Quarterly Market Update

Following five consecutive monthly decreases in CPI data, US inflation continued to see meaningful progress with the August CPI print registering a 2.5% YoY increase, the smallest annual increase since February 2021.

Coupled with supportive developments on the labor marker front, with unemployment rate in August at 4.2%, this backdrop armed the Fed with the confidence to deliver a 50-basis-point rate cut — its first in this economic cycle. The magnitude of this cut was in line with market expectations which had shifted from 25 bps earlier in the quarter.

Markets experienced a sharp-sell-off in early August, with the S&P 500 selling off 6.1% in just 3 days but eventually this proved to be short lived as the S&P 500 moved back to previous highs in less than 8 days. Following this episode equities maintained their strengths throughout the rest of the quarter, supported by easing inflation data and signs of a clear rate cut by the Fed in September. Looking under the hood, markets portrayed a different story compared to the “more of the same” narrative from previous quarters, when US mega-cap tech stocks lead the charge.

In fact, Q3 saw both sector and style rotation as previous winners started to lag, albeit to different extents. This was particularly noticeable in small-cap value¹ vs large-cap growth² space, with the former increasing by 10.2%, while the latter posted returns of 3.2%.

This differs from Q2 when small-cap value dropped 3.6% and large-cap growth gained 8.3%.

From a sector perspective during Q3, Utilities led the rally gaining 19.4% followed by Real Estate and Industrials with returns of 17.2% and 11.6%, respectively.

Energy was the only sector in red, down 2.9%. As a result of these sectoral rotations, after 2 quarters of underperformance in Q3 the S&P 500 Equal Weight returned 9.6%, outperforming its market-cap-weighted counterpart returning 5.9%. Is the market finally starting to take stock of overconcentration risks? Time will tell.

Internationally, Developed Markets³ (DM) rallied 8.1%, driven by Japan and Canada returning 5.7% and 12.0% respectively. Emerging Markets⁴ (EM) equities advanced by 8.7% over the quarter led by China (+23.5% over the quarter) and its announcements of new stimulus policies in the coming months.

Looking at fixed income, treasury yields fell during the quarter in anticipation of the Fed’s interest rate cut. By the end of the quarter, 2-year Treasury yields decreased by roughly 110 basis points (bps) to 3.7%, while the 10-year Treasury yield fell by 56 bps to 3.8%. The spread between the 10-yr and the 2-yr yields turned positive in Q3, for the first time in 26 months.

For the quarter, fixed income markets rallied on the back of lower rates as markets became more confident in Fed’s ability to stabilize the economy while controlling inflation. In EM, Latin America was a notable contributor amidst both tightening spreads and rate cuts by the central banks in the region.

CWB portfolios saw positive returns in Q3 2024:

• Portfolios with higher equity exposure posted higher returns, as the asset class performed well over the quarter.
• Portfolios with higher exposure to small- and mid-cap and value equities gained higher returns as small caps led the rally in the quarter.
• In the US, small-cap outperformed large-cap by 3.2% (Russell 2000 Index rose 9.3% while the Russell 1000 gained 6.1%), driven by the broadening out theme.
• In fixed income, Global Bonds⁵ returned 4.2%, with international rates falling during the period following rate cuts from the Bank of England, the European Central Bank, and the US Federal Reserve.
• US Investment Grade Bonds⁶ returned 5.2%, while municipal bonds⁷ saw a return of 2.7%. High Yield⁸ returned 5.3%, as investors appeared to be more comfortable assuming CCC credit risk partially due to the belief that lower borrowing costs may improve credit fundamentals.

Given the combination of a healthy US economy, declining inflation, resilient labor market, and easing monetary policy, the market has posted strong performance so far this year. While we expect to see some of these trends to continue into year-end, volatility remains elevated amid the upcoming US elections and the ongoing geopolitical issues.

At the time of writing Fed officials are penciling in additional rate cuts in the two remaining meetings this year (November and December) based on their latest projections. Historically equity markets generally perform well during easing cycles, and as we head into Q4 we expect additional rate cuts to continue feeding the current ‘broadening-out’ theme.

Small- and mid-cap companies with solid fundamentals and relatively low valuations may continue to benefit from lower borrowing costs, potentially narrowing the gap to their large-cap counterparts. In Fixed Income, additional rate cuts could continue to drive down short-term yields more than the long-term yields, sustaining recent dynamics towards an upward sloped and progressively steeper yield curve.

While we anticipate volatility to persist through year-end and despite the uncertainties ahead, we believe staying fully invested and maintaining a long-term focus is key. Ultimately, time in the market and not timing the market is what drives wealth creation in our ever-changing market environment.

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