Stocks Rebound from Weak September Start to End Month and Quarter Higher

HIGHLIGHTS:

• The three major U.S. stock indices put in new all-time highs during the third quarter with September culminating in broad equity gains. Large-cap growth companies, as measured by the NASDAQ Composite, peaked in July but enjoyed some momentum to close out the quarter.
• Bonds had gains for the fifth month in a row as rates continued to move lower during the month and hit the lowest level of 2024. The 10-year U.S. Treasury yield ended August at 3.91% and closed September at 3.81%.
• The U.S. economy continued to grow but showed some evidence of slowing economic activity. The ISM manufacturing index remained below 50 in August, but the non-manufacturing index ticked modestly higher to 51.5. Job market activity has slowed, but housing had a bit of a bump higher with the recent decline in rates.
• Fed Chairman Powell kicked off the rate-cutting cycle in September with a 50 basis point cut – the first rate cut since 2020. According to the CME FedWatch tool, odds favor 3 more cuts in 2024 with 2 FOMC meetings remaining.

Download Benchmark Data

EQUITY MARKETS

The month started off volatile for stocks, but not to the same degree as August. However, as the month progressed, stocks rebounded and turned in solid monthly gains. September closed out a strong quarter and first 9 months of 2024 for stocks. See Table 1 for equity results for September 2024, Q3 2024, year to date (YTD) and calendar year 2023.

Table 1

The recent broadening of the market shows up clearly in the quarterly numbers. September had more of the large-cap leadership we have seen so often, but the quarter saw a broadening into small and mid-caps, as well as value and international companies relative to large-cap growth. We have often discussed the difference between the returns of the headline, market-cap-weighted S&P 500 Index compared to the equal-weighted version of the same stocks, which is more reflective of what the “average” stock is doing. The returns of these two measures were relatively in-line with each other in September, but the quarter shows a clear shift to the equal weighted index while YTD performance still shows the market-cap weighted index in the lead. The “average” stock had a better run in Q3, but large-caps still lead year to date.

The NASDAQ stands out with one of the the best domestic index returns in September, but that accounted for all its returns for the quarter. It still shows impressive results YTD, but the gap narrowed considerably with its relative underperformance in Q3. Large-cap value lagged in September compared to growth, with one example being the Russell 1000 Value Index up 1.39% for the month, while the Russell 1000 Growth Index gained 2.83%. For the quarter, however, those returns were 9.43% and 3.19%, respectively, as value outperformed. Year to date, the index returns flipped again with the value version up 16.68% and the growth index gaining 24.55%. So, the market has seen a broadening of late, but large-cap growth still leads so far this year.

Emerging markets had some of the strongest monthly results, advancing over 6.6%. International stocks in general have also enjoyed the recent broadening in the market with solid quarterly and YTD results that rival some of the U.S. equity indices. The first 9 months of 2024 have been very strong for equity markets following a strong year of returns in 2023.

Fixed Income

After hitting the highest level of the year in April, the 10-year U.S. Treasury yield has declined for the last five months. In September, the 10-year yield hit a new low for 2024. This move lower in rates has helped set up generally positive returns for bonds during the period. Most bond sectors were able to push into positive territory after gains in July and additional gains have been added over the last two months. The 10-year U.S Treasury yield ended July at 4.09%. On August 1, the yield closed below 4% for the first time since February and it ended September at 3.81%. See Table 2 for fixed income index returns for September 2024, Q3 2024, YTD, and calendar year 2023.

Table 2

It is apparent that, outside of high yield, all of the YTD returns for these major bond indices have occurred in the last three months. This has coincided with the drop in interest rates and those more rate sensitive sectors (like 30-year U.S. Treasuries) have had the strongest recent results. However, they also struggled more at the beginning of the year. High yield bonds have had a steadier run this year as they often follow the stock market, so they have enjoyed gains throughout 2024.

At the start of the year, we said we believed the 10-year U.S. Treasury yield would be in a range between 3.25% and 4.5% in 2024 (acknowledging that we got above that level in April). The trend in rates has been lower since those April highs, and we believe rates will continue to decline as the Fed begins a rate cutting cycle. We also believe Fed action will impact the front end of the yield curve more dramatically, but that the general trend will be for rates to move lower.

