Market Navigator – October 2024 edition

Don’t fight the trend or the Fed

Two old adages on Wall Street are don’t fight the trend and don’t fight the Federal Reserve (Fed). These remain among two key pillars for today’s equity market.

Indeed, a trend in motion is more likely to continue than to reverse is an adaptation of Newton’s first law of motion. It is also a way to describe a bull market. In bull markets, the surprises tend to be to the upside, even while periodic setbacks against the primary uptrend should be expected. 

While September, like August, started off weak, the S&P 500 was able to “shake it off” to finish the month at a fresh all-time high. The S&P 500 has now risen in 10 of the past 11 months, has the best year-to-date return through September since 1997, and the strongest start to an election year going back to 1950.

Moreover, it has been a global affair, as the international developed markets and emerging markets, aided by China’s significant stimulus announcements in late September, each finished the month at 52-week highs.

Two old adages on Wall Street are don’t fight the trend and don’t fight the Federal Reserve (Fed). These remain among two key pillars for today’s equity market.

The positive market trend is supported by the most aggressive global monetary easing cycle underway since the pandemic. Not only did we receive a super-sized rate cut from the Fed, but the central banks of the top three economies— the U.S., China, and Europe—are now all in easing mode. Indeed, the don’t-fight-the-Fed mantra is expanded to don’t fight global central banks.

This policy support is occurring at a time when lower crude oil and gasoline prices are also providing stimulus to consumers around the globe.

Recent benchmark revisions also indicate that U.S. consumers have more money socked away in savings than previously believed, and lower interest rates are already gradually filtering their way into lower borrowing costs. That said, monetary stimulus is occurring partly to help stem a further cooling of the economy as inflation rates have progressed toward pre-pandemic levels.

Where to next?

Historically, market volatility tends to lift heading into the election as anxiety and uncertainty build, and there is often some type of October surprise along the way. After the election, the market has traditionally tended to see a relief rally as the outcome becomes clear.

Even with the potential for some market hiccups along the way, the good news is the fourth quarter has historically skewed positively.

• Since 1950, the final three months of the year for the S&P 500 have averaged a price return of 4.3% with gains 80% of the time.
• During the six election years when the market was up over 10% through September, it added to its gains by year end each time.

History is important, but only a starting point, and other factors—such as the direction of the economy, interest rates, earnings, geopolitical issues, and the recent strike by U.S. dockworkers—collectively will have an outsized impact on the direction of the markets. Indeed, our work strongly suggests elections matter, but other factors in aggregate matter more.

Still, the weight of the evidence suggests the primary market uptrend should be given the benefit of the doubt and remains supported by solid corporate profits, which are at record levels, alongside global policy support, and a cooling but still resilient domestic economy. Indeed, we are staying on the side of the primary trend supported by global monetary easing.

Tactical outlook & updated view on emerging markets

From a global tactical asset allocation perspective, we remain overweight equities, neutral fixed income, and underweight cash as short-term interest rates move lower.

Within equities, we are currently maintaining our U.S. and large cap bias. That said, this month we are upgrading our view of emerging markets one notch.

• We first downgraded emerging markets (EM) to less attractive in our House Views in June 2021. Since then, EM has underperformed the S&P 500 by more than 50%.
• However, China’s market, which now represents about 28% of the EM index, has unleashed its most aggressive stimulus program since the pandemic to support an economy which has been broadly under pressure, a debt-laden property market, and to provide relief to domestic consumers and the stock market.
• We often say when investor expectations are low, a little good news goes a long way. And in the case of the Chinese stock market, expectations were extremely low with the market down more than 50% from its 2021 peak and investors positioned lightly. Thus, the unexpected and well-timed government stimulus measures sparked a 30% rally since the mid-September lows.
• The Chinese government appears committed to supporting its stock market, at least in the near term, and given how pervasive the negativity had been and how under owned the market was, the rally likely has further to go in the short term.
• For context, even with the recent rebound, China’s market is still more than 40% below its 2021 peak.
• From a longer-term perspective, the challenging structural backdrop for China will likely persist, including debt, demographic, and deglobalization trends. Moreover, as China has been more focused on social issues, corporate profits have stagnated for the past decade. The anti-corruption campaign and crackdown on companies continues. And with a less friendly business backdrop, foreign direct investment has turned negative for the first time since the data was published in 1998.
• Although the latest government measures should boost domestic sentiment and markets, it seems less likely that foreign direct investment will pick up in a meaningful way or that the movement by multinational companies to diversify businesses outside of China will change given the rules of engagement for doing business can shift overnight. The upcoming U.S. election and the future of tariffs will also have an impact.
• Still, on a net basis, government intervention with its support of the stock market is likely to bring further investor inflows into the broader EM complex. Relative EM valuations also remain on the lower end of the range over the past decade. Thus, the evidence has shifted near term, and we are shifting with it.

Within the U.S. we maintain our bias for large caps relative to small caps for now. Small caps are a greater beneficiary of the reduction of short-term interest rates given these companies tend to hold more variable-rate debt, but we are waiting to see improvement in relative earnings and price trends before shifting our position from neutral.  The upcoming earnings season for the large cap technology sector will also be key to positioning.

On the fixed income side, the good news is bonds are acting like bonds again, which historically have tended to do well during Fed easing cycles. We still see an opportunity for investors that are heavily in cash to potentially move some funds into high quality short-term bonds to reduce reinvestment risks. On the other hand, the 10-year U.S. Treasury yield has come down sharply, now trading closer to 3.75%, which appears slightly rich, and we would be patient for a better opportunity to extend duration.

Finally, we still see diversification benefits in holding modest positions in gold and commodities given fiscal imbalances and heightened geopolitical risks. 

As always, we will continue to follow the weight of the evidence and keep you informed as our views evolve.