Global equity markets delivered their best third-quarter returns since 2020, as central banks began loosening monetary policy. Returns were positive across asset classes, geographies and styles. Falling rates also boosted fixed income, with the Bloomberg U.S. Aggregate Index returning 5.2%, its best third-quarter return in 30 years (Figure 1). Markets rallied throughout most of the quarter in anticipation of Federal Reserve (Fed) rate cuts, which finally came to fruition at the September 18 Federal Open Market Committee meeting.
Figure 1: Index Performance
In the third quarter, markets rallied across asset classes, geographies and styles
|
3Q24 |
Jul |
Aug |
Sep |
U.S. Equity |
|
|
|
|
Russell 3000® |
6.2 |
1.9 |
2.2 |
2.1 |
S&P 500® |
5.9 |
1.2 |
2.4 |
2.1 |
WisdomTree US Quality Div Growth |
7.1 |
2.3 |
3.0 |
1.6 |
MSCI USA Minimum Volatility |
9.2 |
3.7 |
4.9 |
0.4 |
S&P 500 Equal Weight® |
9.6 |
4.5 |
2.5 |
2.3 |
S&P 500 Value® |
9.1 |
4.7 |
3.0 |
1.1 |
S&P 500 Growth® |
3.7 |
-1.3 |
2.2 |
2.8 |
S&P MidCap 400 |
6.9 |
5.8 |
-0.1 |
1.2 |
S&P MidCap 400 Value® |
9.5 |
7.6 |
0.6 |
1.2 |
S&P MidCap 400 Growth® |
4.6 |
4.2 |
-0.7 |
1.1 |
Russell 2000® |
9.3 |
10.2 |
-1.5 |
0.7 |
Russell 2000 Value® |
10.2 |
12.2 |
-1.9 |
0.1 |
Russell 2000 Growth® |
8.4 |
8.2 |
-1.1 |
1.3 |
MSCI USA IMI/Real Estate |
17.0 |
7.7 |
5.3 |
3.1 |
International Equity |
|
|
|
|
MSCI ACWI Ex USA IMI |
8.2 |
2.5 |
2.7 |
2.7 |
MSCI World Ex USA |
7.8 |
3.1 |
3.3 |
1.1 |
MSCI World ex USA Quality |
5.7 |
1.6 |
4.2 |
-0.2 |
MSCI World Ex USA Value |
9.7 |
4.8 |
2.9 |
1.7 |
MSCI World Ex USA Growth |
5.9 |
1.5 |
3.8 |
0.5 |
MSCI World Ex USA Small Cap |
10.4 |
5.6 |
1.9 |
2.7 |
MSCI EM IMI |
8.2 |
0.2 |
1.6 |
6.2 |
Fixed Income |
|
|
|
|
Bloomberg U.S. Aggregate |
5.2 |
2.3 |
1.4 |
1.3 |
Bloomberg Municipal |
2.7 |
0.9 |
0.8 |
1.0 |
Bloomberg U.S. Corporate High Yield |
5.3 |
1.9 |
1.6 |
1.6 |
Bloomberg EM USD Aggregate |
5.8 |
1.8 |
2.1 |
1.8 |
Source: Morningstar Inc.; Data as of 9/30/2024
Most asset classes that lagged during the first two quarters of the year, finally turned a corner in the third quarter as headwinds from high inflation, elevated interest rates and U.S. dollar strength reversed course. Whether those trends are sustainable remains to be seen as markets enter a new paradigm of easing global monetary policy (Figure 2).
Figure 2: Global Central Bank Policy Rates
Global monetary policy easing underway, except in Japan
Source: Bloomberg L.P.; Data as of 9/30/2024
View accessible version
One notable market characteristic that changed in the third quarter — in part due to anticipated rate cuts — was the normalization of the spread between the 10-year and 2-year U.S. Treasury (UST) yields, often referred to as the 2-10-year UST yield curve. With the 2-10 curve inverted for more than two years, profitability among companies in the Financials and Real Estate sectors has been under considerable pressure (Figure 3).
Figure 3. 2-10Y UST Yield Curve, bps
Longest period of yield curve inversion finally ended in Q3
Source: Bloomberg L.P.; Data as of 9/30/2024
View accessible version
Key Theme Recap
“Catch-up” rally: Investor anticipation for Fed rate cuts began with the July 11 Consumer Price Index (CPI) report. Not only was the year-over-year growth rate lower than consensus expectations, but month-over-month growth was negative, a first since 2020. Markets initially reacted to the CPI report by rotating out of mega-capitalization growth stocks and into smaller-cap stocks. This was a clear break from the market dominance of a few, large tech companies over the preceding year. However, we believed then, and continue to believe now, that to see a sustained shift away from U.S. large-cap stocks, the earnings outlook for other asset classes needs to improve. One of the biggest challenges to broadening earnings growth is weak global manufacturing activity. Considering the two largest sectors within small- and mid-cap equities are Industrials and Financials, without an upturn in the global business cycle, we expect any performance rotation away from large-cap stocks will be short-lived.
