As we preview the quarter ahead, will the economy continue to hold up better than expected? Coming up, we’ll find out.

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From Thrivent Asset Management, welcome to Advisor’s Market360™, a podcast for you, the driven financial advisor.

If you’ve ever heard the phrase, “I’ve got good news, and I have bad news,” then you have a good framework for the current state of the economy. On the good news side of the ledger, the economy is holding up better than anticipated, wealth is high, retail sales are strong and corporate earnings have been good.

Now for the bad news: wealth is unevenly distributed; the lower and middle classes are showing signs of struggle, prices remain high, and the labor market is something worth watching. The good news/bad news summary is that the economy is slowing, which we expect will result in a soft landing. But there continues to be a risk of recession.

So how will all these factors shake out in the fourth quarter and beyond? To help us interpret the data and analyze the markets, we have three Thrivent experts: Steve Lowe, Chief Investment Strategist, David Spangler, Head of Mixed Asset and Market Strategies, and Kent White, our Head of Fixed Income.

Let’s get into it…

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For many months, economists have been warning that a recession was imminent. But so far, their predictions have not come to pass. We wanted to get our experts’ take on soft landing versus recession. First up, Spangler:

(Spangler) “Yeah, I, too, would be in the camp of more of a soft landing at this point. We’re beginning a rate cutting cycle here with a large, first 50 basis point rate cut into an environment where we're not in recession, but rather, we still have economic strength. GDP is still growing; the consumer is still spending. And we’re seeing that that cycle is being extended.”

Lowe added his thoughts:

(Lowe) “Normally when the Fed is cutting 50 basis points or larger, you’re already in a recession. And this case is purely preventative. So, it’s a little bit different.”

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Looking back, we wanted to get a fix on some of the key trends and key themes over the previous quarter. Here’s Spangler:

(Spangler) “Consumer spending, which is about two-thirds of the total GDP of the United States, is very well supported at this point with the wealth effect. We’re seeing record levels of housing equity. Housing equity is up more than double, or double over the last seven years. The US stock market is also at record highs, and the money supply is beginning to grow after having contracted for some period of time with rising rates. We’re also seeing the velocity of money begin to rise a bit, too. The decline in interest rates, that will support areas of the market that were hurt with rising interest rates. So more cyclical areas would be supported with a reduction of interest rates. And jobless claims are reasonably firm at this point. They’re pretty low. And so, in total, the consumer is well supported, both from the wealth effect and having capacity to continue to spend.”

While these trends are positive, there are also areas of concern looking forward to the end of the year and beyond. Here’s what’s most concerning to Lowe:

(Lowe) “I'm most concerned about the labor market. You know, unemployment is rising and it’s at a level where typically it would keep rising. And, you know, the definition of a recession really, or the hallmark of it, is high unemployment and job losses. And the job market, sort of like the economy, could deteriorate very, very quickly. We’re not seeing that many layoffs. It’s really the companies have pulled back on hiring. They’re very, very reluctant to let workers go because they had a bad experience during Covid, and it costs a lot of money to hire, and it costs a lot of money to train people.”

Spangler has his own set of concerns:

(Spangler) “My concerns are, geopolitical events. You know, these are things, of course, that we can’t predict what’s going to happen. But an example is within the Middle East. If that grows into a wider conflict, it could cause some disruption and volatility in the markets. However, you know, history has shown that, while the market can pull back, with wars it actually ends up being more of a buying opportunity, intermediate and longer term.

“I also have some concerns around the election as well, just in terms of the uncertainty. You know, if we have a contested election, there’s a lot of different directions that could go in. There could be a period of time where we don’t actually know who the winner is, or there might not be one that concedes. So part of the issue is that the markets don’t like uncertainty. They want certainty. And so that would cause some near-term concerns as well.”

We also wanted to hear from White about his concerns about the economy’s future.

(White) “Well, there’s always no shortage of things to worry about. I think one of the risks that we’re kind of looking at and maybe isn’t really priced in the market right now is an environment where the labor market continues to gradually weakened and inflation remains elevated or even begins to accelerate. The Fed likely won't be able to cut rates in this environment, and the markets would probably react really negatively to that scenario.”

White mentioned inflation as a topic that is top of mind for many. Concerns over inflation have been driving what the U.S. Federal Reserve, or Fed, has been doing, which has in turn been driving markets to a large extent. So now that inflation has moderated and even lowered a little bit, how will that change the Fed’s actions? Here’s Lowe:

(Lowe) “Inflation is lower. And what that does is enable the Fed to cut rates and be more dovish. And they’ve cut already. And we expect them to continue to do so. You know, and they’ve raised rates very aggressively compared to history, because inflation was the highest since the 1980s. But it’s falling significantly already. It’s approaching the Fed’s 2% target. But the Fed appears very confident that they have, you know, inflation in the bank, that it'’ sustainably lower. And the Fed has a dual mandate from Congress. One part is price stability, which is inflation. The other is maximum employment, which is the jobs market. So, what this does is it enables the Fed to pivot to the jobs market, which is the key to avoiding a recession right now. And they can lower rates, help the economy and not worry about inflation taking off.”

