It has been quite an eventful two years. In October 2022, we wrote to you during a bear market in both stocks and bonds. Inflation was nearing 8%, and the Federal Reserve had increased interest rates by 3% in just six months, with more hikes on the way to combat rising prices. Recession predictions were common, but so far, it hasn’t happened. As we said back then, “Capital markets do not collapse under their own weight but are driven by fundamentals. And the fundamentals of the economy are pretty good.” That still holds true today.
Sentiment vs. Reality
Before diving into the fundamentals and market results, let’s talk about sentiment. Kyla Scanlon, an economic vlogger, coined the term “vibesession” in 2022. This describes the gap between economic data and how people feel about the economy. We’ve definitely been in a “vibesession.” Consumer confidence has been low since the early days of the COVID-19 pandemic, even hitting a 55-year low in mid-2022.
However, the actual data tells a different story:
- The latest jobs report exceeded expectations with 245,000 new jobs.
- The unemployment rate dropped to 4.1%.
- September’s inflation rate was 2.4%, the lowest since early 2021.
- The Federal Reserve started lowering interest rates in the third quarter, cutting by 0.5%.
- Over the last five years, the U.S. economy has outpaced other G-7 economies (Canada, Japan, UK, EU, and Germany).
- The U.S. stock market hit 47 new highs as of October 19, 2024.
Why Aren’t We Feeling Better?
Unemployment is low, inflation is normalizing, growth is solid, and the stock market is hitting all-time highs. So why aren’t we feeling great? Here are a few reasons:
- The ongoing conflicts in Ukraine and the Middle East may be escalating.
- It’s an election year, and with that comes doomsday rhetoric from both political parties.
- Stock market volatility has been ticking higher since summer. The VIX index, which measures volatility, has spiked three times since midyear.
- Historically, August to October can be volatile months for the stock market.
These concerns are valid but not tied to the economy’s fundamentals. We believe the biggest factor affecting sentiment is the upcoming election. However, we stand by our view that federal elections don’t have a direct impact on our portfolio strategies. Adjusting your investments based on election outcomes can lead to mistakes. We’ve seen this play out more than once.
U.S. Stock Market Update
The U.S. stock market continued hitting all-time highs in the third quarter, driven by lower interest rates, improved inflation data, and solid job gains. All sectors performed well, except for a slight decline in Energy stocks. The S&P 500 gained 5.9% for the quarter and is up 21.6% for the year through September 30, 2024.
We are closely watching the concentration of a few big companies in the market. The “Magnificent 7” now makes up 31% of the market index, driving a large share of returns. Last year, these companies contributed 63% of the market’s performance, and this year it’s 45%. Historically, this level of concentration doesn’t last. It’s likely that these companies will start to underperform compared to the broader market. Managing risk means avoiding overexposure to any one company, and we believe diversification is more important now than it has been in the last decade.
Bond Market Performance
The bond market had a strong quarter. The Bloomberg U.S. Aggregate Index gained 5.2%, driven by cooling inflation and the Fed’s first interest rate cut in over four years. The yield curve, which measures the difference between short-term and long-term bond rates, is also returning to normal. The 10-year bond yield is now higher than the 2-year yield, which is another indicator of a healthy economy.
Reflecting on Bear Markets
Market downturns happen, and they can be hard to predict. In October 2022, we made three key points about bear markets:
- They end – The bear market ended around the time we wrote that letter.
- Expected returns increase – On average, markets gain 22% in the first year and 37% in the first three years after a bear market. As of today, the market has returned 63% since the October 2022 low.
- Prices recover and set new highs – In 2024, the market has set 47 new all-time highs.
Our investment strategy is designed to handle these fluctuations. As markets have surged over the past few years, we’ve reduced some holdings. Long-term clients might face higher capital gains taxes this year, but this is a smart approach when positions become too large or their fundamentals weaken.
Looking Ahead
If your financial situation has changed or you have questions about year-end tax planning, please reach out. We look forward to speaking with you.
Sources:
U.S. Department of Commerce, October 4, 2024
Yahoo Finance, October 16, 2024
Nasdaq, October 21, 2024
