Stocks and Bonds Rose Amid Hopes for a Soft Landing - but Gold Outperformed Them Both

The third quarter of the year ended on a positive note for both stocks and bonds, as investors became increasingly hopeful that the Federal Reserve might successfully achieve a "soft landing" for the U.S. economy. This optimism was echoed by Michael Arone, the chief investment strategist at State Street Global Advisors, who commented on how confidence in this outcome is growing. However, he cautioned that soft landings are rare. The strong performance of gold suggests that some investors remain wary and are hedging against potential risks to the economic outlook.

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SPDR Gold Shares (GLD), an exchange-traded fund (ETF) that invests directly in physical gold, has surged 27.1% this year. This rise includes a gain of more than 13% in the third quarter alone, according to FactSet data. This outperformance exceeds the S&P 500’s 5.5% rise in the third quarter and the 20.8% increase the index has experienced over the course of the year. The strength of gold, a traditional safe haven, reflects the lingering uncertainty in the market, even as stocks have performed well.

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September saw the start of the Federal Reserve’s anticipated interest-rate-cutting cycle. There had been uncertainty surrounding the size of the first cut, but on September 18, the Fed opted for a substantial half-point reduction. This marks a shift from the central bank’s aggressive rate-hiking stance, which was previously aimed at taming high inflation. The goal now is to steer the economy toward a soft landing—achieving a slowdown without triggering a recession.

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Bonds also performed well during the third quarter, with popular exchange-traded funds (ETFs) that track fixed-income assets continuing a monthly winning streak. The iShares Core U.S. Aggregate Bond ETF (AGG), which represents the U.S. investment-grade bond market, posted a 5.3% gain for the quarter, bringing its year-to-date total return to 4.6%, according to FactSet. This marks the ETF's strongest quarterly performance in 2024 so far.

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Riskier corporate bonds, also known as high-yield or “junk” bonds, saw even larger gains. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) rose by 5.7% in the third quarter, bringing its total return for the year to 8.1%. Similarly, the SPDR Bloomberg High Yield Bond ETF (JNK) reported a 5.5% gain in the third quarter, contributing to its 7.9% year-to-date return.

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Arone attributed the rally in junk bonds to several factors, including investors’ growing belief in a soft landing, the Fed’s rate cuts, and improvements in U.S. corporate earnings and profit margins during the second quarter. He noted that as long as profit margins continue to expand, the outlook for high-yield bonds should remain favorable.

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Corporate earnings reports for the third quarter will start to roll out in October. Arone suggested that declining interest rates will benefit companies that need to refinance their debt, particularly those in the high-yield sector. He highlighted the attractive yields that junk bonds are offering, arguing that the rewards currently outweigh the risks.

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At a press conference on September 18, Federal Reserve Chair Jerome Powell reinforced the positive outlook for the U.S. economy. He emphasized that the labor market has cooled from its overheated state and inflation has moderated significantly. Powell’s remarks underscored the overall strength of the economy, contributing to the optimism that the Fed may succeed in achieving a soft landing.

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Despite this optimistic outlook, Arone advocated for maintaining a small allocation to gold as a hedge against the risk of a recession, even though he doesn’t consider that to be the most likely outcome. He advised long-term investors to allocate between 3% and 10% of their portfolios to gold. The yellow metal has historically helped portfolios weather periods of uncertainty and can offer protection against unforeseen risks, or what Arone called “unknown unknowns.”

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The last time SPDR Gold Shares (GLD) experienced a quarterly gain of more than 13% was in the second quarter of 2020, during the height of the COVID-19 pandemic and the associated lockdowns. The current rally in gold is noteworthy, particularly given that declining interest rates reduce the “opportunity cost” of holding non-yielding assets like gold. Arone remarked that while the U.S. economy could experience a soft landing or possibly no landing at all, holding some gold is a wise move in case the optimistic projections prove wrong.

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In conclusion, while markets are increasingly optimistic about the Federal Reserve's ability to navigate the economy toward a soft landing, the strong performance of gold indicates that some investors are still preparing for potential bumps in the road. Bonds, particularly in the high-yield sector, have also benefited from this outlook, as investors look to capitalize on attractive yields in a falling-rate environment. However, the need to hedge against economic risks remains, with gold offering a valuable safety net during uncertain times.

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