S&P 500 Rally
US stocks posted 5.6% total return in the third quarter of 2024, with its fifth consecutive monthly gain in September and hitting a record high1. The market held up during the year’s historically weakest quarter, and we believe that once we get past the November presidential election, the market should continue to advance through the end of the year. This growth should be driven by corporate earnings remaining strong and broadening out from technology into more cyclical sectors as interest rates move lower.
The consumer discretionary sector is the leading sector performer for the third quarter1. This sector includes carmakers, hotels, apparel, and homebuilders. The message from the market seems clear: lower borrowing costs should allow the consumer to spend more.
First rate cut in years…
After four years of rate hikes, the Federal Reserve cut the federal funds rate by 50 basis points amid ongoing signs of cooling inflation and a slowing U.S. economy. Other countries are following suit. China’s central bank went all in with measures to boost their economy out of a slump, and Europe’s sluggish economic indicators have sparked hopes that the European Central Bank will follow suit.
This is the start of a new rate cut cycle. The current debate is how policymakers will approach the size and pace of easing in the coming months. We believe that inflation should continue to move towards the Fed’s 2% target by early 2026.
The impact on the stock market…
Historically speaking, when rates begin to fall, it has been a positive for equities over the following twelve months1. Interest rate sensitive industries such as housing, automotive and financials should benefit as consumers find borrowing less expensive. We believe opportunities may lie ahead in dividend-paying stocks, and small capitalized stocks. Lower rates improve access to capital, and if the US avoids a recession, smaller companies may regain earnings momentum after several disappointing years.
Economic Health Snapshot – Stay the Course
Our economic dashboard shows the US economy to be on stable footing2. Beyond geopolitical issues, and elevated asset valuations, we do not see any major systemic risk at this time. We do expect the job market to remain healthy, but market volatility may increase closer to the election. With economic growth remaining in a healthy zone, combined with global central banks easing financial constraints, we expect markets to move higher as we end the year. This gives us confidence to stay the course when markets get choppy.
Key Investment Theme – U.S. Electricity Demand.
There was an interesting news story this quarter as Microsoft recently signed a deal to help restart Three Mile Island Nuclear power plant3. We find this to be a positive catalyst for U.S. electrical infrastructure growth with powerful investable entry points.
S&P 500 index at inflection points
This chart shows past market cycles in the S&P 500, highlighting peak and trough valuations, as well as index levels, dividend yields and the
10-year U.S. Treasury yield. Given where we stand with respect to the current economic cycle, earnings growth will be the primary determinant if US stock market can defend the current valuation.
Source: Bloomberg, J.P. Morgan Asset Management
The chart above shows real GDP in dollars over the last several years. After the U.S. economy recovered in 2021 following the pandemic, growth has been normalizing but remains strong.
Source: BEA, J.P. Morgan Asset Management, Bloomberg. Trend growth is measured as the average annual growth rate from business cycle peak 1Q01 to business cycle peak 4Q19.
We see opportunity with smaller-sized companies as their earnings are expected to rebound. Smaller companies tend to have greater exposure to financial and industrial parts of the economy. Larger-sized companies tend to be more weighted to technology and healthcare. As interest rates forecasted to decline, we believe smaller-sized companies should see their earnings pickup.
Source: Bloomberg, NBER, J.P. Morgan Asset Management
Key Investment Theme – Electricity Demand
At Channel Wealth, we are always looking for the next investment mega theme that will shape economy in the years to come. This quarter, interesting news came from Microsoft securing a deal to help restart Three Mile Island nuclear power plant3. In 1979 the Pennsylvania nuclear power plant suffered a partial meltdown and became the most significant nuclear accident in US history and has been shuttered ever since. The sites owner announced in September that it inked a deal with Microsoft to reopen the plant. Microsoft will purchase the plant’s entire electric generating capacity for the next 20 years. The news is fascinating for so many reasons. Beyond the controversy, it says a lot about the future of nuclear industry and Big Tech’s power demand.
Electricity demand is expected to grow by 30% between 2022 from 2026 as artificial intelligence is implemented in data centers4, increasing electric vehicle adoption and warmer temperatures all contributing to an increase in energy demand. It’s critical that the US invest in our infrastructure to ensure electric supply can keep pace, whether it’s through traditional or renewable utilities. Our investment team looks at the value chain within the electrical industry to uncover the companies that will benefit most from this theme.
The top chart explores U.S. electricity demand from data centers, which is expected to grow to 260 terawatt-hours, accounting for 6% of total electricity demand in the U.S. by 2026, as AI adoption and implementation continues. The bottom chart shows the number of electric vehicle charging points is expected to grow quickly, making it easier and more convenient for Americans to own electric vehicles. To support this rapid growth, a lot of investment in energy infrastructure will be required.
Source: EIA, J.P. Morgan Asset Management, Bloomberg
MARKET VIEW
Joseph O’Flaherty
CIO Market Strategy
Portfolio Considerations
With U.S. equity markets near all-time highs, and with the backdrop that interest rates may have peaked, we have begun to rotate out of large growth technology companies and look to investments that offer income, or are undervalued, such as small and mid-sized cap companies.
In addition, in our core portfolio we utilize investments that are more defensive and offer downside protection.
Our bond portfolio emphasizes “quality” investment grade corporates and municipals, while extending maturity duration.
Lastly, alternative assets act as the final piece of the investment portfolio as they may provide uncorrelated returns to traditional stocks and bonds.
Sources
- Bloomberg provides all market Data, as of 9/30/2024
- Economic Model includes metrics (unemployment, manufacturing/service indices, wage growth, GDP growth,
Corporate Earnings Growth, Global interest rates, Inflation.) Data provided by Bloomberg - https://www.reuters.com/markets/deals/constellation-inks-power-supply-deal-with-microsoft-2024-09-20/
- P. Morgan – electricity demand growth estimates
Index Definitions
Securities indexes assume reinvestment of all distributions and interest payments. Indexes are unmanaged and do not take into account fees or expenses. It is not possible to invest directly in an index. Indexes are all based in U.S. dollars. S&P 500 Index is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.
Chicago National Activity Index is a monthly index designed to gauge overall economic activity and related inflationary pressure. University of Michigan’s Consumer Sentiment Index is a consumer confidence index published monthly by the University of Michigan. Nasdaq is an online global marketplace for buying and trading securities. New York Stock Exchange is a stock exchange where the equity shares of public companies are bought and sold.
Important Disclosures
Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results.
Channel Wealth and advisors do not provide legal, tax or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions.
This information should not be construed as investment advice and is subject to change. It is provided for informational purposes only and is not intended to be either a specific offer by Channel Wealth or any affiliate to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available.
All recommendations must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be in the best interest of all investors.
Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.
Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa. Bonds are subject to interest rate, inflation and credit risks. Investments in high-yield bonds (sometimes referred to as “junk bonds”) offer the potential for high current income and attractive total return, but involves certain risks. Changes in economic conditions or other circumstances may adversely affect a junk bond issuer’s ability to make principal and interest payments. Treasury bills are less volatile than longer-term fixed income securities and are guaranteed as to timely payment of principal and interest by the U.S. government. Investments in foreign securities (including ADRs) involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risk related to renting properties, such as rental defaults Alternative investments are speculative and involve a high degree of risk.
Alternative investments are intended for qualified investors only. Alternative Investments such as derivatives, hedge funds, private equity funds, and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity, and your tolerance for risk.
Nonfinancial assets, such as closely held businesses, real estate, fine art, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations, and lack of liquidity. Nonfinancial assets are not in the best interest of all investors. Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax, or estate planning strategy.
