The third quarter has come to an end, and it has left many questioning if this is finally when the metaphorical dam breaks. After a rapid ascent in the first half of the year, markets have felt the first sign of turbulence as the S&P 500 finished the quarter down 3.65%. The Nasdaq underperformed, falling 4.12% while the Dow was down 2.62%. In fact, all major sectors fell except for energy, which has shown a nice recovery from its rocky start to the year. Treasuries were notably weaker as the yield curve continued to steepen, with the 10-year rising by nearly 90bps, reaching its highest level since 2007. This did help narrow the inversion between the 2Y and 10Y, however, which fell from a whopping 100bps to 50bps by the end of the quarter. The main thread of the market narrative was the Fed’s policy trajectory, as it has been much of the last year. The Fed decided to hold rates steady in September, and the terminal rate was little changed, but there seemed to be growing acceptance of the Fed’s higher-for-longer mantra, which was manifested in a September dot plot that showed median expectations for only 50bps in rate cuts for 2024 (vs the 100bp in the June edition). Of course, data can change, but it feels as if the sentiment on the rate environment has shifted, resulting in a weaker equity market.

The soft-landing narrative had grown in popularity over the past few months as data remained strong while inflation had reduced. Though recently, there seem to be rising concerns that could knock the economy off the “golden path” toward a soft landing. A spike in energy prices was seen as a major weight on consumers and a threat to the disinflationary narrative. There have also been worries about consumer impacts from the resumption of the student-loan payments. There remain vigorous debates about whether consumers’ pandemic savings had been exhausting and whether the consumer will stay strong. Furthermore, every quarter it feels like we experience world shifting events that are sure to rattle markets, and the past few months have been no different. It began with fear of the government shutdown, which still looms on the horizon as the 45-day band-aid wanes. However, equity markets largely have ignored these fears, as even if there is a small economic impact of a shutdown, it is typically quickly recovered. One potential area of impact could be around the Fed policy path, with some noting that the shutdown would delay economic data. Most recently, we have all seen the horrible atrocities coming out of Israel. The brutality that has and is taking place is indescribable. Despite the despair and empathy we all share, markets have been fairly unphased. While the situation is highly fluid and clearly volatile, longer-term impact remains unclear. The market has often shaken off geopolitical developments, but a big concern here revolves around the potential for the conflict to spread.

Perspective is key: despite the concerns, markets are still notably higher for the year, but it is always important to see what is driving the major indices. The S&P 500 has once again painted a much rosier picture than reality. Despite the 11.7% gain for the cap weighted index over the first 3 quarters, performance has still been dominated by the tech heavyweights, as the average stock is only up .3% YTD. In fact, the contribution from the 10 tech heavyweights has accounted for 100% of the YTD performance for the S&P. Dividend stocks continue to be out of favor, as the average return for a dividend yielding security of >1% is -1.2%, showing a strong favor for growth this year as opposed to last year, where value far outperformed. It is also important to acknowledge seasonality in the equity markets. Though they are not an indication of what will happen, historically, the third quarter is often the weakest period of the year. The good news: the fourth quarter is historically the best, with November and December showing the strongest performance, which could be a nice tailwind for equities.

This past week, I flew to New York to visit with Blackstone’s management team for two days of meetings. Blackstone holds over $1trillion in assets. They expressed their views on the current environment and what to look for moving forward. As the largest real estate holder in the world, and one of the largest issuers of private debt and equity, they typically have a strong sense of underlying economic headwinds and tailwinds, as well as potential opportunities that could be coming around the corner. When it comes to rates, they reiterated that terminal rate matters less than how long rates remain elevated. On average, there have been 8 months between the last rate hike and first rate cut, and Blackstone is betting this case will be even longer. This is likely to cause increased volatility, but investors who have long time horizons should lean into this volatility, buying on weakness in favorable sectors.

Ultimately, the US has experienced 16 recessions, and only 2 of them have resulted in soft landings. The odds are not in our favor, but it is also not inconceivable to believe it can happen. How the economy reacts to the slowdown will likely depend on the consumer. Thus far, in the face of rising credit card debt, higher interest payments, high inflation, and a drawdown in the covid era excess savings, the consumer has yet to pull back, and the consumer will likely define the recession. When it comes to equities, in an environment when multiples will likely compress, growth will be determined by a company’s ability to grow their earnings, which will be important to keep an eye on as we head into earnings season. While our team listens carefully to the firms at the top of the Wall Street food chain, we also know the importance of remembering that trying to predict the future is a fool’s errand. We have learned if we stay focused on proper diversification with a long-term perspective, we have a higher probability of winning over time.

John Webb 

Financial Advisor 
Pinnacle Asset Management
Raymond James Financial Services 

Kidd Private Wealth Group