As I sit down to type a review of the 3rd quarter equity markets on the first day of October, it strikes me what is currently going on around us: a good portion of the Carolinas is under water, Iran is lobbing ballistic missiles into Israel, and all major east coast and gulf coast ports are shut down due to a union strike. And that’s just today’s news – we haven’t even touched on politics yet!
During the quarter, we saw the current President of the United States drop out of the election, while his opponent, a former President of the United States, survived two separate assassination attempts. Never mind the large percentage of Americans fearing the end of the Republic, if “the other side” wins the election in November.
Despite all these negative news stories hitting headlines, major stock indices are at or very near all-time highs as the 3rd quarter ended. How did the markets stay near all-time highs in the middle of all this mayhem?
It is important to remember that stock prices adjust to the economic impact of an event, not the emotional impact. Horrible news headlines do not always translate into horrible stock performance.
There are times when the disconnect from current headline news and stock market performance seems unusually wide, and this is one of those times. It is difficult to watch news stories of human disaster followed by a headline about stocks reaching all-time highs.
NVIDIA
The solid returns in the 3rd quarter came with plenty of volatility. Some of that volatility was provided by Nvidia, the most talked about stock of the past two years. Nvidia was slightly down for the quarter, but what a wild ride it was. The stock declined by 27%, gained 31%, lost 21% and finished the quarter with a 20% gain. You can see in the following chart how the volatility in this one stock influenced the entire S&P 500 over the past quarter.
NVIDIA VOLATILITY
THE LABOR MARKETS
The rest of the market volatility was not driven by any of the news stories that were mentioned earlier. Instead, the cooling labor market played a keyrole. A more balanced labor market has helped inflation continue to ease from its peak in the summer of 2022. The jobs report that was released in early August was so weak that it sparked concerns of a potential recession in the not-so-distant future. Subsequent economic data releases helped ease fears of a dramatic downturn, though the slowdown was significant enough for the Federal Reserve to start reducing interest rates by half a percent in September. These are the types of news headlines that move equity markets.
The idea that the Fed could engineer a soft landing for the economy has resurfaced, and most major indices closed the quarter very near all-time highs. We also started to see a rotation from the mega-cap growth stocks that have delivered dramatic returns over the past 18 months, to areas of the market that have struggled with the higher interest rate environment, specifically small- and mid-cap stocks, and value sectors.
SMALL-CAP EQUITIES
Many of these smaller stocks had already priced in a recession, and that hope that we might avoid a major slowdown allowed for some strong relative performance. The small-cap index had an incredible increase in value mid-July. The bad jobs report in early August took some of the shine off this beaten-up sector of the market, but it still finished with the strongest return of all domestic indices by the end of the quarter.
CORPORATE EARNINGS
I would argue that the most important determinate of stock prices is corporate earnings. When actual (and expected) earnings move higher, you can normally expect stock prices to move with those earnings.
This past earnings season was, by any measure, very good. Unlike the past several quarters, that strong earnings performance was not driven solely by mega-cap growth companies. Those value sectors of the markets, including utilities, financial and health care sectors, provided exceptionally strong year-over-year earnings growth. The stock performance from those sectors reflected that good news. And no sector of the market was happier to see interest rates move down than Real Estate, which also showed an impressive return for the quarter.
All three quarters of 2024 have provided equity investors with solid returns, but this last quarter was the broadest rally for stocks. The continued slow recovery out of China put more pressure on oil prices, subsequently the energy sector was the only economic sector that produced a negative return in the 3rd quarter.
LOOKING FORWARD
The most anticipated event of the 4th quarter will be the election. Traditionally, the end of a Presidential election is a good environment for equity markets, as some political certainty is established for at least 2 years. Markets gain a clearer sense of which economic sectors are likely to benefit based on which political party controls the White House, Senate and House of Representatives.
We are also eager to jump into 3rd quarter earnings season. This earnings season is not expected to be quite as robust as last earnings season, with an expected growth of 5.1% above the same quarter last year. It is the 4th quarter earnings season we are looking forward to. As of today, the 4th quarter earnings growth is expected to be over 15% stronger than same period of last year. If corporations are going to bring down their 4th quarter earnings forecast, they will most likely do it during the 3rd quarter. If we can make it through this next earnings season with full-year estimates still at current levels, we have an excellent chance of finishing this year with yet another positive return for stocks.
These earnings projections, however, may hinge on what changes the Federal Reserve makes during their two meetings in the 4th quarter. Weaker jobs data could prompt the Fed to lower interest rates in a more aggressive fashion the next several months, but that also could also force down corporate earnings. Be careful what you ask for.
On top of all that (natural disasters, domestic unrest, political uncertainty), the geo-political issues seem to be intensifying. Despite these concerns, it’s remarkable to see how resilient the markets have remained. Though uncertainty remains, the economy and the consumer are still humming along steadily, and most stocks are relatively affordable, making for a complex yet promising landscape ahead.
This content is part of our quarterly outlook and overview. For more of our view on this quarter’s economic overview, inflation, bonds, equities and allocations, read the latest issue of Macro & Market Perspectives.
The opinions expressed within this report are those of the Investment Committee as of the date published. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders or employees.