Most central banks are now easing monetary policy: While the size of the Fed’s rate cut at 50 bps (versus the more widely expected 25 bps) came as somewhat of a surprise, the bigger surprise was the People’s Bank of China’s (PBOC’s) announcement of several policy rate cuts and pledges to stabilize China’s financial markets. With these actions by the Fed and PBOC, the Bank of Japan (BOJ) remains the only major central bank that has yet to begin easing policy. We expect loosening policy to become a tailwind for both financial markets and economic growth, albeit with a lagged effect.
Volatility likely to continue through to the U.S. election: Despite global monetary policy easing, market volatility returned in the third quarter. For example, on August 5, the CBOE Volatility Index (VIX) reached the highest level since March 2020 in reaction to a surprise interest rate hike by the BOJ (Figure 4). While the VIX recovered within two weeks, the brief, but sharp, market pullback reminded investors that global central bank action can still have a significant influence on investor sentiment in the short run, whether it be positive or negative. For example, the VIX futures contract that expires close to the U.S. presidential election on November 5 is priced more than 10% above the 10-year average, suggesting investors should continue to prepare for volatility amid election season.
Figure 4: VIX Daily High Price
The August volatility spike is a reminder of continued macro uncertainty
Source: Bloomberg L.P.; Data as of 9/30/2024
View accessible version
Which Asset Classes Led in Q3?
International Small-cap Equity
Our thesis: We believe in the long-term benefit of a small-cap premium for developed international markets. Unlike developed international large cap, small-cap companies are typically found outside core Europe and offer much stronger growth prospects, acting as the innovation engine for countries such as Japan, the U.K. and Canada.
What worked in the quarter: International small-cap equities benefited as major central banks around the globe began their easing cycles. The Bank of England (BOE), Bank of Canada (BOC) and European Central Bank (ECB) all lowered interest rates during the quarter. Additionally, fiscal stimulus packages in China boosted investor confidence that consumer demand will rebound.
Looking ahead: From a valuation and earnings growth perspective, we believe developed international small cap remains attractive relative to developed international large-cap equity, as it has much higher weightings in sectors with high growth potential.
U.S. Small-cap Equity
Our thesis: We believe in the long-term benefit of the small-cap premium and its associated growth prospects. As such, we maintain a slight overweight allocation to small cap.
What worked in the quarter: The beginning of the Fed’s interest rate easing cycle, as well as investor enthusiasm about the potential for an economic soft landing, fueled small-cap equities during the quarter. While every sector except Energy was up, Financials and Real Estate — the most interest-rate-sensitive sectors — led the rally.
Looking ahead: With a forward price-to-earnings ratio of 24.9 times (x), which is well above its long-term average of 21.4x, multiple expansion may be difficult for small-cap equities. However, if the U.S. economy can remain resilient, and the Fed continues to lower interest rates, we believe earning growth has the potential to lead the index higher.
Low Volatility Equity
Our thesis: Given the numerous, notable macroeconomic events during recent periods, we favor defensive stocks with low volatility characteristics, which we believe should provide downside protection during equity drawdowns.
What worked in the quarter: Around mid-quarter, volatility spiked to its highest level since early 2021, which benefited lower-beta stocks. While volatility fell from its early August highs, levels have remained well above those throughout the beginning of the year.
Looking ahead: While near-term concerns of a recession have fallen, volatility is expected to remain elevated due to geopolitical conflict, the upcoming U.S. presidential election and uncertainty regarding the forward path of Fed interest rates.
Which Asset Classes Lagged in Q3?
Core Fixed Income
Our thesis: Core fixed income tends to be the primary ballast in multi-asset portfolios given its broad diversification across Treasury, Corporate and Securitized markets.
What happened in the quarter: The Bloomberg U.S. Aggregate Index had its best quarterly performance of the year amid declining interest rates. The lower risk associated with fixed income contributed to its relative underperformance versus equity asset classes.
Looking ahead: Over the long term, we remain confident that core fixed income can still provide stability in portfolios and generate positive real total returns. In the near term, increased clarity on the path of interest rates should support returns.
High Yield Fixed Income
Our thesis: Over the course of a business cycle, we expect high yield (HY) to outperform core fixed income. Historically, the asset class has a stronger correlation with equity markets than the direction of interest rates. Thus, we believe the diversification benefit of HY is an important consideration for fixed income investors.
What happened in the quarter: HY underperformed as the Fed’s interest rate cut and improving economic data drove HY spreads lower.
Looking ahead: With the economy showing signs of achieving a soft-landing, HY issuers appear to have a better fundamental backdrop in which to roll over maturing debt. However, valuations continue to richen as HY spreads sit near cycle lows.
Emerging Market Debt
Our thesis: We remain constructive on emerging market (EM) debt as we believe the asset class offers better fundamentals and higher yields than developed markets. We also prefer U.S. dollar-denominated EM debt, which should provide an additional tailwind in periods of dollar strength.
