October is here and it’s SPOOOOOOKY season! And by that, obviously, we are referring to the uniquely American tradition of getting dressed up in a costume of a “responsible citizen” and going out to vote for our next President. Scary stuff indeed! But before we get to anything on the election topic, we should get caught up on the wild and wonderful world of investing. Here…..we….go……
The Federal Reserve Bank’s Monetary Policy Positioning, Fall 2024
Oh boy! So now that we’ve started with literally the most boring headline one can conjure, we will drop the formality and try to keep it simple. We are talking interest rates. And inflation. And the economy. And, kind of, the stock market. Okay, okay that’s too many things. All related to some degree, but let’s just talk interest rates.
As you probably remember, our dear financial chaperones at the Federal Reserve set only the very short-terms rates in the market. The idea being that based on their research and judgement they can help the overall US economy speed up or slow down based on how things are going. For example, when the pandemic started, and everything was uncertain, they lowered rates immediately to stimulate the economy. Conversely, when inflation ramped up in 2022, they changed directions and increased rates to cool the economy and stop inflation. Recently, they have determined that inflation is under control, so they are pivoting again and reducing interest rates. Or so the story goes.
So who cares and what does this have to do with anything? Great question, me. This all does seem like policy wonk minutia, but it does provide some helpful information that affects the overall investing market. As in, this recent change of direction tells us the Fed believes inflation is no longer a concern and that interest rates must come down or the economy could suffer. They will do this rate decrease gradually over the next year at various points, but we can discern that the overall trend of rates is officially lower. As rates decrease, a couple of things will happen. First, the strong money market rates of ~5% we have enjoyed the past year plus will disappear sooner than later. Second, the economy and stock market should perform well as rates come down with an emphasis on “should”.
Bringing this down to the financial planning and investing level, this change has some ramifications for us. For example, with money market and cash yields falling we need to rotate dollars into other vehicles and reduce our allocation to money markets. Additionally, this could provide some decent opportunities in stocks and asset classes like small caps and real estate. For the most part, this all falls under the category of “business as usual”. Long-story short, a falling interest rate environment is a good time for investors.
Interest Rates by Length of Time AKA, The Yield Curve
All of us that have ever taken out a loan, know that the longer time we have to pay it back, the higher the rate (e.g., the rate on a 30-year mortgage is higher than a 15-year). This concept is what the “yield curve” is supposed to express in a pretty little picture, showing the shorter-term periods with lower rates and longer with higher rates. Due to all the adjustments and policy changes since the pandemic we have something that looks more like…a sad Big Dipper? Here’s the current yield curve…
Taking a quick gander, you can see it’s not the shape that the textbooks promised. The 3-year and 5-year rates are lower than all the others – what the heck. This, my friends, is called yield-curve inversion. A discussion topic that’s sure to be popular at all of your Halloween parties this year. This current picture above is a result of the Fed increasing short-term rates to fight inflation during 2022 and 2023. Not that it’s incredibly important, particularly when we know why its inverted, but it does speak to some level of disconnection in the markets. Or said plainly, the outlook for the next 3-5 years isn’t as good as the next 1-2 years. However, as the Fed now starts to reduce rates, we should start to see a normal line moving from the lower left to the upper right. The happy yield curve ending that economists over the world will rejoice.
Bulls on Parade
Name your favorite stock market indicator and you can bet it is signaling a bull market. After a gross 2022 and much of 2023, it has been a really good run in stocks. The trend has been for indexes to go higher and objects in motion tend to stay in motion. New all-time highs beget new all-time highs (put that on a t-shirt). Early in 2024 the financial media spoke of the “Magnificent 7”, referring to the seven heroic stocks in the S&P500 that were carrying all the water and propping up markets. Then we heard it was artificial intelligence and AI-or-bust, but the reality has been that we have seen strong performance all over the market. Some of the sectors turned on a little later in the year but overall, this is a very broad and encompassing rally in stocks which we love to see. Here’s some chart art going back to 2020…
Lockheed is a position we hold across the book. As an industrial manufacturer, it’s not in the “Magnificent 7” and it’s definitely not AI, but showing impressive momentum.
This is JP Morgan, America’s largest bank, and another position we hold. Lots of positive momentum in this as well. With industrial and financial stocks performing this well, there is no indication that valuations are getting unnecessarily stretched or the market is on the verge of rolling over. Money moving from sector to sector (as in, from technology stocks to financials and industrials) is a sign of a robust and healthy bull market. Ultimately, all bulls go to the big cattle ranch in the sky but that looks to be quite a ways off given the current activity we are seeing.
The 47th President of the United States of America
Depending on your level of cynicism, you can assume this is the “best” topic and it was deliberately “saved for last” or that your author put it at the bottom so readers could bow out of this altogether – you decide. We do have an election coming up in three to four weeks, as you know. Some of you may be excited about a candidate and some may not but the message from us is that in terms of the financial markets, it’s unlikely to matter who wins. Going back through all of the historical market performance of presidential election years, there is no correlation to a Republican or Democrat winning. The history has been that typically the stock market is a little choppy and sideways heading into the big day then goes on to make gains by the end of the year. This was even the case of the “hanging chad” debacle of 2000 when we didn’t have a President elect for months as Team Bush and Team Gore fought it out in courts. Also, this was the dynamic when a certain polarizing figure was elected the 45th President in 2016. The difference this year is that the stock market has been very strong leading into November. There were a couple of weeks of volatility in August but overall, it’s been quiet and positive so it would not be surprising if we get a little volatility closer to the election and the weeks after. However, history really shows it doesn’t matter who wins.
What will make a difference to all of us are how the tax law changes are handled by the 47th. The “Tax Cuts & Jobs Act” that was passed in 2017 sunsets in December of 2025, meaning that if it isn’t extended or replaced, the law will revert back to the old structure. In political years, that’s a lifetime away as we know Congress increasingly loves to wait until the last minute, miss the deadline, make a bunch of excuses, call each other names, then pass something similar to what they were discussing all along. Anyway, point being, that those changes can really make a difference to personal financial plans so we will be speaking more about those changes as we get closer. At this point, it would be very hard to guess what they might come up with.
