Almost a year ago on July 26, 2023, the Federal Reserve raised the fed funds rate for the 11th and what many believe to be the last time in the current credit tightening cycle. Beginning in March 2022, short-term rates rose from 0.00% to 5.50%, culminating in one of the fastest rate-increases of that magnitude in history. The Fed then paused to monitor the data, anticipating it would soon start cutting rates in response to a rapidly slowing economy. At the beginning of this year, with inflation falling as supply-demand imbalances normalized, the consensus opinion was for 6-7 cuts in the fed funds rate in 2024, with more to follow in 2025 and 2026. But the economy ignored the Fed’s credit tightening efforts, so the consensus was revised downward to 3-4 cuts, then 1 or 2 cuts, and currently to a realization that the Fed may not cut rates at all this year.
What was thought to be a momentary pause before the cuts began has now become a case of who’s on first. It seems someone forgot to tell American consumers that they were supposed to reduce their spending as the cost of financing rose on all types of debt including credit cards, automobile loans, and home mortgages. This time last year, many economists and market pundits believed that unless the Fed aggressively reversed course, the U.S. economy would experience a significant slowdown, possibly a recession throwing millions of people out of work. However, they opined, with a little luck and optimal Fed timing, we might avoid a recession and achieve a “soft landing” with minimal economic pain. Very few predicted the current scenario, which some are now calling the “no landing” economy.
Equity investors ignored the uncertainties in the economy and Federal Reserve monetary policy and pushed prices to new highs during the second quarter for all three major indices. Large companies (S&P 500) helped themselves to a 4.28% return in 2Q-24 and a triple-portion 15.29%, in the year’s first half, much of which was driven by gains in technology companies and in particular, artificial intelligence (AI). One firm, Invidia, accounted for approximately 30% of the S&P 500’s year-to-date return. Mid and small-sized companies and developed international markets gave back earlier gains, posting losses for the quarter and mixed results for the year’s first half, while international emerging markets gained 5% and 7.49% for 2Q-24 and 1H-24, respectively.
Concerns over valuation continue with the S&P 500 trading at a P/E (Price/Earnings) multiple of 21x expected twelve-months forward earnings, a 16% premium to its 10-year average. Another tool used to gauge valuation is the PEG (price-to-earnings-growth) rate. A PEG above 1.0 is often considered expensive and below 1.0, under-valued. The PEG ratio of the S&P 500 is currently 1.28. Because no one can consistently predict any company’s growth rate, an over-reliance on P/E and PEG ratios can lead to regrettable portfolio management decisions. Wealthview’s philosophy is to participate in the growth of the world’s greatest companies with an “invest now” mentality and avoid trying to time entry and/or exit points. Risk should be managed through broad diversification and optimal asset allocation to balance the need for growth, income, or liquidity with the desire for reduced volatility.
The economy as measured by GDP (Gross Domestic Product) is estimated by the Atlanta Fed’s GDPNow tracker to have grown 1.7% (annualized, after inflation) in Q2 with no recession in sight. Additionally, the labor market remains strong with new job formation above the breakeven level. The pace of economic growth and job creation supports the argument by many that the Fed will not lower rates anytime soon, fearing it may re-ignite inflation. Inflation has moderated substantially from recent highs but may be in a holding pattern above the Fed’s desired 2% target rate. The May PCE (Personal-Consumption Expenditures price index), which was released Friday 06/28/24 showed an expected 2.6% year-over-year increase, slightly below April’s 2.7% YoY reading. Month-over-month, the PCE was flat and the core PCE (excluding volatile food and energy) rose only 0.1%. The housing market is weakening due to mortgage rates that have more than doubled in the past 18 months. Counter-intuitively, home prices are going up as many people do not want to move and swap their 3% mortgage for a 7% rate. This is putting pressure on supply, thus increasing prices.
As usual, risks are ever-present. The Federal Reserve is being cautious in the timing of its next rate decision. If the economy shows signs of sustained slowing the Fed will lean toward lowering rates sooner, which markets will like. There is a risk that the Fed will wait too long to lower rates and the impact on housing and construction in particular, and labor markets in general will be substantial. Of course, it’s an election year which is typically good for markets, but all bets are off as to the response to the outcome of November’s election. The geo-political situation remains cloudy with wars in eastern Europe and the Middle East. Finally, our debt and deficits are an ongoing concern and must be addressed at some point before debt levels push interest rates to new cyclical highs.
Investors must prudently navigate risks without burying their heads in the sand or taking impulsive, often disastrous, actions in response to, or in anticipation of, various events. One of the biggest risks to a three-decade retirement is the anticipated increase in the cost of living. Retirees could face a reduction by half or more in their purchasing power during their retirement from a 2.5%-3.0% inflation rate. If their income in retirement does not grow at a rate equal to or greater than the increase in their expenses, retirees will be faced with the unpleasant options of reducing their standard of living, exhausting their principal, or going back to work.
Goal-focused, plan-driven, long-term investors understand the need to match their expected liabilities (annual spending needs) with sufficient resources (future dollars). The best way to do this is through an intelligent financial plan that clearly identifies their life’s goals, the future cost of those goals, the resources available to fund those goals, and their perceived tolerance for risk. Their plan’s success will then depend on implementing low-cost, tax-efficient, risk-appropriate investment strategies intended to increase the probability the funds needed will be there when called upon. Many also understand the importance of partnering with a team of professionals which allows them to turn their focus back to their families, careers and other interests. At Wealthview, we are privileged to fulfill this role for those families with whom we are partnered.
Best wishes for a great summer.
Samuel J. Taylor, CIMA®, AIF®, CRPC®
Wealthview Capital, LLC