With inflation cooling and central banks cutting rates, the options available for investors to build diversified portfolios are stronger than they have been for much of the post-Covid period.
The third quarter of 2024 ended with healthy returns across most major asset classes, despite several bouts of market volatility. A combination of weaker US economic data, an interest rate hike from the Bank of Japan and thin summer liquidity saw stocks hit particularly hard in early August. However, the long-anticipated start of the Federal Reserve’s rate cutting cycle in September, along with a less hawkish tone from Japanese policymakers and new stimulus in China, helped to soothe investor concerns and support a strong rally in stocks into quarter end.
Developed market equities delivered a 6.5% return over the period. The parts of the stock market that had previously suffered most from high interest rates generally outperformed, with small caps delivering 9.5% and global REITs returning an impressive 16.2%. Conversely, growth stocks gave up some of their recent outperformance but remain up more than 20% year to date.
Fixed income markets were buoyed by the prospect of lower rates, with the Barclays Global Aggregate index returning 7.0% in the third quarter. Government bonds and credit both delivered solid returns, while emerging market debt rallied by 6.1% over the quarter, taking it close to the top of the charts for fixed income sector performance year to date.
Commodity performance was much more muted, returning just 0.7% over the quarter. Amid growing concerns around the health of the global economy, Brent Crude oil prices fell by 17%, although gold did rally to new all-time highs.
14 months on from its last interest rate hike, the Federal Reserve (the Fed) kickstarted its cutting cycle with a 50 basis point (bp) move in September. With the unemployment rate having drifted up from a low of 3.4% in April 2023 to 4.2% today, Fed officials have now made it clear that they do not welcome any further weakening in the economy and are keen to quickly move interest rates back to less restrictive levels. Later in the month, the Fed’s more circumspect view on the economy was vindicated by the largest monthly decline in consumer confidence in over three years.
A comparison of market pricing for future interest rates at the start and end of the third quarter demonstrates how the rate outlook is perceived to have shifted. On 30 June, market pricing saw US interest rates reaching 4.4% by the middle of 2025. Now, investors believe that rates are more likely to hit 3.2% over the same period.
With inflation cooling and activity relatively muted, other western central banks also deemed it appropriate to cut rates. 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 bp cut at its August meeting.
The shift in investors’ expectations for interest rates helped government bonds to perform strongly. US Treasuries returned 4.7%, while European sovereigns returned 4.0% over the quarter. UK Gilts were somewhat of a laggard, returning 2.4%. A tighter labour market in the UK is resulting in persistently elevated wage growth, forcing the Bank of England to be somewhat more circumspect about the pace of future easing.
Credit also performed strongly. Investment grade (IG) credit spreads ended the quarter marginally lower, with quarterly returns of 6.3% bringing year-to-date returns for the sector back into positive territory. High yield spreads also tightened marginally, helping the sector to return 5.3% in the US and 3.5% in Europe.
In equity markets, Asia ex-Japan was the top performing major region, returning 10.6% over the quarter. Having treaded water for much of the quarter, Asian stocks rallied strongly towards the end of September after Chinese policymakers announced a raft of new stimulus measures. While many of these measures have been seen in isolation over the last year, such as cuts to interest rates or reduced downpayment requirements for home purchases, the coordinated nature of September’s announcement was the clearest signal yet that Beijing stands ready to support the Chinese economy and markets.
Elsewhere in Asia, Japanese stocks found themselves at the other end of the rankings, falling by 4.9%. The Bank of Japan’s July rate hike and comments from Governor Ueda that guided towards further rate hikes ahead were almost immediately followed by a very weak US labour market print. As interest rate differentials narrowed between the US and Japan, the Japanese yen appreciated sharply alongside an abrupt unwind of many “carry trades” that were reliant on cheap Japanese borrowing costs. A more reassuring tone from BoJ officials later helped Japanese stocks to pare losses, but the market still ended the third quarter in the red.
European equity returns were more muted, with markets in the UK and Europe ex-UK delivering 2.3% and 1.6% respectively. Economic data reinforced the sluggish nature of the eurozone recovery so far this year, with Germany’s reliance on manufacturing acting as a particular drag amid both weak demand from China and rising competition from cheaper Chinese exports. UK data has generally been more upbeat so far in 2024, although consumer confidence did fall in September in advance of October’s UK budget announcement.
The S&P 500 continued its long march higher, returning 5.9% over the quarter. Encouragingly for equity investors, there were signs of the long-anticipated “broadening out” of returns finally starting to play out. US value stocks outperformed their growthier counterparts by 7% points, while small cap stocks rallied in anticipation of lower interest rates ahead.
Another strong quarter across asset classes leaves many parts of the financial markets sitting on double digit year-to-date returns. For multi-asset investors, perhaps the most significant takeaway from this summer is the shift in the outlook for stock/bond correlations. With inflation having returned to tolerable levels, central banks once again stand ready to support the economy via lower interest rates in the event of a shock to growth – as was evident in the midsummer slump in risk assets, when a sharp fall in bond yields helped to offset equity losses. There will likely be more volatility ahead, with November’s US election one of several potential catalysts, but the options available to investors looking to build resilient portfolios are now stronger than they have been for much of the post-Covid period.