Quarterly Performance Update

U.S. Stocks Rallied Despite a Sharp Short-Term Sell-off

The volatile third quarter ended on an upbeat note for stocks, with the S&P 500^® Index reaching several record highs and returning 5.89%. The quarter’s rally drove the index’s year-to-date return to 22.08%.

All S&P 500 Index sectors except energy advanced, led by utilities and real estate, up 19% and 17%, respectively. Size and style indices also posted strong returns, with value outpacing growth and small-caps outperforming large-caps. The Russell 2000^® Value and Russell Midcap^® Value indices were top performers, each gaining more than 10%.

Weak Data Triggered Volatility

U.S. stocks advanced despite a steep sell-off in early August, fueled primarily by unexpected manufacturing sector weakness and disappointing labor market data. The unemployment rate reached 4.3% in July, the highest since October 2021, while payroll growth was surprisingly weak in June and July. Additionally, the Bureau of Labor Statistics said the economy added 818,000 fewer jobs than originally reported for the 12-month period ended in March.

Despite these developments, stocks quickly recovered and finished August with a gain. Continued easing in inflation, a jump in retail sales and strong second-quarter earnings reports helped fuel the turnaround.

Fed Announced Aggressive Rate Cut

By September, the Federal Reserve (Fed) reclaimed center stage as investors focused on a much-anticipated rate cut. Concerned about job market weakness, the Fed delivered a half-point cut, larger than the quarter-point cut many had expected. This action dropped the short-term lending rate range to 4.75% to 5%.

Fed Board Chair Jerome Powell indicated the larger rate cut represented a “recalibration” of monetary policy as risks to inflation and employment become more balanced. He noted the cut aims to prevent further labor market weakness while maintaining the economy’s resilience.

Non-U.S. Stocks Outperformed U.S. Market

After declining slightly in the second quarter, non-U.S. developed markets stocks (MSCI World Ex-USA Index) rebounded strongly, gaining 7.76%. The third-quarter rally pushed the index’s year-to-date return to 13.1%.

European stocks advanced but lagged the broader index. Amid still-weak economic growth, the European Central Bank reduced its benchmark interest rate by a quarter-point as inflation moderated. Headline inflation in September fell to 1.8%, below the central bank’s 2% target and the lowest level in more than three years.

Eurozone manufacturing slipped further into contraction mode in September, dropping to its lowest level so far this year. The services sector weakened at quarter-end but remained expansionary.

Economic indicators were relatively stronger in the U.K., where stocks outperformed the broader index. A September expansion in manufacturing marked the fifth consecutive month of growth, while the services sector logged its 11^th straight monthly expansion.

The Bank of England in August cut interest rates for the first time since the COVID-19 pandemic, but policymakers left rates unchanged in September. Annual inflation remained unchanged at 2.2% in August, slightly higher than the central bank’s 2% target.

Stocks in Japan advanced but underperformed broader developed markets. The Bank of Japan raised interest rates in July to the highest level since 2008 and held rates steady in September. Inflation reached 3% in August, the highest level since October 2023.

Late-Quarter Rally in China Propelled Emerging Markets Index

Bolstered by a 23. 9% September gain in China’s market (MSCI), emerging markets (EM) stocks were the quarter’s top performers, returning 8.72% (MSCI Emerging Markets Index). The People’s Bank of China announced several measures to boost the nation’s struggling economy and aid the stock market. Policymakers cut interest rates, lowered bank reserve requirements and launched a loan program for investors to purchase Chinese stocks.

Dovish Central Banks Aided Bonds

U.S. bonds, as measured by the Bloomberg U.S. Aggregate Bond Index, returned 5.2% for the quarter, as Treasury yields declined. Among index sectors, investment-grade corporates and mortgage-backed securities outperformed while Treasuries underperformed.

The headline Consumer Price Index (CPI) grew at an annualized pace of 2.5% in August, down from 3% in June. Annual core CPI inched lower from 3.3% in June to 3.2% in August. The annual core Personal Consumption Expenditures inflation rate, the Fed’s preferred gauge, climbed from 2.6% in June to 2.7% in August.

Despite core inflation lingering above the 2% target, the Fed pivoted to a less restrictive stance and cut interest rates by half a point. The market’s easing anticipation ahead of the Fed’s announcement, along with the actual rate cut, drove Treasury yields lower. The yield on the 10-year Treasury note dropped 61 basis points (bps) to 3.79%, while the two-year Treasury yield fell 111 bps to 3.65%.

Elsewhere, government bond yields in the U.K. and Europe also declined, and global bonds generally rallied. However, the U.S. dollar declined versus other currencies, weighing on the Bloomberg Global Aggregate Bond Index (USD, Hedged), which returned 4.24% for the quarter.

EM bonds also delivered solid gains for the quarter, with local currency-denominated securities generally outperforming U.S. dollar-denominated bonds. EM sovereign securities broadly outperformed corporate bonds.