We maintain our long-standing position favoring credit versus pure rate exposure in this interest rate environment and that has served us well so far in 2024. We also believe the role bonds play in a portfolio, to provide stable cash flow and to help offset the volatility of stocks in the long run, has not changed. Furthermore, we believe that bond yields remain attractive, and we are seeing some of the best bond yields in years. In our opinion, having an active bond management approach makes sense in these volatile times.

Economic Data Highlights and Outlook

The soft-landing scenario seems to be developing in the U.S. economy. Data released in September (largely covering August), continued to point to weaker economic growth, but growth nonetheless. The third reading of Q2 2024 GDP remained at 3.0% annualized growth, slightly better than an expected drop to 2.9%. The Atlanta Fed GDPNow estimate for economic growth (as of September 30) shows the economy running at an estimated 3.1% annualized growth rate for the third quarter. The U.S. economy seems to be running somewhat ahead of our expectation of 2.25% growth for all of 2024.

Job market data continues to largely reflect some modest softening occurring, but it also still reflects a healthy labor market. Non-farm payrolls grew by 142,000 in August, below expectations of 165,000. Additionally, prior month job additions were reduced to a mere 89,000 from the prior estimate of 114,000. However, the unemployment rate remained at 4.2% as expected, a modest improvement from the 4.3% level in July. The 4.3% reading was the highest unemployment rate since October 2021. Moderation in the job market is not unexpected following a rate-tightening cycle and weakness over the last several months was a catalyst for the Fed to cut rates by 50 basis points in September. Job openings still outnumber the unemployed, but that gap has narrowed dramatically. Chart 1 shows the number of unemployed people in the U.S. compared to job openings.

Chart 1

Labor markets are normalizing, and as a result, tighter labor market conditions exist. With the Fed’s dual mandate consisting of price stability and full employment, the weaker job market supports the Fed beginning to cut rates. Indeed, we saw the Fed follow through on this in September. Overall, we would still view the job market as healthy and coming more into balance. It seems unlikely that the economy would slow too drastically with the current position of the labor market. We continue to expect that the economy will slow from its pace in 2023, but that it will still grow in 2024 resulting in a “soft landing,” Even if a recession developed, we believe it would be mild due to the strength of the consumer. We believe opportunities exist in the stock and bond markets under either a slow growth or mild recession scenario, but we believe the odds favor a soft landing at this point.

The other side of the Fed’s dual mandate, price stability, continues to improve. The Consumer Price Index (CPI) rose as expected by 0.2% in August, and the annual increase matched expectations at 2.5%. This compares to the prior annual increase in July of 2.9%. The core CPI reading was modestly higher for the month compared to expectations (0.3% vs. 0.2% expected), but the annual increase was in-line at 3.2%. Both headline and core Producer Price Index (PPI) readings were higher than expected for the month, but this followed revisions that were lower for both in the prior month.

The year-over-year increases for headline and core PPI were 1.7% and 2.4%, respectively, were both as expected, with once again the prior month readings being revised lower. Rounding out the inflation readings for August, the preferred inflation measure of the Fed, the Personal Consumption Expenditures (PCE) Price Index largely matched expectations. The headline PCE Index had an annual increase of 2.2% in August (modestly lower than the 2.3% expectation) after an expected 0.1% monthly gain. The core PCE reading (the reading the Fed targets) was in-line with expectations with a 2.7% annual increase after a 0.1% gain for the month (when a monthly gain of 0.2% was expected). Chart 2 shows the headline and core PCE Price Indices continuing to trend toward lower.

Chart 2

For illustrative purposes only. For illustrative purposes only. Past performance is not indicative of future results.

With inflation improving and the job market showing some recent weakening, the Fed took action and cut the Fed Funds Target Rate by 50 basis points in September. This was the first rate cut by the Fed since the pandemic in 2020. At the end of September, Chairman Powell gave a speech, and the market interpreted his comments as leaning toward a slower rate cutting cycle. After the speech, the CME FedWatch Tool put the odds of a 25 basis-point cut at about 63% in November when it had favored a 50 basis-point cut previously.

