The Horizon

The third quarter of this year can be characterized as a dynamic time for investors, with a normalizing economy, a still-solid U.S. consumer, a relatively solid labor market, a broadening in corporate earnings growth, and elevated geopolitical risk.

Within this macroeconomic backdrop, it can be challenging to parse through the noise and make sense of the investment landscape. In this edition of The Horizon, we emphasize ways investors can take action within their portfolios and stay the course as we approach year-end. We highlight the long-term reasons for a secular equity bull market and our recent upgrade within the Financials sector.

Amid the myriad of near-term market dynamics, it's easy to lose sight of the underlying market direction. The stock market moves cyclically with the business cycle, but it also follows a secular, or longer-term, trend that can persist for years or even decades. In “Thinking Longer-Term: We See Continued Upside for U.S. Equities,”¹ from our weekly Capital Market Outlook report, we explain why we believe the secular bull market remains intact and what this means for investors.

Secular market periods materialize over long time horizons and are typically defined by major regime shifts, such as technological revolutions or notable policy transitions. Cyclical bull and bear markets are situations where Equities rise or fall by at least 20%. This scenario, in addition to economic expansions and recessions can exist within both secular bull and bear markets. It is the momentum in the market that differentiates a secular market. We believe U.S. Equities remain well entrenched in a secular bull market that began after the 2008-2009 Global Financial Crisis (GFC) and broke out to the upside in 2013 when the S&P 500 Index recovered its prior GFC all-time high. Despite the pandemic-era pullback and the 2022 bear market drawdown, the trend remains upward. From a secular view, the long-term run over 752% from its 2009 generational low is modest at best compared to the last two secular equity bull advances that gained +1,159% and +2,353% (data as of 9/30/24).

While risks remain over the next decade, we see many positive factors emerging that should drive future long-term growth in U.S. equities, including an artificial intelligence (AI)-led technological revolution and an emerging equity culture. First, technological advancement powered the previous secular bull market with the proliferation of computers and dawn of the internet age. Optimism surrounding the positive implications of AI advancements could create a similar situation in the next phase of the secular bull market, as it has the potential to boost corporate productivity and profitability across new industries and jobs. As the Federal Reserve (Fed) has begun to cut rates, the cost of capital is likely to fall, allowing for increased investment and broader AI adoption.

Second, more U.S. households are investing than ever before. According to the latest Survey of Consumer Finances, about 58% of U.S. households now own stocks through various investment accounts, the highest on record. More specifically, direct stock ownership rose from 15% in 2019 to 21% in 2022. We believe the ongoing secular bull cycle should continue, fueled by accelerating innovation, the buildout of domestic supply chains and high-tech manufacturing, investment in the energy transition, and expectations for the great wealth transfer. This is a powerful new wave of stock market participation, and with the possibility of rising volatility, we view near-term pockets of weakness as opportunities to add to equities.

Much of this year has been centered around Fed activity and when they would begin the next easing cycle. In the third quarter, investors received their answer, as the Fed lowered interest rates by 50 basis points, easing monetary policy for the first time in over four years. Accordingly, the Global Wealth & Investment Management Investment Strategy Committee (GWIM ISC) upgraded Financials to a slight overweight from neutral. In our recent Equity Spotlight report, "Fins Up: Upgrading the Financial Sector to Overweight (Industrials Cut to Neutral)"² we explore the reasoning behind our tactical change.

Lower interest rates can help improve credit quality, net revenue, and asset valuations on Financials balance sheets. Essentially, a measured reduction in interest rates should be bullish for earnings, credit quality, and equity capital. Perhaps counterintuitively, a lower Fed funds rate benefits deposit gatherers because of the immediate decline in interest expense paid on deposits. The possible decline in interest revenue from loans and securities would be much more gradual, so net interest income has likely bottomed for this cycle. In fact, the roll-off of low-yielding securities (from 2020 and 2021) acquired before the Fed raised rates in 2022 could benefit net revenue as they are replaced by higher-yielding securities. There has been an increase in regional bank mergers this year, suggesting sufficient confidence to deploy capital following the regional banking troubles back in March 2023. Additionally, a lower Fed target rate generally lowers interest rates across the curve (and within the U.S. financial system), which can increase bond prices and minimize losses generated by higher rates. Shrinking unrealized losses in bond portfolios should contribute to equity holders in the form of a higher book value and increased capital flexibility for banks, insurance companies and asset managers. Capital return will likely remain a major reason for the investment case for the Financials sector. Overall, we believe there is an opportunity for investors to diversify their portfolios with the inclusion of Financials given the changing macro backdrop.

Ultimately, any market turbulence in the final few months of 2024 will likely encounter powerful tailwinds that should provide a solid foundation for continued equity strength. We continue to advocate for a balanced, diversified portfolio, with exposure to equities, fixed income and alternative investments, where appropriate. We recommend investors remain fully invested, as we believe this will be beneficial for longer-term financial success.