Joe Lucey

The Rate Cuts and The Economic Future

The Federal Reserve finally did it—they cut interest rates for the first time in four years. Before their meeting, it was widely expected that a cut was coming, but there remained some mystery as to the cut’s size. While only a quarter-point cut was anticipated, they opted for a more aggressive half-point cut in a move similar to their inflation-combatting tactics. Pre-announcement speculation suggested that a half-point drop would signal concerns about the economy weakening—a bad sign for markets. However, the stock markets reacted oppositely, rallying sharply after the cut was announced.

Looking ahead, two more quarter-point rate cuts are currently expected in 2024 as well as a series of four quarter-point cuts in 2025. In 2026, it’s expected that two further cuts will follow.  This would bring the Fed Funds rate down to around 3%. While we don’t necessarily agree with the anticipated magnitude of the expected cuts, we can assume that they are directionally accurate – short-term rates are likely to move lower in the next year or two. 

Meanwhile, inflation remains slightly above the Fed’s 2% target, with the consumer price index and personal consumption expenditures lingering around 2.5% and continuing to trend downward. It is possible the Fed could pause rate cuts or even reverse course and raise rates if inflation happens to take hold again. However, their aggressive half-point cut suggests they feel confident that the economy is softening and lower rates are warranted.

Stock Market Snapshot

Despite indications of a slowing economy, the stock market seems virtually unstoppable and continues to provide robust returns. The S&P 500 returned over 5% in Q3 and is now up more than 20% year-to-date. We remain cautious as valuations remain stretched. Certain areas of the market look more attractive than others, depending on sector and market capitalization. We expect small caps – companies requiring loans to grow – to outperform large caps in the coming months as interest rates continue to decline.

In terms of fixed income, interest rates for terms longer than three months have already adjusted, so we don’t anticipate much further downward movement. While fixed income has posted solid returns this year, future gains may be somewhat limited. With shorter-term rates dropping, investments in money markets and T-bills will earn lower interest and therefore garner fewer “real” returns when inflation and taxes are considered. Now could be a good time to explore other options for income and safety, whether that means locking in current rates or considering alternative strategies with better potential returns.

Election Effects

Many may be concerned about how next month’s election will affect the economy, but historically elections have a limited impact on the markets. This year should be no different. The election outcome may affect different sectors, but the overall market impact is likely to be muted. However, markets dislike uncertainty, so a post-election rally could occur once the results are in.

The Bottom Line

If you are concerned about the stock market and seeking returns beyond what fixed-income investments can offer, this may be an opportune time to explore strategies participating in market upside while limiting downside impacts. Many investors have become complacent after enjoying the strong returns of the stock market since the beginning of 2023. We will caution risks abound; do not put your retirement plan in jeopardy by taking on an inappropriate amount of risk – whether it be too little or too much. Call us if you would like to review your portfolio and ensure you remain on track to enjoy a worry-free, secure retirement: 952-460-3290.

Normal Ebb and Flow?

August began with a rough start for the equity markets but, luckily enough, quickly rebounded. September began in a similar fashion. A softening in economic data drove the initial pullback, particularly the higher-than-expected unemployment reported in July, as well as manufacturing data signaling weakening demand. This sparked renewed recession concerns. Stress in Japan’s banking sector and fears over the unwinding of the yen carry trade also played a role. However, as investors reassessed the situation, they realized that although the data was softening, not much else had changed which ultimately, prompted the market bounce back.

Corrections are part of normal market gyrations. In fact, since 1980 the S&P 500 has averaged a correction of approximately 14% each year. With the recent pullback of only around 6% from its recent high, the year’s performance so far could be considered better than normal.

July’s Tech Stock Switch-Up

July was an interesting month in the markets as the “Magnificent Seven” tech stocks, which had been driving the S&P 500 and Nasdaq higher, took a breather. There was an ensuing rotation from growth to value with stocks and sectors outside of technology leading the markets. As a result, the Russell 1000 Growth Index lost 1.7%, while the Russell 1000 Value Index gained 5.1%, and the Russell 2000 Small Cap Index gained a whopping 10.1%.

Tech stocks recovered in August and all major indices were up for the month. While the dip may have been a short-term buying opportunity, we caution those of you susceptible to the fear of missing out (FOMO) that it may be too late. It’s still unclear if July’s movements mark the start of a new trend or if there will be further follow-through – which we believe will be the case as we approach fall and the upcoming elections.

Fall’s Forecast

It is widely anticipated that the Federal Reserve will begin to cut interest rates at their next meeting in mid-September, especially after Fed Chair Jerome Powell remarked that “the time has come” during the Jackson Hole Symposium. Expectations are for a one-quarter point rate cut, but a half-point cut may be on the table depending on August’s employment report. Although rate cuts may seem like good news for the markets, they appear to be already priced in, and there’s a risk of a negative market reaction. The Fed dropping interest rates is often a result of slowing economic activity. However, lower interest rates may be a tailwind for small-cap stocks as they will benefit more from lower borrowing costs than large-caps.  

In addition to the expected rate cuts, we’re cautious about stock valuations. The S&P 500 in aggregate is trading at a high price-to-earnings level compared to historical averages, meaning the markets are expensive. While these valuations aren’t at absurd levels relative to major corrections of the past, it may become difficult to justify such high valuations going forward unless earnings grow more than expected. It wouldn’t be surprising to see the market slow down and possibly take a breather. Returns may be more muted than we’ve experienced in the past couple of years. Much of the good news, such as Fed rate cuts and strong earnings growth, has already been factored into the markets, leaving them arguably “priced to perfection.”

What That Means For Your Finances

If (when) the Fed’s rate cuts do happen, there shouldn’t be too strong of a market reaction since much is already priced in, as discussed. As short-term interest rates drop, income earned from savings accounts and other short-term fixed instruments will also fall. This is a good time to lock in higher rates while you still can. We expect the yield curve to “un-invert” and normalize, with intermediate and long-term rates remaining much the same as they are now.  

While we are cautious about the markets in the near term, we remain very bullish in the long term and continue to believe the U.S. growth story is intact. Advances in technology will continue to drive productivity and economic growth. Success in the markets is based on patience and maintaining a long-term perspective. Those who chase returns in the short term often find themselves being burned. Conversely, those who do not take enough risk may find themselves missing out.  

If you have money in savings or are concerned about the equity and bond markets, this is a good time to consider alternative strategies for generating income or providing protection. Contact us to discuss options that may be appropriate for you.

Give us a call: 952-460-3290.