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Let’s now turn our attention to the global markets. We wanted to hear about how various economies around the world are doing and whether any of them present a good investment opportunity. We got Spangler’s take:

(Spangler) “So, international is an interesting question because with the Fed lowering interest rates, it allows other international countries to lower rates as well. So, for example, the emerging markets have more capacity to lower rates if we’re lowering rates. And that can be supportive. But overall, we’re still underweight international, particularly in developed markets, and having a lot to do with Europe and slow growth within Europe.”

Spangler also weighed in on emerging markets:

(Spangler) “We’re of moderately underweight emerging markets. Within the emerging markets, just today, this week, the Chinese government has come out with a whole series of monetary stimulus to the markets—supporting mortgages, supporting the equity markets and lowering borrowing rates, among other things. So that that is supportive and stimulative within China. But it’s really just a, I think a small step because it’s not addressing the substantial overhang of their housing market, real estate markets and extremely low consumer confidence and sentiment within China. So, without much larger stimulative measures within China, we still would remain underweight China or emerging markets by some modest degree.”

Spangler also had some thoughts on Europe. Specifically, why European countries do not keep pace with U.S. companies.

(Spangler) “So entrepreneurship, new business formation, the capital markets, private equity, venture capital, angel investors, friends and family, all of that is an ecosystem that’s unmatched and unparalleled within the global economy. And so, the innovation is it within the United States. It’s not in other areas, internationally. And Europe has tremendous structural problems as well, from demographics, very intractable employment, and much, much higher regulation. So, the innovations and growth is not going to come from Europe, it’s going to come from the United States. And so, we remain overweight within the domestic markets. And principally, as I said, the main underweight is within developed markets, internationally.”

Lowe had this to add about Europe:

(Lowe) “Germany in particular, it’s been very anemic, you know, and that’s kind of the heart of the European economy. So, it’s hard to see that really getting going without the largest economy there going.”

To summarize, our experts recommend remaining overweight in domestic versus international.

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Earlier in the episode, we touched on interest rate cuts, but we felt like a deeper discussion was warranted. We asked White where he thinks interest rates are heading.

(White) “So the Fed just began their cutting cycle with a 50-basis point cut. That’s the first reduction in the Fed funds rate in over four years. So, they’ve started cutting rates, though, from what the Fed viewed as a very restrictive level. And the Fed funds rate is still above where anyone believes the neutral rate really is. So, from that perspective, there’s still a lot of room for the Fed to continue recalibrating rates to lower levels. We'’e likely to see probably two more 25 basis point cuts this year, possibly a 50 in November, depending on what the labor market looks like. We have two more labor readings between now and then. So, if they come in weaker, maybe they'd go another 50. And then in 2025, the Fed dot plot right now is showing four cuts or 100 basis points of easing into 2025.”

Having hypothesized on the Feds’ actions, we wanted to know if the market is on the same page with the Feds’ views. Here’s Lowe:

(Lowe) “Relatively aligned, but it’s still pricing in more cuts than the projections that the Fed put out. The Fed is looking for four cuts in 2024, followed by four more in 2025. The market is closer to five this year, and five more in 2025. You know, I think if the Fed does cut less than expected, you could see, you know, rate markets react to that.”

We will let White have the last word about interest rates:

(White) “Recent economic data point to an economy that is perhaps slowing down a little bit, but definitely not heading into a recession, in our view. Some recent data actually point to an economy that remains quite strong. And it might be reaccelerating a little bit from the summer. So, with a soft landing as our base case, our expectation is that it will take longer for inflation to reach the Fed’s 2% target. And as a result, the curve is likely to continue to steepen, meaning that long rates are going to decline less than short rates. And we think that the ten-year Treasury yield is likely to remain in a range from 3.5 to 4 percent.”

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Next, we want to turn our attention to fixed income. The first thing we wanted to cover was the shape of the yield curve which is currently a little out of whack. Here’s Lowe:

(Lowe) “The curve has been steepening, it’s un-inverted after the longest inversion ever, which was more than two years. And that’s where, you know, short rates are higher than long rates. And usually, it's the other way around. And the catalyst for the curve steepening was the Fed cutting shorter rates. And you know, that impacts two-year rates significantly. You know and long rates actually rose, as you mentioned, partly I think because of improving growth expectations. And more concerned that as the Fed cuts, inflation might come back, but, you know, expect it to continue to steepen.”

White had this to add about the yield curve:

(White) “Yeah, another factor behind our view for a steeper Treasury curve besides inflation not going away as easily, is that the fiscal backdrop will likely keep a floor on kind of rates out the curve, ten years and 30 years especially. We’ve also had some periodic weak Treasury auctions throughout the last year, and those are likely to happen again periodically over the next 12 months. So, we could see more of these, which would keep some upward pressure on interest rates out the curve.”

