Q3 2024 Market Recap: A Broadening Rally With a Few Bumps Along the Way
Q3 2024 Market Recap: A Broadening Rally With a Few Bumps Along the Way
The third quarter marked a noticeable shift in market dynamics. If the first half of 2024 was defined by explosive gains in tech, Q3 felt more subdued, with leadership broadening to a wider range of sectors. For Q3 2024, the Dow Jones Industrial Average led the pack with an 8.2% gain, followed by the S&P 500 up 5.5%, and the Nasdaq trailing with a modest 2.6% rise. Whether this marks a sustained change in leadership or just a temporary rotation remains to be seen.
For the S&P 500, the year-to-date rise of 20.8% marks its best first-three-quarter performance since 1997—back when everyone was captivated by the dot-com boom. And for those skeptical of today’s rally, it’s worth recalling that from 1998 through March 24th of 2000 (the dotcom peak for the S&P 500), the S&P 500 went on to gain an additional 60%.
A Look Back at Market Divergences: Dot-Com Era Déjà Vu?
The current market environment, characterized by high valuations and concentrated gains in a few large-cap stocks, has similarities to the late 1990s tech boom (though it also bears some resemblance to the late 1960s and early 1970s, when the ‘Nifty Fifty’ stocks dominated the market. These were considered ‘one-decision stocks’—companies so highly regarded for their business quality that investors were encouraged to buy and hold them regardless of valuation).
During the tech boom, the S&P 500 outpaced the Russell 2000 by 93% from 1994 to 1999, as investors flocked to stocks of fast-growing companies. But when the bubble burst, the tables turned: small caps outperformed the S&P 500 by 114% through 2014, according to Spencer Jakab of the Wall Street Journal. Whether history will repeat is uncertain, but today’s set-up does have echoes of that era, with fatigue in the largest tech stocks and early signs of renewed interest in value-oriented and smaller cap names. (We remain cautious, however, as there have been many false starts where small caps appeared poised for a comeback, only to fade.)
What’s Behind the Gains?
It’s never easy to pinpoint exactly what drives the stock market in any given quarter, but a few key factors were at play: cooling inflation, a dovish turn by the Fed, and a growing belief that maybe, just maybe, the economy can achieve a soft landing. The Fed even chipped in with a half-point Fed funds rate cut, and with more reductions on the table before year-end, investors welcomed the prospect of cheaper money.
But before we get too carried away, remember that this rally isn’t set in stone. Any one of a half-dozen factors—election-year surprises, lofty valuations, growing geopolitical tensions, or an unexpected shock—could derail the market’s upward trajectory. Keeping a little cash on the sidelines might not be the worst idea to take advantage of any future market turbulence that allows you to purchase stocks at more attractive valuations (plus the yield on money market funds still remains attractive).
Not All About AI Anymore
If the first half of 2024 was dominated by the excitement around AI, Q3 was a reality check. Investors began to ask perfectly reasonable questions like, “Will all this AI spending translate into profits?” Alphabet and Amazon were prime examples. Alphabet’s capital expenditures nearly doubled, making some investors uneasy, while Amazon’s sales forecast fell short, even as it continued to ramp up AI spending. The result? Both stocks slid—Alphabet down 8.9% and Amazon off 3.6% for the quarter.
It’s not that the market has lost faith in AI’s potential. Far from it. But now there’s a growing recognition that turning potential into profits will take time and, likely, a lot more investment.
A Broader Rally Takes Shape
With the AI frenzy taking a breather, investors went hunting for value in less flashy areas, leading to a more widespread rally. Utilities stole the show, jumping 18% as falling bond yields made their dividends look more appealing as well as the expected increase in demand from AI data centers fueled higher earnings expectations. Real estate followed closely, up 16%, and industrials joined the party with an 11% gain. Even regional banks, which had been struggling, perked up, with the KBW Bank Index climbing over 10%.
All of this helped prop up the S&P 500, even as the “Magnificent Seven” tech giants lost steam. So, while the market’s momentum held up, this time it wasn’t all about Big Tech.
What’s Happening in Small-Caps?
After a slow start to the year the Russell 2000 advanced 8.9% for Q3. Notably small-cap stocks, as measured by the Russell 2000, would have been negative for the first half of 2024 were it not for a staggering 188% gain in Super Micro Computer, which temporarily buoyed the index. However, Super Micro fell back to earth this quarter (declining almost 50%) after exiting the small-cap index due to its significant increase in market cap (even with the ~50% decline the stock is still up ~43% for the year!). Despite the stronger showing in Q3, small caps are still ~10% below their all-time highs.
We believe that in an arguably overextended market, some of the best bargains can still be found in this segment. Plus, any further lowering of interest rates should be a tailwind for smaller companies that often have higher levels of floating-rate debt.
Bonds and Yields: A Turning Point?
The 10-year Treasury yield dipped to 3.8%, down from 4.3% at the end of June. This marked a sharp reversal after two consecutive quarters of rising yields. And the big news? The yield curve, which had been inverted since mid-2022, finally turned positive in September.
At the risk of repeating ourselves, whether the Fed reduces interest rates twice this year or only once, it’s worth putting today’s rates in proper historical context. At 3.8% and 1.6% (as of September 30, 2024), nominal and real yields are still low by historical standards. The economy can—and has—functioned with rates at these levels or even higher. If today’s figures seem elevated, they’re only high relative to recent history.
The Road Ahead: Soft Landing or Another Swoon?
As we head into the final lap of 2024, the market seems to be balancing on a tightrope between optimism and anxiety. Bulls argue that the Fed’s rate cuts, a cooling inflation picture, and steady economic growth will keep us on an upswing. With a 21% year-to-date gain, the S&P 500 is having its best nine-month stretch in an election year since 1950.
Bears, however, caution that with valuations looking stretched by historical standards and over 80% of S&P 500 stocks trading above their 50-day moving averages, this rally might just be running on fumes. And let’s not forget, the upcoming election could throw some unexpected surprises our way.
Final Thoughts: A Market Running on High Expectations
For now, the market seems to be holding up, supported by hopes of a dovish Federal Reserve and expectations that inflation is under control. However, as we enter Q4, it's evident that this rally is resting on increasingly fragile footing. Investors will be closely monitoring earnings reports, consumer trends, the labor market, and Federal Reserve statements for any signs of weakness in the market’s foundation. With valuations stretched and economic uncertainty still in play, it’s a good time to keep a cautious eye on the horizon. As history has shown, when sentiment is this high, even a small disappointment can trigger a sharp response. Staying nimble and focused on individual stock opportunities—particularly in small and mid-cap names (where we are currently finding the most bargains)—will be key for navigating the months (and years) ahead.