Markets Remain Guardedly Risk-On in Election Run-Up
Oct 7, 2024
In its 4Q 2024 Outlook, PGIM Quantitative Solutions sees a moderate growth outlook with elevated volatility heading into the U.S. presidential election.
RESILIENT MARKET DESPITE NEAR-TERM VOLATILITY
The third quarter saw a continuation of the risk-on theme evident in markets for much of this year. In the first half of July, the S&P 500 Index hit a succession of record highs, while bonds rallied on increased speculation that the Fed would cut rates in September. But risk assets fell sharply in mid-July, and the Magnificent Seven posted significant losses that left the index down over -10% from peak to trough. Commodity prices also saw notable declines, particularly among energy and industrial metals. Intense volatility continued in early August, triggered by a weak U.S. jobs report. However, markets stabilized later in the quarter, supported by reassuring macro data and Fed Chair Powell’s dovish message at Jackson Hole.
Year to date, many asset classes and segments have posted solid gains. Risk assets continue their strong advance, driven by U.S. large-cap growth stocks that are benefiting from robust demand. Interestingly, gold-which typically performs well during periods of high-risk aversion and inflation worries-has also posted strong gains. Meanwhile, the U.S. Aggregate Bond Index had a rough first half as inflation worries resurfaced, but has since stabilized and notched modest gains as inflation began to moderate and rate cuts came into focus. As much as the first half of 2024 was marked by low volatility and strong gains in risk assets, the sudden flare-up in risk aversion in July and August set the stage for continued market volatility in the near term, until at least the U.S. election is over.
SUPPORTIVE BACKDROP FOR FIXED INCOME
For fixed income, the steady moderation in economic growth, along with rising confidence that core inflation is easing, has resulted in a sharp drop in the 10-year Treasury yield over Q3, to around 3.6%. Rates volatility is likely to persist as markets continue to evaluate the extent of rate cuts, especially given the sustained strength of the economy. The environment of moderate growth and inflation along with expected rate cuts will likely be supportive of credit spreads remaining around their current tighter-than-average levels.
EARNINGS GROWTH MAY CONTINUE TO BROADEN
U.S. earnings growth is expected to improve over the next four quarters, with slower large-cap tech earnings offset by an improvement in earnings growth for the rest of the market. However, lower-risk assets and fixed income securities are likely to benefit if growth falls faster. On the other hand, if falling inflation and solid growth drive lower interest rates, both risky and more conservative assets stand to benefit. Commodities have recently lagged as risk aversion increased amid prospects of slower global growth. This dynamic is likely to persist in Q4 with growth continuing to slow, particularly in China.
ELECTION YEARS HISTORICALLY FAVOR BONDS
On average, equity markets have posted moderate gains during election years, although lower than historical annual averages. It can be difficult to isolate the effect of elections on equity market performance due to diverse macro and policy environments over the many election years. The increased volatility during election years has made stocks move up gradually for most of the year, usually followed by a relief rally in the final two months as the uncertainty lifts. Among equity factors, quality and low-risk factors perform relatively better. While value has done well during election years, its best performance is usually during the initial part of the presidential cycle. Growth factors typically do well later in the cycle. Momentum factors, such as those based on price and earnings, also perform well mid- to late-cycle.
Meanwhile, fixed income assets outperform stocks on average during election years. Historically, the Fed tends to set policy a little looser during election years, putting downward pressure on interest rates. Combined with increased volatility in risk assets, the environment for fixed income is relatively more favorable.
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The S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. The U.S. Aggregate Bond Index is a broad measure of the investment grade, U.S. dollar-denominated, fixed rate taxable bond market. The index includes Treasuries, government-related and corporate securities, and fixed rate agency MBS, ABS, and CMBS (agency and non-agency). Indices are unmanaged and are provided for informational purposes only. Investors cannot directly invest in an index. Past performance does not guarantee future results.
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