What happened in the quarter: EM debt benefited from narrowing spreads and longer duration characteristics as multiple central banks cut interest rates. However, a weaker U.S. dollar weighed on returns.
Looking ahead: EM debt offers an attractive yield pickup; it has U.S. high yield-like characteristics, but with stronger underlying fundamentals relative to the slower growth prospects across the developed world. However, valuations now appear rich relative to other fixed income asset classes.
Accessible Version of Charts
In the third quarter, markets rallied across asset classes, geographies and styles
|
3Q24 |
Jul |
Aug |
Sep |
U.S. Equity |
|
|
|
|
Russell 3000® |
6.2 |
1.9 |
2.2 |
2.1 |
S&P 500® |
5.9 |
1.2 |
2.4 |
2.1 |
WisdomTree US Quality Div Growth |
7.1 |
2.3 |
3.0 |
1.6 |
MSCI USA Minimum Volatility |
9.2 |
3.7 |
4.9 |
0.4 |
S&P 500 Equal Weight® |
9.6 |
4.5 |
2.5 |
2.3 |
S&P 500 Value® |
9.1 |
4.7 |
3.0 |
1.1 |
S&P 500 Growth® |
3.7 |
-1.3 |
2.2 |
2.8 |
S&P MidCap 400 |
6.9 |
5.8 |
-0.1 |
1.2 |
S&P MidCap 400 Value® |
9.5 |
7.6 |
0.6 |
1.2 |
S&P MidCap 400 Growth® |
4.6 |
4.2 |
-0.7 |
1.1 |
Russell 2000 |
9.3 |
10.2 |
-1.5 |
0.7 |
Russell 2000 Value® |
10.2 |
12.2 |
-1.9 |
0.1 |
Russell 2000 Growth® |
8.4 |
8.2 |
-1.1 |
1.3 |
MSCI USA IMI/Real Estate |
17.0 |
7.7 |
5.3 |
3.1 |
International Equity |
|
|
|
|
MSCI ACWI Ex USA IMI |
8.2 |
2.5 |
2.7 |
2.7 |
MSCI World Ex USA |
7.8 |
3.1 |
3.3 |
1.1 |
MSCI World ex USA Quality |
5.7 |
1.6 |
4.2 |
-0.2 |
MSCI World Ex USA Value |
9.7 |
4.8 |
2.9 |
1.7 |
MSCI World Ex USA Growth |
5.9 |
1.5 |
3.8 |
0.5 |
MSCI World Ex USA Small Cap |
10.4 |
5.6 |
1.9 |
2.7 |
MSCI EM IMI |
8.2 |
0.2 |
1.6 |
6.2 |
Fixed Income |
|
|
|
|
Bloomberg U.S. Aggregate |
5.2 |
2.3 |
1.4 |
1.3 |
Bloomberg Municipal |
2.7 |
0.9 |
0.8 |
1.0 |
Bloomberg U.S. Corporate High Yield |
5.3 |
1.9 |
1.6 |
1.6 |
Bloomberg EM USD Aggregate |
5.8 |
1.8 |
2.1 |
1.8 |
Source: Morningstar Inc.; Data as of 9/30/2024
Figure 2: Global Central Bank Policy Rates
Global monetary policy easing underway, except in Japan
U.S. Federal Reserve |
Bank of England |
European Central Bank |
Bank of Japan |
|
9/30/2024 |
5.00% |
5.00% |
3.50% |
0.25% |
9/30/2023 |
5.50% |
5.25% |
4.00% |
-0.10% |
9/30/2022 |
3.25% |
2.25% |
0.75% |
-0.10% |
9/30/2021 |
0.25% |
0.10% |
-0.50% |
-0.10% |
9/30/2020 |
0.25% |
0.10% |
-0.50% |
-0.10% |
9/30/2019 |
2.00% |
0.75% |
-0.50% |
-0.10% |
9/30/2018 |
2.25% |
0.75% |
-0.40% |
-0.10% |
9/30/2017 |
1.25% |
0.25% |
-0.40% |
-0.10% |
9/30/2016 |
0.50% |
0.25% |
-0.40% |
-0.10% |
Source: Bloomberg L.P.; Data as of 9/30/2024
Figure 3. 2-10Y UST Yield Curve, bps
Longest period of yield curve inversion finally ended in Q3
2-10Y UST Curve |
|
9/30/2024 |
13.779 |
9/29/2023 |
-47.662 |
9/30/2022 |
-45.425 |
9/30/2021 |
120.787 |
9/30/2020 |
55.313 |
Figure 4. VIX Daily High Price
The August volatility spike is a reminder of continued macro uncertainty
Date |
VIX Index - Daily High Price |
9/30/2024 |
17.79 |
8/5/2024 |
65.73 |
9/29/2023 |
17.74 |
9/30/2022 |
33.25 |
9/30/2021 |
24.71 |
9/30/2020 |
27.12 |
3/18/2020 |
85.47 |
9/30/2019 |
17.35 |
Source: Bloomberg L.P.; Data as of 9/30/2024
