Q3 Letter - 2024
Q3’2024 Recap: Rate Cuts Begin – A New Cycle, or Post-Cycle?
Inflation continued to moderate throughout the quarter, prompting the Federal Reserve to enter a new phase in the interest rate cycle. On September 18th, the Fed cut rates by half a percent, marking the end of a rate-hiking cycle that began 30 months earlier in March 2022. While the rate cut was largely anticipated, its impact on the markets were less pronounced than many expected. It appears that attention has shifted to the labor market, the other component of the Fed’s dual mandate now that inflation has become less of an issue. The trajectory of future rate cuts will be more dependent on how the labor market conditions evolve, making it a key variable to monitor when determining the pace and depth of future reductions.
A Labor Market to Date, Not Fall-in Love With, Yet
The September jobs report released early in October reinforced our view that the labor market remains robust, though it is slowing and is less dynamic than in recent years. The Fed is forecasting the unemployment rate to rise slightly higher to 4.4% by year end, 0.3% above the current 4.1% unemployment rate, compared to our cycle-low of 3.4%. We believe we’ll see a slightly stronger than expected labor market and in-line inflation, which holds the Fed to only cut 25 basis points one more time this year.
However, if the U.S. labor market does encounter more deterioration than expected, the Fed is well-prepared to address any weakness with more aggressive rate-cuts if necessary. Importantly, there is no substantial evidence of widespread layoffs that could materially harm consumer spending—the critical engine of our economy and corporate earnings. As long as consumer spending holds, which we view as highly probable for the foreseeable future, the labor market is more likely to see a gradual slowdown rather than a crash.
The monthly jobs data from September showed a 254K increase in new payrolls alone, and the 223K in private payrolls confirms the underlying strength of the private sector. The net upward revisions to the prior two months should also allay any residual concerns about the softness seen in prior months. Labor income is a key variable, and the large increase in jobs was combined with a fairly solid 0.4% increase in average hourly earnings, compounding an upward revision to earnings for the prior month. Aggregate payroll earnings rose at a 4.4% annual rate in Q3’24, only a touch below their 4.8% rise over the past year. The strength in income reflects continued business demand for labor and provides continued support for consumption growth. Furthermore, the Fed’s decision to ease monetary policy is likely to support growth and stabilize this slowing labor market.
Labor demand picked up across most service industries in September. Consumer-related payrolls were particularly strong, with renewed growth in retail and in leisure & hospitality.
Labor demand picked up across most service industries in September. Consumer-related payrolls were particularly strong, with renewed growth in retail and in leisure & hospitality. Healthcare payrolls also reaccelerated, and business services payrolls rebounded after a couple months of decline— easing any lingering concerns about those sectors. In contrast, the manufacturing sector remained weak, consistent with earlier survey signals. However, as we’ve seen throughout the post-COVID recovery, manufacturing tends to follow its own cycle, often diverging from the broader economy, which continues to show strength. Much like a small leak in an otherwise strong dam, the weakness in manufacturing may cause ripples, but it’s unlikely to flood the larger economic landscape, which remains steady and resilient. The GDP growth rate for the third quarter of 2024 is estimated to be between 1.8% and 3.2%, and we believe the high end of that range is likely.
Over the past few decades, the U.S. economy has transitioned from a manufacturing-based system to one that is predominantly service-oriented, driven by technological advancements, globalization, and a growing consumer preference for services over goods. This transformation has diversified the economy, making it less vulnerable to the sharp swings of traditional economic cycles. It raises the question: Has our post-industrial, wealthier society become more resilient to economic downturns—or perhaps even entered a "post-cyclical" era? It’s an intriguing idea to consider, as the evolving story of the U.S. economy—part history, part ongoing experiment—continues to unfold.
Happy 2nd Birthday to the Bull Market: October 2022 – October 2024
This ongoing bull market just turned two-years old, still significantly shorter than the average bull market duration of approximately 5 years, based on the last 11 bull markets since the creation of the S&P 500 index in 1957. Historically, bull markets over the past few decades have delivered an impressive average total return of 169.3%, far exceeding the current 55.2% rally we've seen over the past two years. While history doesn’t guarantee future performance, it does suggest that bull markets often extend well beyond two years. More importantly, it highlights that the overall market trend tends to hold greater significance than the specific levels the market reaches at any given point.
Long Versus Short Duration Rates: A Tale of Diverging Paths
One potential risk to the longevity of the bull market is the possibility of long-term interest rates rising more than expected—these are the rates consumers rely on for major purchases like mortgages and car loans. A counterintuitive market dynamic has emerged after the Fed cut their short duration target rate 50 basis points in mid-September, the long end of the curve has actually increased by ~50 basis points, with the 10-year treasury yield rising from 3.58% to 4.09% a month later. This raises the question of whether inflation should regain more of our focus given the severity of this move. While that action makes it more difficult to remain bearish on rates here if they move above 4.2%, it seems more likely a new range is forming, with yields settling in the high 3% to low 4% range.
