U.S. Equity Investment Environment
U.S. equity markets surged to record highs, fueled by lower bond yields, a constructive sector rotation and broader market participation, despite several bouts of volatility. With inflationary pressures easing, along with a softening labor market, the Federal Reserve commenced its long-awaited rate-cutting cycle with an aggressive 50bps cut. The unemployment rate remains at historically low levels, falling slightly to 4.1% in September, and inflation eased to 2.4%. The Dow Jones Industrial Average rallied 8.7%, while the S&P 500 gained 5.9% in Q3. In contrast, the Nasdaq Composite underperformed, with a 2.8% return, highlighting a rotation in market leadership. Utilities led all sectors, up 19.4% this past quarter and 30.6% for the year, followed by real estate, returning 17.2% during the last three months and 14.3% year to date. Energy, the only sector to post a negative quarterly return, fell 2.3%. The technology sector lagged, up only 1.6% with Microsoft Corp. and Nvidia Corp. posting negative quarters, down 3.6% and 1.7%, respectively. Small- and mid-capitalization issues delivered strong results over the prior three months, as the S&P SmallCap 600 and the S&P MidCap 400 advanced 10.1% and 6.9%, respectively. Contrary to previous quarters, value stocks outperformed growth-oriented issues.
International Equity Environment
Foreign developed markets performed well with the MSCI EAFE Index advancing 7.7% for the quarter. The U.S. dollar weakened against major currencies, providing a tailwind for international equities. The European Central Bank cut interest rates by 25bps to 3.5% in September as inflation has waned to 1.8%. U.K. markets rose 7.9% in Q3, with the British pound reaching its highest level against the U.S. Dollar since February 2022. After the Bank of Japan raised rates by 15bps, the Japanese yen strengthened from historical lows in June, which brought unprecedented volatility to the Japanese equity market. Despite this temporary selloff, Japanese stocks rallied 5.7% in the third quarter, driven by the significant appreciation in the yen. The MSCI Emerging Markets Index outperformed its developed counterparts, rising 8.7% for the quarter. This was primarily caused by China, which surged 23.5% after a massive $7.5 trillion yuan stimulus package. Despite concerns over stretched valuations, stocks in India climbed 7.3% in the last three months, now up 25.4% for the year, reaching record highs in late September.
Fixed Income Environment
The Bloomberg U.S. Aggregate Bond Index rallied 5.2% in the third quarter in anticipation of interest rate cuts. In September, the Federal Reserve lowered the federal funds rate by a half-point, the first since 2020, to a range of 4.75-5.0%, to support growth and stabilize a slowing labor market. This represents a significant turning point for the Federal Reserve policy, as it tries to fulfill its dual mandate of stable prices and full employment. The market is now pricing in another 50bps in rate cuts for 2024. The 10-year Treasury yield fell 62bps during the last quarter while the 2-year Treasury yield dropped 111bps as inflation fears subsided. As a result, the long-standing yield curve inversion ended, with the current spread finishing the quarter at 15bps. The Bloomberg Municipal Bond Index rallied more modestly, advancing 2.7% this past trimester, while high-yield bonds
continue to outperform, up 5.3%. Long-dated Treasury bonds, which are more sensitive to interest declines, experienced the strongest gains, rising 8.0% for the quarter.
Commodities Environment
The S&P GSCI Index retreated 5.3% in Q3, amid growing concerns around the health of the global economy. Fears of increasing deficits and central bank buying contributed to gold’s strong performance, rising 12.9% during the quarter and 27.2% for the year, closing near all-time highs. Despite heightened tensions in the Middle East, energy fell sharply by 12.2% led by heating oil, which dropped 15.7%.
