08 Oct 2024
The market gets its cut
After projecting Fed cuts incorrectly and often for well over a year, market participants finally got their hoped-for reduction in interest rates as the Fed lowered its target by 50 basis points. And with the Fed’s preferred inflation gauge, the PCE Index, showing a gain of just 2.2% in the 12 months ending in August, they are closing in on their 2% goal. However, the continued strength in the jobs market has dampened expectations for another large cut, with the futures market indicating an 88% chance for a 25-point cut in November.
On the jobs front, initial jobless claims dipped at month end, job openings experienced an uptick, surpassing 8 million once again, and layoffs and voluntary resignations both edged lower. The September jobs report showed that 254,000 jobs were added during the month, blowing past expectations of 150,000, the unemployment rate declined to 4.1%, and average hourly earnings accelerated by 4% year-over-year, ahead of consensus (+3.8%) and the prior month (+3.9%). This has contributed to economists continuing to revise their 2024 GDP forecasts higher, with the latest reading coming in at 2.6% (Bloomberg). Thankfully, the dockworkers strike ended just three days after it began; otherwise, it’s likely that those GDP estimates would have started to come down.
Curiously, despite record corporate earnings and a solid economic picture, the share of CFOs who say that now is a good time to take risk has fallen to just 12%, down from a high of about 65% in 2021, according to a survey from Deloitte. Perhaps that is related to election uncertainty, which, fingers crossed, should be resolved by January 20, 2025, we all hope.
What happened in the markets during the quarter?
EQUITIES: REITS AND SMALL CAPS SHINE
Rate cuts by several central banks helped REITs and global small caps achieve healthy gains. REITs advanced by almost 16%, international small caps returned 11.1%, and U.S. small caps ended higher by 9.3%. Emerging markets (+8.7%) and international large caps (+7.3%) also performed well, beating the S&P 500®, which managed to grind higher by 5.9% even though Nvidia, Microsoft, Amazon, and Alphabet were all down for the quarter. U.S. investors’ exposure to foreign equities benefited from a falling dollar, as the currency impact added a whopping 644 basis points to the total return for international large caps.
From a factor perspective, high dividends and low volatility performed exceptionally well, while momentum and growth struggled. In that environment, utilities were the big sector winner, advancing by 18.7%, with financials and industrials both adding about 11%. Tech firms gained a modest 1.6%, with semiconductors losing ground, and energy shares brought up the rear with a loss of 3.0% on falling oil prices.
As earnings season begins to ramp up, 3Q European earnings growth is expected to outperform the U.S. for the first time in a couple of years (Charles Schwab and I/B/E/S), but the U.S. earnings picture looks solid, nonetheless. S&P Global reports that corporate earnings in the third quarter are expected to set another record, with a 3.6% increase over 2Q 2024 and a 15.7% increase over 3Q 2024. For the entire calendar year, earnings are expected to increase by almost 11%, and in 2025, earnings should see another 16% improvement.
BONDS: SOLID RETURNS ON FALLING RATES
The bond market advanced by 5.2% over the quarter, as the yield curve moved lower across all maturities and steepened. The yield on the 10-year Treasury fell by 55 basis points, and the 1-year to 3-year section of the curve fell by about 1%. Duration paid off nicely, with long-term Treasuries advancing by 7.8%. Credit also rewarded investors, with high-yield bonds gaining 5.3% and investment-grade corporates increasing by 5.8%. At this point, high yield spreads are about as low as they’ve been since before the GFC, suggesting that meaningful appreciation from here is unlikely, something that is reflected in our return assumptions for the asset class and our overall positioning.
COMMODITIES: METALS UP, ENERGY DOWN
Commodity prices rallied by almost 5% in September to end the quarter up 0.7%. China’s stimulus plans gave industrial metals a boost, and rate cuts from numerous central banks helped push precious metals higher. Gold was up about 13% for the quarter, while copper advanced by 4.1%. Sugar and coffee futures gained 10.2% and 22.8%, respectively, on unfavorable weather conditions, and agricultural commodities as a group returned 3.7% in the third quarter. And the energy complex continued to struggle even as the ongoing war in the Middle East intensified, pushing prices off the lows for the month. Oil prices fell by about 12% for the quarter, and OPEC has been warning that oil prices will go as low as $50 a barrel if its members don’t stop cheating on production quotas.
