Monthly Market Update – September 2024

Key Points

• GOING BIG – Investors were pleasantly surprised by the Federal Reserve initiating the first rate cutting cycle since 2020 with a jumbo-sized 50 basis point cut. Markets had been expecting a more typical 25 bps cut. It is only the third time in modern history that the Fed has started rate cuts with a 50 bps cut.
• RALLY OR RECESSION – A study of 10 rate cutting cycles finds that 4 of the 10 cutting regimes were associated with recessions while 6 were not. The research shows fairly clearly that forward returns will largely depend on whether the economy enters a recession (i.e., a hard landing) or avoids one (i.e., a soft landing). 
• UN-INVERTED – The yield curve (the difference between the 2-year and 10-year U.S. Treasury yields) had been inverted for a record 26 months but returned to its normal upward sloping form in September. The normalization of an inverted yield curve has been followed by a recession historically.
• MORTGAGE RATES AT 2-YEAR LOWS – The surprise decision by the Fed to cut rates by a half point appears to be having its intended consequence on mortgage demand. Mortgage rates ended September at the lowest level since September 2022. But don’t expect mortgage rates to fall back to their 3% generational lows. 
• CHINA FIRES STIMULUS BAZOOKA – China announced a massive stimulus blitz to arrest the steep decline in their economy and markets. They included interest-rate cuts, lower bank reserve requirements, lower interest rates on existing mortgages, and funding for companies to finance share buybacks.
• Q4 SEASONALITY IS STRONG – Election years tend to experience choppier markets, particularly in the weeks just before the election, but post-election, markets have shown a similar pattern of rallying into the end of the year as non-election years. The average fourth quarter return for U.S. stocks in presidential election years is +3.2%.

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of September 30, 2024. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

Much like August, September started off on the wrong foot for investors with a pullback over the first several days of trading. And also, like August, markets rallied throughout the remainder of the month to end September with healthy gains. Historically, September has been the weakest month of the year for the S&P 500 Index, but this year, it ended with a +2.1% total return and closed the month at an all-time high. That was the best, and only positive, September performance for U.S. stocks since 2019. But it wasn’t just U.S. stocks that rallied in September, virtually all major asset classes were up. Some of the same proximate causes led to the month’s early jitters, including soft August employment growth, disappointing construction spending, and weak manufacturing activity. But assets got a jolt from several catalysts that sent them higher as the month went along. Inflation reports in the second week of the month showed a continued moderation of pricing pressures, leading to speculation that the Federal Reserve (the Fed) may initiate the first rate cutting cycle since 2020 with a 50 basis point (bps, or 0.50%) cut rather than the typical 25 bps point cut. And the following week, on September 18, that was exactly what the Fed delivered. It was only the third time in modern history that the Fed had started rate cuts with a 50 bps cut. The previous two times were in 2007 and 2001, when the economy went into recession. However, the Fed maintains that the current economy remains resilient and expects a soft landing. The Fed’s projections show two more cuts of 25 bps in 2024 (one each at the November and December meetings, respectively) and 100 bps of cuts in 2025. It took a little time for markets to digest the Fed’s interest rate pivot but by the end of the week, markets powered higher. 

In the final full week of September, the market received some additional juice, this time from China’s central bank. On September 24, China announced a barrage of stimulus measures. Those included sharply reducing its reserve requirement ratio to the lowest level since the 2020 pandemic and cutting its short-term interest rate. They also took several steps to shore up the country’s debt-straddled property market, lowering existing mortgage rates and making purchases of second-homes easier. Chinese stocks soared on the news, but it also gave a big boost to emerging markets as well as U.S. stocks. The MSCI Emerging Markets Index led major asset classes in September with a +6.1% gain, thanks to the Chinese news. Other major central banks are also on the rate-cutting bandwagon. The European Central Bank delivered its second rate cut in September (taking interest rates to 3.5%), while the Bank of England embarked on its own easing cycle with a 25 bps cut at its August meeting. Among others, central banks in Hungary, the Czech Republic, Switzerland, Mexico, and Sweden all delivered rate cuts in September. 

With central banks across the globe delivering rate cuts, bond yields have been falling, and bond prices have been rising. The benchmark 10-year U.S. Treasury yield fell to its lowest level (3.6%) in 15 months before rebounding to end September down 13 basis points at 3.79%. That helped U.S. bonds return +1.3% in September and +5.1% for the third quarter. Non-U.S. bonds were up even more, returning 2.0% for the month and +8.5% for the quarter.

