By Tim Courtney, Chief Investment Officer

This year has been surprisingly strong across almost every asset class, something we don’t often see. Inflation has been cooling, interest rates have steadied, and markets are largely optimistic. However, returns ultimately come from risks, and each asset class still faces risks and challenges. Let’s take a closer look at where things stand.

Starting with fixed income, investment-grade bonds returned 5.8% during Q3.,¹ delivering a positive real return above the current inflation rate of 2-3%.² This happened because interest rates fell. However, this creates a narrower cushion between rates and inflation. If inflation picks back up and moves higher than current rates, real bond returns could be negative. This would be a repeat of the purchasing power lost between 2020 and 2023.³

High-yield bonds, including floating-rate loans, are up around 6.6%.⁴ The catch, though, is that these bonds are far more sensitive to economic slowdowns. The companies issuing high-yield bonds typically have lower quality balance sheets. While prices for these assets are holding steady, they will likely start to decline if the market senses we are approaching a recession. 

Turning to equities, U.S. large caps, driven by the S&P 500, have gained about 25% this year, making them the top-performing equity class globally.⁵ Much of this growth is fueled by strong sentiment around tech and AI. But, the historically high price of these assets remains a concern. Large caps are trading at roughly a 50% premium to their historical valuations.⁶ The last time we saw prices this elevated was in the early 2000s, which led to a “lost decade” of negative returns from 2000 through 2009.⁷ If AI’s potential doesn’t fully pan out or enthusiasm wanes, portfolios focused on the most expensive areas of the market could see a large correction.

Other equity segments, including small caps⁸ and international stocks,⁹ have also seen strong returns, up about 16% and 7%, respectively. While not as high as large caps, these areas benefit from more reasonable valuations, aligning closely to their historical averages. However, like high-yield bonds, they tend to be more economically sensitive, so a slowdown could hit them harder. Internationals also have the risk of a rising U.S. dollar, which has limited their returns YTD.¹⁰

 Real assets, specifically REITs, have had returns between 5-11%.¹¹ They’ve gotten a boost from the recent stability in interest rates, but questions remain about demand, especially in the office and retail spaces. There’s an oversupply in many places, and shifts in how companies and consumers use space are still playing out.

 Commodities are mixed this year. Master Limited Partnerships, primarily pipeline companies, are up over 20%,¹² yet broader commodity indexes, including oil, metals, and agricultural goods, are mostly flat due to cooling inflation. One standout is gold, which has risen about 30%,¹³ an unusual performance given the broader market optimism and falling inflation.

In short, it’s been a strong year with almost every broad asset class positive. As always, there are risks associated with every asset. If you have questions about this, please contact your Exencial advisor.

Sources:

1. Bloomberg (10/1/24) - US Investment-Grade Bonds Return 5.8% in Best Quarter of 2024
2. CNBC (11/13/24) - Annual inflation rate hit 2.6% in October, meeting expectations
3. Investopedia (8/13/24) - Understanding Interest Rates, Inflation, and Bonds
4. Morningstar (11/4/24) - Where Are The Opportunities in High Yield Bonds Now That Interest Rates Are Falling?
5. Yahoo! Finance (11/13/24) - S&P 500 YTD Performance
6. Yardeni Research (11/13/24) - Stock Market P/E Ratios
7. MarketWatch (10/22/24) - Wall Street is worried stocks might be on the cusp of a ‘lost decade’
8. Yahoo! Finance (11/13/24) - Russell 2000 YTD Performance
9. Yahoo! Finance (11/13/24) - MSCI WORLD YTD Performance
10. The International Monetary Fund (6/11/24) - Dollar Dominance in the International Reserve System: An Update      
11. Seeking Alpha (10/19/24) - The State Of REITs: October 2024 Edition
12. ETF Trends (10/8/24) - Which Energy Subsector Is Up Over 20% YTD?
13. Reuters (10/17/24) - Gold hits record highs on US election uncertainty, more policy easing

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The S&P 500® Index (S&P 500®) is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.® Index (S&P 500®) is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.