US equity markets were hit by a fall in mega-cap tech stocks in July, but bounced back as an ease in inflation and softening labour market enabled a bigger-than-expected rate cut from the Fed
The S&P 500 Equal Weight index outperformed the standard market-cap-weighted version, while the Nasdaq-100 recovered to end the quarter with a relatively modest gain
While S&P 500 ETFs continued to gather the most assets, S&P 500 Equal Weight exposures saw increased demand during the quarter
The third quarter was certainly eventful, not least with the replacement of Biden as the Democrat’s presidential candidate. That event seems quite a long time ago especially with everything else that took place during the quarter. In terms of equity markets, there was a sharp sell-off in July that continued through the first week of August, with large-cap tech stocks dragging indices lower. Investors were beginning to question the time it would take to see financial rewards from some of the sizable investments that many companies were making in artificial intelligence (AI).
Economic data especially on the US employment market was also causing some angst among investors concerned that the Fed might have been waiting too long to begin loosening monetary policy. Plus, an interest rate hike by the Bank of Japan saw the yen strengthen and forced many investors to close out yen carry trades, amplifying the market downturn.
Over the last half of the quarter, conditions stabilised and equity markets recovered. At the end of Q3, the S&P 500 had returned 5.9%, well ahead of the 2.1% return of the more tech-heavy Nasdaq-100. However, both market-cap-weighted benchmarks were eclipsed by the S&P 500 Equal Weight index, which recorded a 9.6% gain for the quarter. The recent strength in the equal weight index reflects the greater breadth of contributors (see sector performances for more detail) than the mega-cap dominance that propelled the other indices during the first half of the year.
On the economic front, inflation eased gradually during the quarter, and the Fed’s attention turned to the other part of its mandate: employment. Concern was growing as the unemployment rate ticked up, and there was a huge miss on a jobs creation report ahead of the Jackson Hole Economic Summit. Fed Chair Powell gave a clear indication to the market that a September rate cut was coming. As it turned out, the Fed cut rates at that September meeting by a larger-than-expected 50 basis points, with another 50 basis points (in total) projected by the end of 2024.
Q3 |
YTD |
|
|---|---|---|
S&P 500 NTR |
5.9% |
22.1% |
Nasdaq 100 NTR |
2.1% |
20.0% |
S&P 500 Equal Weight NTR |
9.6% |
15.2% |
Source: Bloomberg, Invesco, to 30 September 2024
ETFs tracking the standard S&P 500 index continued to dominate flows overall in the quarter. Those tracking the Nasdaq-100 saw small new outflows in July, coinciding with the market fall and rotation away from big tech into some of the more defensive areas of the market, but Nasdaq inflows returned in the final two months of the quarter. However, the biggest mover in terms of flows was seen in S&P 500 Equal Weight ETFs, with positive net inflows in each of the past three months and September’s flows even surpassing those into ETFs tracking the market-cap-weighted index.
Sector flows were also mixed during the quarter. After overall net outflows in July (mainly from Health Care and Financials), activity picked up in the next two months, with appetite returning for Technology sector ETFs but also in more defensives including Utilities, Consumer Staples and the previously mentioned Health Care and Financials sectors.
Sector composition was detrimental to the performance of the Nasdaq-100 compared to the S&P 500, particularly the Nasdaq-100’s greater exposure to the Information Technology (>17% overweight v S&P 500) and Communication Services (>6%) sectors. That the Nasdaq excludes Financials and has no exposure to Real Estate also detracted from the index’s relative performance in the quarter.
Every sector aside from Energy produced a positive return in Q3, with some of the more unloved areas of the market gaining favour over those that had been the strongest performers. Utilities powered to a gain of 18.5%, followed by Real Estate (+16.3), Industrials (+11.1%) and Financials (+10.2%). Despite the large pull-back in July, Magnificent 7 stocks recovered strongly with Technology and Communication Services sectors both managing to end the quarter in positive territory, albeit underperforming the S&P 500 index return.
Near-term market attention will be focused increasingly on the elections in November and the two scheduled FOMC meetings, the first one just after the elections and the other in December. History shows that US elections rarely impact the overall direction of equity markets, but policy differences between Trump and Harris could have an effect on certain sectors. Just how much of their agenda either candidate could get done will largely depend on who controls Congress. Industries that are likely to be supported by both candidates, for different reasons, include defence and cyber security.
Read our views on the potential policy implications and some ETFs to consider in An investor’s guide to the US presidential election.
As for the Fed, two more rate cuts are expected by the end of the year, with 25 basis points at each meeting being the most likely scenario. Lower rates should benefit large swathes of the US equity market, as lower borrowing costs encourage spending by both companies and consumers. The high dividend payers such as utilities tend to be in demand, as we saw in Q3, while financials and real estate tend to benefit from increased demand for loans and property purchases. At the same time, technology companies are among those that should benefit from lower cost of capital.
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The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
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Data source Invesco/ Bloomberg as at 30 September 2024 unless otherwise stated.
Views and opinions are based on current market conditions and are subject to change.
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