3Q 2024 Market Commentary on Proxy Strategies
Overall Market
Equities
- US Markets
The third quarter of 2024 was marked by significant volatility, particularly in early August, when a weak jobs report sparked fears of an economic slowdown. The S&P 500 experienced its largest one-day drop since 2022, and concerns about the Federal Reserve’s potential failure to achieve a soft landing led to a market rotation that dominated Q3. Despite these challenges, the S&P 500 managed to gain 5.8% during the quarter, with a boost from the Federal Reserve’s “jumbo” 50bps rate cut in September, which reflected a slowing labor market and increased confidence in inflation control. The small-cap Russell 2000 also outperformed, driven by expectations of continued rate cuts.
- Sector Rotation
Throughout Q3, investors moved away from the high-performing tech sector, driven by profit-taking and a cooling of the AI boom. As a result, the Nasdaq Composite gained just 2.7% for the quarter, while the tech-heavy “Magnificent 7” stocks underperformed the broader market for the first time since late 2022. As tech stumbled, value stocks began to outperform growth stocks, with sectors such as utilities, real estate, financials, and industrials attracting greater investor interest. Interest rate-sensitive sectors like utilities and real estate were among the leaders, benefiting from the Federal Reserve’s rate cuts, as investors favored more stable, economically linked sectors amid shifting market dynamics.
- International
Emerging market (EM) equities, represented by the MSCI EM Index, gained 7.9% during the quarter, outperforming developed markets (MSCI World Index, +6.5%). In July, a momentum shift led to underperformance in earlier winners due to China’s economic strain, declining commodity prices, and a downturn in overvalued tech stocks. Volatility increased in August, spurred by a US recession scare and unwinding of the yen carry trade.
In September, emerging markets saw strong gains due to stimulus measures from Beijing and a larger-than-expected US rate cut. China, Hong Kong, and India all performed well, with Chinese markets particularly benefiting from government actions. Latin America, led by Brazil, also posted robust results. International markets overall outpaced the S&P 500, with rallies driven by expectations of further rate cuts. The EuroStoxx 600 gained 2.2%, reflecting improved sentiment across Europe as the European Central Bank cut rates for the second time in the year.
Fixed Income
- U.S. Bonds
In the U.S., the leading benchmark for bonds, the Bloomberg Barclays US Aggregate Bond Index, delivered a very strong quarterly return, driven by falling inflation, mixed economic data, and investors’ anticipation of an aggressive rate-cutting cycle by the Federal Reserve. The Bloomberg US Treasury Index returned 4.7% during the quarter, as the Federal Reserve, in its September meeting, cut interest rates for the first time in four years. The larger-than-expected 50bps reduction reflected a slowing labor market and increased confidence in inflation dynamics, leading to a sharp fall in Treasury yields.
- Bond Duration and Credit Quality
Longer-duration bonds significantly outperformed shorter-duration ones during the quarter, as investors reached for higher long-term yields amidst falling inflation, underwhelming labor market data, and the expected unwinding of the inverted yield curve—which has seen short-term rates exceeding long-term rates for over two years. Nonetheless, shorter-duration bonds also posted positive returns in Q3, contributing to a strong overall rally across the bond market.
In the corporate bond market, investment-grade bonds slightly outperformed lower-quality “junk” bonds, although both experienced solid quarterly gains. Investors preferred the safety of investment-grade bonds amid growing economic uncertainty, favoring them over higher-yielding, higher-risk securities for the first time in 2024.
- International Bonds
In Europe, the European Central Bank (ECB) made its second 25bps rate cut of the year in September, encouraged by improved inflation dynamics and weak economic growth. Inflation in the Euro Area cooled to 2.2% during the quarter, the lowest level since mid-2021, contributing to the Bloomberg EuroAgg Index’s 3.7% return.
In the UK, inflation printed at 2.2% year-on-year in both July and August, after reaching the Bank of England’s (BoE) 2% target in June. The BoE cut rates by 25bps in August and maintained them in September. Despite the restrictive monetary policy—with inflation at 2.2% and interest rates at 5%—the fall in Gilt yields was less pronounced compared to other markets.
In Japan, the Bank of Japan (BoJ) raised its policy rate by 15bps to 25bps at the end of July. Despite this hawkish move, the BoJ slowed the reduction of its government bond purchasing program and indicated that it would avoid rate hikes during periods of market instability, leading to a decline in the 10-year yield over the quarter. The Bloomberg Global-Aggregate Total Return Index posted a return of 7.0% for the quarter, reflecting the broader positive performance of global bonds.