Two noticeable laggards in September were energy and the U.S. dollar. WTI Crude Oil fell more than -7% in September, and down -16.4% for the quarter, leaving it at its lowest level since March 2023. The U.S. Dollar Index was down nearly -1% for September and -4.8% for the fourth quarter, its first quarterly decline in four quarters and worst quarterly drop since the fourth quarter of 2022.

Looking forward, the next few weeks could be choppy with the U.S. presidential election upon us and increased political tensions in the Middle East as the conflict between Israel and Hezbollah intensifies. But with China injecting massive stimulus in the world’s second largest economy, the Fed and most other major central banks cutting interest rates, plus the seasonal strength that November and December typically bring, it remains difficult to be bearish.

Source: Bloomberg. Data as of September 30, 2024.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

GOING BIG

Usually, the surprises during an election year come in October. But investors were pleasantly surprised by the Federal Reserve (the Fed) on September 18 when they initiated a rate cutting cycle, the first since 2020, with a 50 basis point (bps, or 0.50%) rate cut. Markets were expecting a more typical 25 bps cut until just days before the Fed’s September meeting, when futures markets started pricing in the increased possibility of a larger 50 bps cut following weaker than expected employment data and housing reports signaled an increased risk of recession. It is only the third time in modern history that the Fed has started rate cuts with a 50 bps cut. The previous two times, in 2007 and 2001, the economy did fall into a recession. However, the Fed maintains that the current economy is resilient and expects a soft landing. Fed chairman Jerome Powell said the Fed is confident that inflation is moving to their 2% target. The Fed’s projections show two more cuts of 25 bps in 2024 (expecting one each at the November and December meetings) and 100 bps of cuts in 2025. As the chart below shows, the Fed was aggressively focused on combating stubborn inflation with 11 rate hikes over 16 months, then left it unchanged for more than a year. The pivot to an easing cycle with a half-point cut shows the focus has shifted to economic growth versus inflation as unemployment has ticked up and activity in the housing market has slowed.

Fed Cuts Rates by Half Percentage Point

Federal Funds Rate Target

Note: Chart shows midpoint of target.
Source: Federal Reserve, The Wall Street Journal.

RALLY OR RECESSION

An analysis by Goldman Sachs Investment Research identified ten rate cutting regimes since 1984. Studying historical analogs is helpful and can help set expectations for how markets may behave in the current environment, but it is important to note that the small sample size is statistically insignificant, and every economic cycle is unique. Acknowledging that the Goldman research finds that four of the 10 cutting regimes were associated with recessions (1990, 2001, 2007, 2020) while six were not. Goldman further classified those six non-recessionary cycles as “policy normalization” cuts (1984, 1989, 1995) or “growth scare” cuts (1987, 1995, 1998). The chart below shows the median performance in the one year before and one year following the first Fed rate cut, indexed to the day of the cut itself. For the S&P 500, stocks have appreciated ahead of the first cut as investors anticipate the policy pivot. Moreover, markets tend to rally further after the Fed actually starts to cut in the absence of recessionary conditions but tend to fall in an almost mirror-like pattern to the downside when the rate cuts are motivated by recession. The research shows fairly clearly that forward returns will largely depend on whether the economy enters a recession (i.e., a hard landing) or avoids one (i.e., a soft landing). By moving rates with an aggressive 50 basis point cut, Powell opened the door to speculation about whether the Fed is more worried about the economy than it is saying publicly. But Powell sounded bullish on the outlook for the economy, saying that the risks facing the economy are “roughly in balance,” and the rate cut “reflects our growing confidence that with an appropriate recalibration of our policy stance, strength in the labor market can be maintained.” And with GDP expected to be in the 2.5%-3.0% range this quarter, corporate earnings holding up well, retail sales still robust, and ISM services PMIs well into expansion territory, Powell and the Fed appear justified in their soft landing outlook.

Equities Tend to Rally After Fed Starts to Cut… as long as Recession is Avoided

S&P 500 performance before and after the start of rate cuts

Source: Goldman Sachs Global Investment Research, The Wall Street Journal.

UN-INVERTED

J.P. Morgan Asset Management recently highlighted that after 26 months of inversion, the yield curve, measured by the difference between the 2-year and 10-year U.S. Treasury (UST) yields, has returned to its normal upward sloping form. As shown in the chart below, historically, the normalization of an inverted yield curve has been followed by a recession. Indeed, prior to the last four recessions, the yield curve regained its positive slope after an extended period of inversion. That is a small sample size, though, and could be more coincidental than predictive. There are plenty of economic indicators that would argue against an impending recession. The prior recessions were born from either economic bubbles, unforeseen external shocks, or a combination of both. The upcoming U.S. election and/or elevated geopolitical tensions could disrupt the current economic expansion, but the services sector of the economy (which makes up the majority of economic activity) is robust and remains well into expansionary levels. Despite the change in status of the yield curve, the risk of some exogenous shock sparking a recession is unforecastable, and past recessions have been quite delayed before the recessions occurred. In 2019, 175 days passed between the universion of the yield curve and the recession, which was sparked by a global pandemic. In 2007, 287 days passed from the yield curve uninversion and recession, which was caused by a massive subprime mortgage crisis. In 2001, only 84 days passed from the yield curve uninversion and recession, but that came with the “dot.com” internet bubble stemming from the collapse of largely unprofitable companies at sky-high valuations.