The housing market seems to have gotten a bit of a jolt in August with the recent drop in interest rates. Housing starts and building permits in August both exceeded expectations and improved from the prior month levels. New home sales were better than expected, but below the July mark and existing home sales were modestly below expectations and dropped from the prior month. The S&P CoreLogic 20-City Index of home prices rose by 5.92% for the year through July, ahead of expectations of 5.90% but below the prior month’s annual increase of 6.54%. Mortgage rates tend to follow what is happening with the 10-year U.S Treasury, so the recent decline in Treasury yields should keep the trend moving lower for mortgage rates as well. Chart 3 shows the average 30-year mortgage rate and building permits. With mortgage rates at about a two-year low, hopefully that will continue to support improvements in the housing market.

Chart 3

For illustrative purposes only. For illustrative purposes only. Past performance is not indicative of future results.

The ISM indices were mixed in July. The ISM Manufacturing Index improved in August to 47.2, but that was below expectations of 47.5. Manufacturing continues to be in contraction mode. (This index had an identical reading in September at 47.2, once again below the expectation of 47.5.) The ISM Non-Manufacturing Index, which covers the much larger service industries in the U.S. economy, had a modest improvement for the month to 51.5 compared to expectations and July’s level of 51.4.

Retail sales (ex. auto and gas) at a 0.2% monthly gain were below expectations of 0.3% growth. The preliminary University of Michigan Sentiment reading for September improved modestly to 69.0 from 67.9 and expectations of 68.5. After breaking a two-year streak of declines in February, the Conference Board’s Leading Index has now declined for 6 straight months. For August, it fell -0.2%, which was modestly less than the -0.3% expectation.

September started out volatile (though not to the same degree of August’s start), but stocks rallied back and posted a positive overall month and quarter. The elevated volatility was also likely exacerbated by the shift in market leadership in recent months, which has broadened to value companies, small and mid-caps, and international stocks. After a multi-year stretch when large-cap growth has for the most part dominated the market, the third quarter saw other areas of the market contribute. Generally speaking, we believe more breadth in the market would be a healthy improvement moving forward. Equity market volatility helped bonds rally and yields have dropped sharply in recent months with the 10-year U.S. Treasury hitting its lowest level of the year in September. Economic data so far has not been overly surprising from our perspective with slowing job market activity following the aggressive rate hike cycle by the Fed. We maintain our belief that the economy will grow in 2024, but likely at a more muted pace than last year and that seems to be developing. The good news is that currently, earning expectations for 2024 and 2025 are for double-digit growth, but that is obviously subject to revision. Over the long run, we believe company earnings drive stock prices, so we like that fundamental backdrop.

We know October started with an escalation of the crisis in the Middle East and we are also entering the final countdown to our U.S. election. Although these could spur volatility, we believe the economic and market fundamentals remain solid. As always, we believe it is imperative for investors to stay focused on their long-term goals and not let short-term swings in the market derail them from their longer-term objectives.

Investment Implications

Clark Capital’s Top-Down, Quantitative Strategies

It was a positive month for markets across asset classes in what is normally a seasonally weak period ahead of the Presidential Election.

Three rules apply to today’s market: don’t fight the fed, don’t fight the tape, and watch credit. All three continue to be supportive of risk assets. The Presidential Election is now about a month away. Polling suggests a very tight race that likely will come down to the wire. We expect some level of heightened election volatility. As long as credit trends remain strong and supportive, which they have all year, we would view any volatility and associated market weakness as a buying opportunity and a pause that refreshes.

Clark Capital’s Bottom-Up, Fundamental Strategies

A positive inflation trajectory, the Federal Reserve’s 50 basis point rate cut, and China stimulus broadened the market rally to include dividend-based strategies and value-oriented sectors. Six of the nine S&P style boxes made all-time highs, and most sectors were positive led by Utilities and Consumer Discretionary. Market leadership reversed from long- term trend leaders Technology and Communications to rate sensitive, small-cap and defensive sectors. After reaching new market highs in September, seasonal trends suggest defensive sectors could continue to perform well leading up to the Presidential Election.

ECONOMIC DATA

Download Market Recap