The Portfolios in Q3 2024
Global Equity:
Heading into Q3, global equity lagged the major indexes due to a lack of significant exposure to the “Magnificent 7” stocks, which had driven the markets to multiple all-time highs. With a more conservative approach that leaned towards value, as well as mid and small caps (largely through equal-weight S&P 500 index ETFs), August’s sudden sell-off in big tech had a much smaller impact on the portfolio. Diversification across dividend-paying stocks, REITs, gold, government bonds, and international ETFs helped the Global Equity portfolio hold up well during the most volatile periods of the quarter.
Later in September, with hopes of an eventual 50 bps Federal Reserve rate cut, small caps surged. While we had patiently awaited this rotation away from high-priced tech and mega caps—and were rewarded during the quarter—we continue to lag on a year-to-date basis. For perspective, U.S. Small Cap Value ended Q3 up 10.15% but is only up 9.21% year-to-date (YTD). REITs ended the quarter strong, with a 17% return, but are only up 14.3% YTD. This means that this asset class and sector, which we held for most of the year, were negative until Q3.
Overall, we are satisfied with the performance of the strategy over the third quarter—not just because of returns that outperformed the S&P 500 for the period, but also because we continue to provide positive risk-adjusted returns, reducing clients’ downside risk when it matters most. We continue to see opportunities in the asset classes and themes that began to play out in the third quarter and will remain tactical in our management of the portfolio.
Growth Portfolio
Q3 was a solid quarter for our Growth strategy, as it slightly outperformed the S&P 500, beating it by about 4%. While we strive to maintain diversification, it’s clear that much of the growth over the past two decades has come from the technology sector. As a result, approximately 48% of our Growth strategy is invested in various technology companies. However, Q3 proved to be a challenging quarter for the tech sector, which was down for the period (-0.48%). Despite the downturn in large-cap tech, the Proxy Growth portfolio benefited from significant mid- and small-cap stock exposure. This diversification helped drive performance, as mid- and small-cap growth more than doubled the performance of their large-cap counterparts.
Additionally, several high-conviction stocks, which have been held in the portfolio long-term, were key drivers of this success. Companies like The Trade Desk (TTD), CrowdStrike (CRWD), Shift4 Payments (FOUR), and Fiserv (FI) have been held as long-term buy-and-hold investments, and we have been rewarded for our patience, with these stocks averaging a 67.75% year-to-date (YTD) gain. We continue to believe that our focus on relatively smaller companies with consistent earnings growth is a good complement to the larger, well-established names in the portfolio.
Equity Income
The long-awaited rotation from growth to value occurred in Q3, and our Dividend-focused strategy benefited significantly. Not only does the strategy inherently include value stocks, given the nature of dividend-paying companies, but sector exposure also worked in our favor. Specifically, we allocated more than a third of the portfolio to Utilities, Real Estate, and Financials—three of the top-performing sectors in Q3. In addition, the portfolio maintained a 10% position in Energy stocks, which was the worst-performing sector during the period (-2.32%).
Overall, sector and individual stock selection played a significant role in our strong outperformance of the S&P 500 in Q3, exceeding it by more than 5.5%. Equally important, we maintained a dividend yield above 4%, continuing to provide our clients with a steady income along with market appreciation.
Performance Comparison Summary for Q3 2024
- Dividend Income outperformed all other categories, delivering a strong return of 4%, driven by high-performing value sectors.
- Global Equity had a solid performance, returning 65%, benefiting from diversified investments across different asset classes and regions.
- Growth Portfolio achieved a return of 25%, with significant mid- and small-cap stock exposure helping to drive performance despite challenges in the tech sector.
- S&P 500 recorded a return of 5.9%, lagging behind the Dividend Income, Global Equity, and Growth portfolios. The market-cap-weighted index was impacted by only three of the “Magnificent Seven” stocks posting gains during the quarter, and those gains were significantly smaller compared to their earlier performance.
General Information and Not Financial Advice Disclaimer: The information provided is for general informational purposes only and should not be considered financial or investment advice. Consult a financial advisor before making any investment decisions. Past performance is not a reliable indicator of future performance, and there is no guarantee that the trends described will continue in the future. Investing involves risks, including the possible loss of principal. Market conditions can change, affecting the performance of the investment. The information contained herein is believed to be accurate as of the publication date. However, no assurance is given regarding its accuracy or completeness. The authors of this commentary may hold positions in the securities discussed or have other interests in their performance.