Un-inverted: 10-Year Treasury Yield minus 2-Year Treasury Yield

After a record 764 days of inversion, the “2’s/10’s” curve has normalized

Note: shaded areas represent U.S. recessions.
Source: Federal Reserve Bank of St. Louis via FRED.

MORTGAGE RATES DOWN BUT NOT TO 3%

Signs of a cooldown in the economy, including the housing market, likely drove the Fed to deliver a larger-than expected half-point rate cut. And the surprise decision looks like it is having its intended consequence on mortgage purchases and mortgage refinancing. Mortgage rates ended September at the lowest level since September 2022. The average rate on the standard 30-year fixed mortgage fell to 6.14%. Still, mortgage rates remain roughly double what they were before the Fed started its hikes in 2022. And the era of ultralow 3% mortgage rates is unlikely to return anytime soon. Mortgage lender Fannie Mae predicted mortgage rates would fall to 5.7% by the end of 2025. Freddie Mac has forecast mortgage rates would “gradually decline” over the next few quarters.

Mortgage Rates Hit 2-Year Low, But Don’t Expect 3% Again

Mortgage Bankers Association (MBA) 30-year Fixed Rate Mortgage

Source: Bloomberg, Mortgage Bankers Association.

CHINA FIRES STIMULUS BAZOOKA

China’s economy has struggled mightily for the past two years. They had a delayed exit from the Covid-19 lockdowns, remain mired in deep and widespread real-estate downturn, and consumer and business confidence has been in the dumps. And when the world’s second largest economy is suffering, the rest of the world feels it. China is responsible for nearly 20% of world Gross Domestic Product (GDP), and an even larger share of world trade. With recessionary conditions that broad and for that long, the stock market was understandably depressed too. As shown in the chart below, the MSCI China Index fell from its all-time high of 16.74 on February 21, 2021, to 6.06 on October 31, 2022. That’s a crash of -63.7% over about a 20-month period. Of course, there’s been some up and down since, but as recently as September 11, Chinese stocks were still about -58% below the February 2021 all-time high. But on September 24, Chinese officials responded with a massive stimulus blitz meant to jolt the economy and markets. It’s the biggest stimulus package since the country’s response to Covid. The measures included interest-rate cuts by the People’s Bank of China (PBoC), China’s central bank, a lowering of bank reserve requirements to encourage lending, an easing of interest rates on existing mortgages and the equivalent of more than $100 billion in credit offered to brokers to buy sagging stocks or for companies to finance share buybacks. The PBoC also increased the share of loans it would cover to fund local governments’ purchases of unsold real estate inventory to 100% from 60%, a noticeable increase in the attempt to stem the property glut. As big as those numbers are, they are somewhat dwarfed by the size of the Chinese economy and may not amount to more than a short-term boost, given the deep structural problems that have led to the profound slump the Chinese economy is facing. In the first five trading days since the stimulus was announced, ending September 30, the Chinese stock market jumped +22% (in U.S. dollar terms), yet that still leaves it about -46 below its 2021 peak.

Stimulus Blitz Boosts Chinese Stocks, but they Remain -46% Off Peak

The MSCI China Index (shown in U.S. dollars terms)

Source: Bloomberg, MSCI.

Q4 SEASONALITY IS STRONG

We just flipped the calendar to the fourth quarter of 2024, and the election notwithstanding, that is typically a good thing for markets. As we show below, election years tend to experience choppier markets, particularly in the weeks just before the election. But post-election, markets have shown a similar pattern of rallying into the end of the year. Using Morningstar data, Blackrock calculations from 1926 to 2023 shows that despite some October jitters during election years, the average fourth quarter return for U.S. stocks in presidential election years is +3.2%. And those results tend to be robust across the market. History shows that 9 of the S&P 500 Index’s 11 sectors have typically risen in the fourth quarter of election years since 1992, according to analysis by CFRA Chief Investment Strategist Sam Stovall.

Markets are Historically Strong in Q4 Regardless of Elections

S&P 500 Seasonal Annual Return, 1976 – 2023

Source: Goldman Sachs Global Investment Research.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.

Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.