preventing a recession after a period of monetary tightening. More noteworthy than the market’s continued advance in and of itself is how it moved. The “Magnificent Seven” stocks lagged as so-called ‘value’ stocks outperformed ‘growth’ stocks, small company stocks beat large-cap stocks, and the stodgy utilities sector went on a rampage (up 18.92%) to finish Q3 as the top performing sector year-to-date (after being in 9th place out of 11 sectors at the end of Q2).
The equal-weighted version of the S&P 500 companies returned 9.53% in Q3 versus 5.33% for the ‘official’ market-cap weighted S&P 500 index, as ‘value’ stocks beat ‘growth’ stocks by a margin of 9.11% to 2.69%. Declining interest rates served as a tailwind for small-cap stocks as the Russell 2000 index rose 8.96% in Q3. Meanwhile, the energy sector tanked (down 3.07%) amid concerns over the slowing economy and finished Q3 at the bottom of the year-to-date sector rankings. International stocks also posted strong performance during the quarter, as developed markets measured by the MSCI EAFE index gained 7.4%. A huge economic stimulus package announced by the Chinese Communist Party served to awaken China’s stock market from its long slumber at the tail end of the quarter, igniting a 20% gain in little over a week’s time which in turn propelled the MSCI Emerging Markets index to an 8.8% gain in Q3.
Investors’ rotation out of overvalued technology shares and into cheaper sectors, the leadership of the utilities sector, the bond market’s strong advance, and gold’s continued rise to all-time highs are all historically indicative of a broader underlying risk-off consensus building under the surface. If economic conditions don’t ultimately produce a stock market correction, geopolitical tensions and the culmination of the US election season could drive a fresh round of volatility.
Important Disclosures
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Market data provided by JPMorgan Asset Management and MarketWatch.com.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa, Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.