With U.S. inflation on the decline, the Federal Reserve lowered short-term interest rates.
The Federal Reserve’s preferred inflation measure, the Core PCE deflator, has fallen to 2.7%, moving steadily towards the 2% target. This improvement allowed the Fed to reduce the overnight Fed Funds rate by half a percentage point. Two-year U.S. Treasury yields have decreased from 4.2% at the start of the year to 3.6% currently. Longer-term maturities now offer higher yields than short-term instruments, reversing the recent trend. Given the uncertainty surrounding future rate changes, we are maintaining a balanced exposure to both short and intermediate-term fixed income securities.
Economic growth remains steady.
The U.S. economy continues to show resilience, with real GDP (Gross Domestic Product adjusted for inflation) growing by 3% over the past year. Consumer spending, which accounts for 68% of GDP, remains strong. Currently, there are few indicators suggesting an imminent risk of recession.
Above-average stock returns continued into the third quarter.
The third quarter saw emerging equity markets outperform developed international markets, with the MSCI EM index returning 8.7% compared to the MSCI EAFE index’s 7.3%. Both surpassed the broad U.S. stock market, which returned 6.2% (Russell 3000 index). This performance marks a shift from the U.S. market’s dominance during the first half of the year.
A new group of U.S. stocks drove returns in the third quarter.
In last quarter’s Commentary, we noted that it was unlikely that the positive momentum in large tech stocks such as Nvidia would continue indefinitely. This proved to be the case, as small company stocks (Russell 2000 index) outperformed, returning 9.3% compared to 5.9% for the largest companies (S&P 500 index). In another reversal of past trends, stocks classified as “value stocks,” those more attractively priced given their earnings and cash flows, returned 9.3% (Russell 1000 Value index), while “growth stocks,” many of which are well-known technology companies, returned 3.1% (Russell 1000 Growth) for the quarter.
We are not changing our investment strategy in advance of the U.S. election.
Despite the political rhetoric, individual politicians typically have minimal impact on financial markets. Even presidential influence is limited, as tax code and government spending decisions ultimately rest with Congress. Given the uncertainty surrounding which party will control the Senate, House of Representatives, and White House, there is no reason to change investment strategies at this time.
In uncertain times, diversification is the best strategy.
There are numerous global concerns to consider, including China’s economic stimulus efforts to combat deflation, ongoing wars in Europe and the Middle East, and unrest in Africa. While these known uncertainties are factored into financial markets as efficiently as possible, it’s the unforeseen events that pose the greatest risk. To protect wealth against these “unknown unknowns,” diversification remains the most effective strategy. Our primary focus is on minimizing the impact of these global concerns on our clients’ long-term financial goals.
* All index returns are in U.S. Dollar terms