Credit markets have been relatively rich. We wanted to get White’s take how valuations look there. And if he is seeing any signs of weakness.

(White) “Credit market valuations still remain relatively rich. They’ve been that way for most of the last couple of years or so. We don't have much cushion in credit spreads if the economy were to weaken, and spreads began to widen. So, we’re a little defensive there. But under the soft-landing scenario that we're expecting, one with moderating growth and moderate inflation, credit generally performs pretty well in that environment. So, we may not like valuations particularly at this point, but from a yield perspective, an all-in yield perspective, we do still find credit attractive.”

Here are White’s thoughts on corporates:

(White) “Investment grade corporate yields are still far higher than they've been over most of the last 15 years. And as for corporate fundamentals, corporate balance sheets are still pretty well positioned right now. And we’re unlikely to see any meaningful weakness or deterioration in those, even if the economy is a bit weaker than we’re expecting.”

We also wanted to know how Fed rate cuts might affect the credit market. Again, here’s White:

(White) “I think the one part of the credit market that would benefit the most from a Fed rate cutting cycle are the riskiest parts of the high yield market, especially triple-Cs. Many of these companies finance themselves with floating rate debt. And as the Fed was raising rates to fight inflation, the interest burden on these companies made it really difficult for them to survive. A lot of them have just been barely getting through. And now with Fed cuts and Fed rate cutting cycle on the horizon, that will begin to flow through to their loans, which will relieve some of this burden.”

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Next, we turn our attention to equities which have been noticeably more volatile recently. But there’s also been signs of a broadening out from the current extreme concentration on the Magnificent Seven. And is that broadening sustainable? Here’s Spangler:

(Spangler) “Well, as you have mentioned, there has been some broadening more recently. But year to date, the Mag Seven—or the Big Six, however, we want to say it—is still the market leader, but we are seeing a broadening out within the S&P 500. The S&P 500 Equal Weight is over the last month and more has been performing better than the capitalization-weighted index. And we are seeing mid-caps and small caps also performing a little bit better than they have throughout the, you know, the early part of the year and last year as well. So, the question then is what is broadening out? So, is broadening out into mid-caps and small caps and from growth to value, or is it really just within the S&P 500?”

Spangler has an opinion about that:

(Spangler) “I think that I’m a little bit more in the camp of broadening out within the S&P 500, and not as much into mid-caps and small caps and value from growth. Although currently they have been performing a little bit better. But your question was a little bit to sustainability, and I don’t see that necessarily as sustainable and durable into 2025. And it's a little bit more of a near-term phenomenon with the more recent decrease in interest rates. And, you know, the thing about small caps as well is that it doesn't take a lot of money to move from large into small to really push the price of small caps. But that's a lot more of, like, what we would call a technical rally and not necessarily a fundamentally based or sustainable and durable rally within small caps relative to large caps.”

In terms of preference for value, small cap, mid-cap and large cap equities, Spangler still likes large cap equities. That is mostly the result of how and why companies are growing. Because of venture capitalists, many small companies never have an initial public offering or IPO, before they are purchased. Large tech companies are also acquiring promising small companies before they ever reach the stock market. The result is mostly low quality offerings in the small cap space. Lowe agrees that small caps will continue to underperform and offers his opinion on what it will take to change that dynamic:

(Lowe) “So to sustainably outperform, they’re going to need stronger economic growth. You know, Fed cuts help, you know, because they have a lot of debt. But overall, they’re secularly challenged.”

And since there continues to be a lot of buzz around AI, we wanted to check in on where investments in that sector might be heading. Here’s Lowe:

(Lowe) “I think another trend that we’ve already seen in spurts is that the market is going to demand proof from companies involved in AI that they can actually make money at this and monetize it. You know, kind of ‘show me the money.’ You know, and that excludes the chip companies, which are already—the semiconductor companies that are already making money off this. So overall, relatively positive, but challenges.”

To summarize the outlook on equities, it does look promising. Thrivent is currently overweight domestic versus international, and within international, developed over emerging markets. Thrivent is overweight in large caps, overweight in mid-caps, and only a little underweight in small caps. Of course, there are always challenges to growth, so investors need to remain vigilant.

Overall, there is a lot of good news in the economy. And while a soft landing looks increasingly likely, we will be keeping an eye on the labor market, which has the potential to lay waste to the Fed’s plans for more rate cuts.

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We hope you enjoyed this fourth quarter outlook. Once again, we would like to thank Steve Lowe, David Spangler and Kent White for their insights. What did you think of this episode? Email us at podcast@thriventfunds.com with your feedback or questions for our experts. Want more episodes of Advisors Market360^™ and other market and investing insights? Visit us at thriventfunds.com, where you can learn how we can partner with you, the driven financial advisor. Bye for now.

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Past performance is not necessarily indicative of future results.

Investing involves risks, including the possible loss of principal.

All information and representations herein are as of September 24, 2024, unless otherwise noted.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

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