Q3 2024 Review: Maybe The Market Does Care?

Maybe the market does care? Out of nowhere, the broader market “woke up” and decided there were a whole lot of compelling investments that had little to do with AI. For the first time this year, the average S&P 500 stock outperformed the market cap weighted index, going up 9%, or almost double. 

Many of our previously beaten down companies caught this strong tailwind. As discussed last quarter, we saw this coming and can easily explain why the market finally came to its senses. Well, not really. Sometimes the market just decides to care, but it isn’t always clear why.   

For example, VF Corp, owner of Vans and The North Face jumped 56%, with excitement for CEO Bracken Darrell’s turnaround plan taking shape. However, it will take years, not a quarter, for these brands to fully transform. Instead, is it possible that all it took was the prospect of interest rate cuts to boost beaten down consumer stocks? 

Meanwhile, Scotts Miracle-Gro, the leading supplier of lawn and garden products, climbed 37% as the summer gardening season was better than expected. Still, earnings are down significantly from peak Covid years. Perhaps it was the potential for cannabis legalization and increased demand for Scott’s hydroponics business that led to the stock surge?

We’ve thought for a while that eventually the large telecom providers would have to increase their investment in 5G infrastructure, which must be the reason that Crown Castle Inc, one of the largest domestic owners of cell-towers, jumped 25%. Unfortunately, investment growth remains sluggish, so maybe it was renewed interest in their underutilized fiber assets to support AI datacenter growth?

We can go down the portfolio and pick out companies that outperformed the market; Option Care Health (14%), Air Products (20%), Medtronic (17%), Fiserv (22%), and Kinder Morgan (13%). But the truth is, we have no idea why September was the month for our sleeping giants to awake, or if our good fortune will continue in October. 

A quarter like this serves as a reminder that in the short run, markets are often driven more by sentiment or changes in the wind than actual fundamentals. While the recent narrative has been dominated by AI and big tech, it only took a shift in outlook, perhaps lower rates or renewed optimism about the economy, for other sectors to finally start catching up.

Meanwhile, big tech remains on a collision course in AI. After two decades of playing in their own lanes (Apple in mobile, Google in search, Amazon in e-commerce, Microsoft in enterprise software, and Meta in social media) these companies are now directly competing for the holy grail of AI. With near all-time high valuations and a much more uncertain future, we continue to position our portfolios towards more compelling and safer opportunities. One quarter, in either direction, doesn’t change this.

One thing that is clear is general excitement about the Fed cutting interest rates. Rate cuts bring the prospect of lower mortgage costs, higher equity prices, and a “soft-landing” (where the Fed gently lands the economy while bringing down inflation). Recent history tells us the odds favor easier monetary policy (i.e. lower rates) leading to a more buoyant market, but there are no guarantees.   

Over the last forty years, the Fed has cut interest rates seven times. In five of those periods, stocks were higher one year after the first cut. Twice, in 2001 (telecom bubble) and 2007 (housing bubble), stocks were (much!) lower. Most of the time things turn out ok, but they could also turn out quite poorly. Thankfully, our value investing strategy doesn’t require us to guess how far the Fed will cut, or how the market will respond.

The market also remains fixated on the upcoming US presidential election. A month out, it looks like a toss-up, with a handful of states and tens of thousands of votes likely to decide the future President. If the last eight years taught us anything, not only are close elections difficult to predict, but how the stock market will react may be even more challenging. In any event, history shows that the president’s political affiliation has very low correlation with future stock performance.  

What is most concerning is that the world remains stuck in two very hot wars, the Middle East and Ukraine, and a smoldering cold war between the US and China. Oil and commodity prices change with intense volatility as new fronts begin in the Middle East or as China announces economic plans to bolster its flagging economy. Best of luck to anybody who has to try and figure out the endgame for these wars, how much the Fed is going to cut rates, who is going to win the election, and if these factors are going to make the market go up or down. 

While it is nice to see our companies lead the market this quarter, nothing about our investment process or discipled approach changes. We remain focused on investing in companies with strong long-term potential and paying a reasonable price for that growth. As has proven true for decades, through both Republican and Democratic administrations, and high and low interest rates, the best investments are typically made during periods when a particular sector or company is out of favor. The challenge is to remain invested for when sentiment eventually shifts. It always does. 

_{Compass Wealth Management LLC is a SEC registered investment advisor, clearing transactions primarily through Pershing Advisor Solutions and Pershing LLC subsidiaries of Bank of New York Mellon Corp. This letter is written by Compass for the benefit of its clients and does not necessarily represent the opinions of its affiliated organizations. It is based on information believed to be reliable, but which is not guaranteed to be correct. Nothing herein shall be construed to be a solicitation to buy or sell securities, indicate that past performance is predictive of future returns, or recommend individual investments.}