Q3 brought with it a number of challenges yet equities measured by the S&P posted moderate gains. Led by the Energy, Information Technology and Healthcare sectors in which both the Tactical Allocation Portfolio and Sector Equities models participate regularly. Despite that sector exposure both models pulled back, giving up a fraction of their gains year-to-date.
Surging U.S. Treasury yields was certainly the headline of the quarter. The 10-year reaching a high of approximately 5.30% for the first time since 2007. Government bond yields have risen due to inflationary pressures from the continued conflict in Iran, growth expectations in AI, and a rise in term premium. Generally defined as compensation to bond holders to offset inflationary uncertainty, liquidity and default risk. We are in no way endorsing the U.S. Government will default on its loans, yet the market has priced in additional risk. The bottom line is that long-term borrowing costs will rise as a result. Putting additional pressure on the cost-of-living of consumers and smaller, private and publicly traded companies that rely on ongoing leverage to grow and sustain their businesses. Evidenced by the -7.2% pullback in the Russell 2000 index in Q3, which represents domestic small cap equities.
On the inflationary side, the Federal Reserve, and other developed countries’ central banks, raised benchmark rates. The Federal Reserve for the first time since July 2023. We expect another Fed Funds increase of .25% before year end as the Consumer Price Index rose in September to 3.74%, above consensus.
Despite all the above we feel there is still potential room to grow through year-end. Historically speaking, mid-term elections, despite shifts in seats held, has little intermediate-term effect as we covered in a recent Weekly Market update update (see Planning & Resources). The demand for continued buildout of AI infrastructure and the sheer dollar amounts being spent, and leant, by the majority of Mag-7 should drive continued demand despite a recent rotation away from semiconductors. And arguably most importantly corporate profits grew year-over-year through Q3 29.6%. The stock market measures the expected future earnings of publicly traded companies. The economy production, spending, employment and income of a country.
And if not, rest assured our focus remains on the risk-management side of how we approach capital and debt markets. The enhancements to the strategy we rolled out in January added additional measures to protect our clients’ investment. One specifically tracks volatility and allows us to take fractional risk out of the models, providing what we refer to as ‘gap down’ protection. Likewise, that same measure allows us to add exposure to seize a new opportunity. We value the continued confidence as we move into an ever-changing environment. Please keep your eyes on our Weekly Market updates for the very latest from all of us at 1st & Main.