To turn more bullish on long duration Treasuries, inflation would likely need to drop more than expected, but that doesn’t seem likely given the resiliency in the labor market and consequently, consumer spending. As a result, the 10-year treasury yield appears anchored around 4.0%. It’s also important to note that the recent rise in yields follows a five-month period of declines, suggesting that profit-taking and momentum may have pushed the yield to 4.1%—potentially higher than warranted given inflation’s steady decline to the mid-2% range. Since this move is only about four weeks old, it’s too early to declare a sustainable trend shift. The broader downtrend in both yields and inflation likely remains intact, but likely over a longer period of time which has been getting priced in. With this rise in yields, expectations for rate cuts have been tempered, now forecasting just five more cuts over the next nine months (by July 2025). The "terminal rate" is projected to settle at 3.26% by early 2026, reflecting a gradual easing path.
Q3 2024 Earnings Preview
The S&P 500 is expected to report Q3’24 earnings growth above 7% for Q3 2024, even though the blended earnings growth rate is currently at 4.1%. Historically, actual earnings for the S&P 500 have surpassed estimates, and it is likely that positive earnings surprises will push the final growth rate above initial projections. Over the past five years, actual earnings have typically exceeded estimates by an average of 8.5%, suggesting that the final growth rate for Q3 could reach as high as 11.6%. To date, 79% of the 30 companies that have reported actual results for Q3 have delivered earnings above estimates, though expected earnings growth for the index has slightly declined since September 30.
The Information Technology, Communication Services, and Health Care sectors are leading the charge for earnings and revenue growth in Q3, while the Energy sector is expected to report the largest year-over-year decline in earnings due to lower oil prices. The Information Technology sector, driven by companies like NVIDIA, is forecasted to post the highest earnings growth at 14.9%. In terms of revenue growth, the blended rate for Q3 is 4.6%, and the IT sector is again the leader with an 11.8% increase, followed by Communication Services. Energy, on the other hand, is the only sector expected to report a decline in revenues.
Looking Ahead to 2025
As we move through the final quarter of 2024, we remain cautiously optimistic about various pockets of the market. While Q3 results hold importance, they are likely to take a backseat to the forward guidance companies will provide for Q4 and, more significantly, their outlook for 2025.
While there are other potential risks on the horizon — such as the possibility of rising long-term interest rates and inflation resurfacing — the fundamentals of the economy, particularly the labor market and consumer spending, remain strong. Demographic tailwinds remain favorable, consumer balance sheets are all-time robust, and sentiment appears more likely to improve than deteriorate into the end of the year. Our focus, as always, is on proactive portfolio management, with a keen eye on market trends, inflationary pressures, and interest rate developments. By staying vigilant and adaptive, we aim to manage risk effectively while positioning portfolios to take advantage of opportunities as they arise.
But Wait, There’s Something Happening in November First
We’ve saved the most contentious topic for last—because what better way to wrap up a letter than by diving into politics? With the election now less than a month away, it’s difficult to ignore its potential market impact. Historically, markets often experience a relief rally once the uncertainty lifts. Although the race appears close, the most likely outcome remains gridlock in government, which tends to be favorable for markets by preventing major policy shifts thereby reducing uncertainty. Additionally, both parties seem committed to infrastructure investment and other pro-growth policies, making a significant market shift as a direct result of this election less likely. While election outcomes rarely have a significant impact on overall consumer spending, certain policies—such as tax cuts, deregulation, or tariffs—could influence specific sectors. We will continue to evaluate which policies are likely to be implemented, offering clearer insights into which sectors might see shifts in their earnings potential—though the overall impact on consumer spending and thus corporate earnings is expected to remain limited.
Staying Ready – And Remember, The Fed’s Got Your Back (and So Do We)
As has always been the case, we will continue to remain in the "ready position" to act if risks materialize such as if the labor market showed signs of weakening beyond a normalized level. It’s important to note again that the Fed is acting from a position of strength given they can loosen financial conditions quickly if they believe the labor market is beginning to deteriorate. Consequently, even if inflation remains around 2.5% or inflects upwards slightly, that’s not high enough for the Fed to ignore unemployment concerns. In such an environment, owning assets like stocks is crucial as the value of cash decreases. There’s an argument to be made that asset prices are likely to be supported even if demand cools, given the Fed's ability to lower interest rates from their current levels. In that scenario, certain companies will benefit more than others which makes our job as asset allocators even more valuable.
Thank you for your continued trust in our guidance as we navigate these dynamic market conditions together. We are grateful for the trust that you have placed in us to monitor these conditions affecting the financial markets, and we look forward to continuing to serve as your advisor. If you have any questions or concerns, please do not hesitate to contact us.
Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.