Q3 2024 Model Portfolio Review

Performance flat in Q3, +1.2% YTD with live catalysts at play.

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The S&P 500 (SPX) continued its upward rise in Q3, appreciating 5.5% to close the quarter at a record high of 5,762.48 (note this has since been surpassed by subsequent, successive new highs reached over the last few trading days).

The quarter-end high is notable given that it swiftly followed genuine concerns of an economic slowdown (or worse) earlier in the quarter, not to mention the risk of war in the Middle East upending the global economy by driving oil prices (and therefore inflation) higher again. Nevertheless, as at quarter-end, the market discounted these risks and marched higher.

In looking at what worked during Q3, it is interesting to note that both technology (XLK) and energy (XLE) stocks declined over the quarter, producing negative returns as well as underperforming the SPX. This marks a divergence from their relationship since the energy crisis began in early 2022, when these sectors typically moved inversely to each other.

Instead, what worked best in in Q3 was utilities (XLU, +19.35%), real estate (XLRE, +17.1%) and industrials (XLI, +11.5%):

At a headline level, this would make sense as expectations for interest rate cuts rose during the quarter, and utilities, real estate and industrials are among the more interest rate-sensitive sectors that should benefit from rate cuts.

However, digging into sectoral performance, there are a few interesting observations that provide some further insight into market sentiment/thinking that I don’t think is apparent from the headline sector moves.

Despite Q3 being the quarter where AI hype led by NVIDIA (NVDA) finally appeared to falter (more on this below), it seems that AI hype remains alive and well, only having shifted from semiconductors to the power supply and infrastructure required for AI.

Firstly, in looking at the performance behind XLU, it seems this has become a second derivative of the AI trade, being a play on AI electricity demand, with utilities such as NextEra Energy (NEE) and the Southern Company (SO) appreciating strongly in Q3 on the assumption that they will benefit strongly from surging demand for electricity from data centres for AI computing processes.

Similarly, within the real estate sector, it has been the data centre REITs such as American Tower (AMT) and Prologis (PLD) that have led the sector higher, again on the assumption that they will be major beneficiaries of increased data centre demand driven by AI. By contrast, NVDA, the erstwhile posterchild of all things AI-related, finished the quarter down -1.69%:

Indeed it appears that NVDA’s run may have finally run out of steam, with Q3-24 being the first quarter in eight quarters since Q3-22 that it closed down for the quarter:

That said, while NVDA was marginally down in Q3, it remains up +145% for the YTD, but I think its noteworthy that its momentum appears to have waned:

And so the Q3 outperformance of the utilities and real estate sectors appears to have been as much to do with AI as with interest rate cuts.

Aside from this evolving AI theme, as noted above the other major sector that outperformed in Q3 was industrials, which was led by aerospace and defence names (General Electric GE, Raytheon RTX, Lockheed Martin LMT)) which implies the market is perhaps pricing in geopolitical/conflict risk after all, or at least a new regime for security and defence spending. Additionally, infrastructure-related names, notably Caterpillar (CAT) also performed strongly, supported by its exposure to mining as it relates to electrification and infrastructure capex:

Moving from the broader market to the Model Portfolio, the Portfolio underperformed the market in Q3 with a flat performance, and this is in part attributable to the fact that it had no exposure to the winning market themes for Q3.

However it did benefit from some idiosyncratic events playing out with respect to some of its positions, and I believe performance will improve further in coming quarters as additional event-catalysts play out.

Now let’s move on to a review of the Portfolio’s positions as at the end of Q3.