Dan Reiter, CFP®, CPA
This article provides a comprehensive overview of the economy and market conditions in the third quarter. We'll discuss recent economic developments, their impact on the market, and potential outlook for the remainder of the year.
I. A Closer Look at the Economy
Perspectives on the economy started a bit choppy, but have exhibited a remarkable resilience, defying initial expectations of a slowdown. An early August report on the economy showed that job growth slowed sharply and unemployment increased to its highest level since 2021. This resulted in a bumpy beginning to August as most major US stock indexes fell more than 3% in one day.
However, the softening employment numbers served as one nexus for the Federal Reserve to cut interest rates. In August, Federal Reserve chair Jerome Powell did much to solidify the intent to begin cutting interest rates for the first time in several years when he was quoted as follows:
“It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions.”
Since, economic news has been largely positive. Inflation cooled for a fifth consecutive month in August to 2.5% annualized. The Federal Reserve implemented its first rate cut at its September meeting, and a third quarter report by the Bureau of Economic Analysis showed real gross domestic product increased at an annualized rate of 3% in the second quarter of this year.
All said, hopes are increasing that the combination of economic factors is setting up for a possible “Goldilocks” (not to hot nor too cool) economy where numbers remain strong enough to ward off any near-term recession, but soft enough to encourage the Federal Reserve to continue to cut interest rates.
II. Economic Developments Result in Broadening Market Returns
Our latest economic and market review written in early July warned not to overlook smaller and value companies in favor of a handful of large technology companies proved prescient. Just a few days after the article’s writing, smaller stocks soared over 3.5% while the “Magnificent Seven” collectively lost almost $600 billion in market value, the largest one-day loss since February 2022. Value stocks gained 8.95% in the quarter, a 3-percentage point outperformance over the broader US market.
Ultimately, the Magnificent Seven and stock market darlings of the first half of the year recovered some during the quarter but had more of a mixed bag of returns. Nvidia lost some ground while Alphabet, Microsoft, Amazon, Apple, Meta, and Tesla all ended modestly higher.
The quarter was also largely positive for bonds, with a rally of 5% for a broad bond index as the Fed started its rate cut cycle.
III. Looking Ahead: Challenges and Opportunities
With the potential for two more rate cuts this year, the market is pricing in another half-percentage point move by the Fed. A better than anticipated September jobs report (254,000 jobs created versus 150,000 expected) adds continued optimism on the economy as we look to finish the year. Ultimately, the hope is that such a combination of factors will continue to spell good news for stocks. Particularly smaller companies that normally tend to be more cyclical with the economy but rely heavier on debt and low rates to finance growth.
With any short-term period, however, there are always risks. Growing tensions in the Middle East add additional geopolitical risks. Positive economic indicators are great but have a greater than zero percent chance to reignite inflation fears. Finally, as we all know, we are also now within thirty days of an election in the US.
So, what should investors do?
First and foremost, take a fresh look at your investment allocation to determine if you’re aligned with the right balance of risk and return. The strong return in the prior year provides a foundation of strength to potentially pocket and take some of the market gains off the table with a shift into more conservative bonds.
Second, continue to review and consider your exposure to a handful of just a few large domestic companies, as the top ten stocks (out of 500) still make up over 35% of the value of the S&P 500. Significant opportunities are still present in smaller companies. For example, one columnist notes that in a review of 2000 small publicly traded companies, at least 235 are expected to be at least as profitable as the S&P 500 with a weighted average expected return on equity of 46%, more than double that of the S&P 500. More interesting? With a forward price-to-equity ratio of 22 they are about 10% cheaper.
Ultimately, maintain a long-term perspective. Remember that at times the bumps in the road get bigger as uncertainty sets in. Yet, investors that remain disciplined stock investors have continued to reap the rewards in creating significant wealth.
The third quarter of 2024 has been a dynamic period for the economy and markets. While there are challenges to navigate, the overall outlook remains optimistic. By understanding the underlying factors driving market movements and adopting a disciplined investment approach, investors can position themselves for long-term success.
Investment advice, financial planning, and retirement plan services are provided by Prosperity Planning, Inc., an SEC registered investment advisor. The information contained herein, including but not limited to research, market valuations, calculations, estimates and other material obtained from these sources are believed to be reliable. However, Prosperity Planning, Inc. does not warrant its accuracy or completeness. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or to participate in any trading strategy. If an offer of securities is made, it will be under a definitive investment management agreement prepared on behalf of Prosperity which contains material information not contained herein and which supersedes this information in its entirety. Any investment involves significant risk, including a complete loss of capital and conflicts of interest. The applicable definitive investment management agreement and Form ADV Part 2A will contain a more thorough discussion of risk and conflict, which should be carefully reviewed before making any investment decision.
