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Returns of 0.3% for global equities and 2.3% for UK government bonds might suggest the third quarter was a quiet one. In fact, it was anything but! The third quarter saw markets at their most choppy in almost 2 years as they questioned the strength of the Global economy, the willingness of policymakers to cut interest rates and the valuations of some of the key US stocks that have driven index gains of late. A slightly longer re-cap than normal this time around, to reflect the huge amount going on!
Ultimately, markets got the answers they wanted! The third quarter saw widescale interest rate cuts and US economic growth numbers come in at 3%: evidence that the World’s biggest economy is alive and well! Corporate profits (whilst not uniformly brilliant) showed enough strength to justify market valuations and, encouragingly, we saw a broader array of companies participate in gains as their results surprised to the upside.
Corporate earnings
Corporate profitability is the number one driver of long-run stock returns and US company profits, notably within the technology and consumer discretionary sectors, have powered much of the recent gains in stock markets. These companies (which comprise Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta and Tesla) are affectionately known as “The Magnificent 7”, owing largely to the “Magnificent” c100% growth in profits that they’ve generated (as a whole) over the last year! Excepting Tesla (which is the smallest weight within the index), the third quarter saw all these companies post more profits than had been expected (by stock analysts), with only Amazon failing to beat its sales forecasts.
With the Magnificent 7 having scraped over an extremely high bar of expectations, many other US companies posted strong profit numbers which beat expectations and saw resultant share-price gains. This was particularly prevalent in sectors such as Utilities and Consumer Staples, where earnings showed big beats compared to modest expectations. In aggregate, US companies posted their fourth consecutive quarter of positive earnings’ growth and their best quarter of growth since Q4 2021. UK and European companies surprised to the upside with their numbers, with companies within the UK stock market posting their first quarter of positive earnings growth in over a year.
The US economy in the spotlight
The question marks over the health of the global economy were principally focused on the US economy. Being the biggest economy, the US rightly garners most attention and the release of weak manufacturing and jobs numbers in early August prompted a sharp sell-off within equity markets.
The manufacturing numbers, although weak, were not unexpected and at circa 10% of US total output, we’d note a decreasing role in their importance to US growth. Indeed, the ISM Manufacturing series have shown US manufacturing to be in “contraction” for 22 of the past 23 months over which time the US stock market has risen by circa 30% in Sterling terms! A timely reminder that the stock market does not equal the economy!
The US jobs market does warrant close attention, and it showed clear signs of fatigue in the 3rd quarter. Jobs (and pay rises!) are much harder to come by than they were 2 years ago, but wages are still growing ahead of inflation, we’re not seeing layoffs pick up (i.e. companies shedding staff) and an unemployment rate of 4.1% is a good way below its long-term average of 5.7%. These factors helped keep the US Consumer spending in the third quarter, which is the big driver for US growth.
UK going strong?
Closer to home, UK economic data continued to be strong, and this was reflected in the strength of the UK stock market and our currency. Q3 saw the FTSE All Share rise by 2.2%, with domestically focused shares doing best. Pound Sterling is perhaps the best barometer for the health of the UK and a 5.8% rise (vs the US Dollar) in the third quarter demonstrated the improved outlook for the UK. Perhaps it’s been the wet weather, perhaps it’s been the funereal tone of the new Government, but there has been a marked difference perception and reality!
For the UK, the reality has been a continuation of stronger data, whilst the perception has manifested in a notable drop in both consumer confidence and business confidence: both of which are key ingredients to long-term growth. The cautious UK Consumer upped their savings’ rate in the third quarter (to 10% of disposable income), but consumer spending remained strong (likely due to the rise in real wages) and this fed through to stock prices and earnings, with domestically focused shares faring particularly well.
Central Bank stimulus
Interest rate cuts came in Q3 from the Bank of England, the European Central Bank and the US Federal Reserve, with the latter making a larger than usual cut (of 0.5%) and providing a clear signal that they’d be looking to cut further. This provided a much welcome boost to investment markets in the last few weeks of the quarter, with this being amplified even further by a very large stimulus injection from the Chinese authorities.
The World’s second largest economy has been something of a sleeping giant in recent years and late September saw the Chinese authorities unleash the biggest amount of stimulus on the economy since the depths of the pandemic. Time will tell whether lower interest rates and more favourable mortgage terms can coax Chinese consumers out of cash savings (where savings rates are around 45% of disposable income!) and back into property and investment markets. However, it made for a late surge for emerging market stocks, which finished the quarter up by just shy of 5%.
What’s coming up?
As we look ahead to the fourth quarter, we expect markets to focus on continued strength in corporate earnings, the US election and the path of future interest rates. Whilst the US election result is too close to call, we’d note that US debt levels of circa $35 trillion will be instrumental in shaping the path of future policy. The Congressional Budget Office expects debt interest costs to top $1 trillion in fiscal year 2025. The next President may face constraints due to this, whatever their political stripe. Lower interest rates will not only be welcomed by Consumers, Corporates and Governments alike, but they’ll also help tease out some of the $6.5 trillion dollars currently sitting in US money market funds. The path may not be a smooth one, but we expect this backdrop to be supportive of further asset price growth as we head in Q4 and beyond.
The source for all data is Bloomberg (unless stated otherwise)
The value of investments and the income from them can go down as well as up and you could get back less than you invested. Past performance is not a reliable indicator of future performance.
The content of this article is not intended to be or does not constitute investment research as defined by the Financial Conduct Authority. The content should also not be relied upon when making investment decisions, and at no point should the information be treated as specific advice. The article has no regard for the specific investment objectives, financial situation or needs of any specific client, person, or entity.