How are Frontier strategies positioned?
ALLOCATION CHANGES
Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Multi-Asset Income, and Faith-Based Strategies, and the additional difficulties of properly conveying how those asset allocation changes flow through to trade-level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.
Focusing on our Core Strategies relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. small caps, emerging market equities, managed futures, floating rate loans, and cash/short-term bonds. We are generally underweight U.S. and international large-cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will occur. As was the case last month, because of the continuing decline in return expectations for cash/short-term bonds, at the beginning of October, our asset allocation models experienced reductions in managed futures, floating rate notes, and cash, with corresponding increases in TIPS and high-quality bonds.
The return expectation for international small caps has now surpassed that for emerging markets and tops all asset classes. And after a year of strong performance for both equities and bonds, return expectations have moved lower across the board compared to twelve months ago. The one exception is for commodities, which have seen a slight improvement but remain in negative territory. Floating rate and high yield bonds have essentially the same return expectation at this point, ahead of all other fixed income sectors, but relative to the past 20 years, TIPS sit nearest to the top of their range.
PERFORMANCE ATTRIBUTION
Thanks to a massive rally in Chinese equities on announced stimulus plans, emerging market equities finished the quarter on a high note, and Frontier’s overweight exposure in many of our strategies benefitted as a result. Our positioning in international and U.S. small caps was also additive, as small caps outperformed large caps around the globe. Long-term Treasuries, which led all fixed-income sectors, were a bright spot, as were our underweights to commodities. Negatively impacting relative performance was our underweight positioning to REITs, which were the best-performing asset class during the quarter. In addition, our managed futures exposures detracted from absolute performance, ending in the red, and our overweights to leveraged loans in certain strategies, while positive contributors trailed other fixed-income investments, hurting relative returns.
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Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Growth | S&P 500 Growth | Measures the performance of the large-capitalization growth stocks in the U.S. equity market. |
| U.S. Small Cap Growth | S&P 600 Growth | Covers roughly the small-cap growth range of American stocks, using a capitalization-weighted index. |
| U.S. Infrastructure | S&P Global Infrastructure | A stock market index that tracks the performance of 75 of the biggest publicly listed companies in the global infrastructure industry. |
| International Developed Equity | MSCI EAFE | An equity index which captures small-cap representation across 21 Developed Markets countries around the world, excluding the U.S. and Canada. |
| Chinese Equity | MSCI China | Captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). |
| Global Equity | MSCI All Country World | A stock index designed to track broad global equity-market performance |
| Emerging Market Equity | MSCI Emerging Markets | Captures large and mid-cap representation across 24 Emerging Markets (EM) countries. |
| Investment Grade Corporates | Morningstar US Corporate Bond | Measures the performance of fixed-rate, investment-grade USD-denominated corporate bonds with maturities over one year. |
| High Yield Bonds | Morningstar U.S. High Yield Bonds | Measures the performance of USD-denominated high-yield corporate debt. It is market-capitalization weighted. |
| TIPS | Morningstar US TIPS | Represents inflation-protected securities issued by the U.S. Treasury. |
| Leveraged Loans | S&P / LSTA U.S. Leveraged Loan 100 | Designed to reflect the performance of the largest facilities in the leveraged loan market. |
| Long-Term Treasuries | Morningstar US 10+ Yr Treasury Bond | Measures the performance of fixed-rate, investment-grade USD-denominated Treasury bonds with maturities greater than ten years. |
| Municipal Bonds | Morningstar US Municipal Bond | Measures the performance of fixed-rate, investment-grade USD denominated tax-exempt debt issued by U.S. state, U.S territory, and local government entities with maturities greater than one year. |
| REITS | FTSE NAREIT Equity REIT | A free-float adjusted, market capitalization-weighted index of U.S. equity REITs. |
| Commodities | Bloomberg Commodity | Broadly diversified index that allows investors to track commodity futures through a single, simple measure. The DJ-UBSCISM is composed of futures contracts on physical commodities. |
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