Paul Jesinskis, CFP®
Financial Advisor
“The market is a pendulum that swings between unsustainable optimism and unjustified pessimism.” ~ Benjamin Graham
Prologue
Markets performed strongly over the third quarter, with global equities and bonds advancing. Despite some volatility during the summer due to recession fears, the unwind of the Yen carry trade, and tech valuation concerns, markets recovered thanks to central banks’ dovish pivot, strong US economic data, and China’s stimulus announcement.
September is typically the weakest month of the year for stocks, but thanks to the much-anticipated federal funds rate cut, the S&P 500 turned in its first positive performance in a September since 2019, achieving its 43rd record high of the year! Another development out of China, the announcement of a significant stimulus package boosted Chinese equities. This jolt of news spurred a frantic rally in Emerging Markets, leaving it the best performing major asset class for the month of September.
A theme has developed over the last quarter has been a noticeable shift away from US tech stocks, with defensive and cyclical sectors such as utilities, industrials and financials serving as beneficiaries of the move. Additionally, with the anticipation of rate cuts, we’ve seen the rate sensitive US small-cap stocks stage an impressive rally over the last quarter, the Russell 2000 advanced 9.27%. While large companies continued to gain in value, small- and mid-size companies are starting to participate along with Developed International and Emerging Markets, underscoring the importance of maintaining in a diversified portfolio.
While it’s good to see the broadening of the market and the lowering of interest rates excites investors, plenty of variables could spark volatility in the weeks and months ahead, including the health of the economy, employment, volatility in the middle east, the US election and Fed messaging.
Please reach out with questions.
-Paul
Noteworthy links:
- Howard Marks: Shall We Repeal the Laws of Economics?
- RJ: Investment Strategy Quarterly
- RBA: Fade the election
Chart of the Month
International equities are trading at a significant discount and offer an attractive yield pickup relative to U.S. equities on average
Article of the Month
What a lower interest rate means to the market
More than two years after first taking steps to contain swelling inflation, the Federal Reserve (the Fed) has taken a step back, suggesting monetary policy decision-makers have confidence that inflation will continue to move closer to the Fed’s target, allowing them to turn some attention to economic growth.
At its September meeting, the bank’s Federal Open Market Committee (FOMC) trimmed the target range of the federal funds rate – effectively the baseline interest rate across the U.S. economy – a half of a percentage point to 4.75% – 5.00%, down from 5.25% – 5.50%. The Fed is expected to make additional reductions in time, with decisions informed by data on inflation, the rate of unemployment, consumer spending, labor productivity and other key metrics.
The Federal Reserve, the independent authority over U.S. monetary policy, is charged with two distinct and often competing mandates: to support price stability – understood as a steady, low rate of inflation – and full employment. After roughly two years trying to slow the economy with higher interest rates to dampen inflation, this action is expected to bolster the economy and prevent a further slowdown.
What this means for your financial plan
The U.S. has a high-trust, credit-driven economy, so changes in interest rates have far-reaching effects. Investors and consumers may expect changes to:
Retail credit: Interest rates on new loans are likely to come down, including rates on mortgages, auto loans, securities based lending and home equity loans. Interest rates on existing variable rate loans, such as adjustable-rate mortgages and credit cards, may also decrease.
For those who took on a new traditional loan during this period of elevated interest rates, it probably won’t be worth the cost in fees to refinance, at least not yet, but the current consensus is that the Federal Reserve will continue lowering rates. However, don’t expect the near-zero interest rates of the early 2010s or 2020/2021 to return. They were a historical anomaly the Fed was slowly addressing before the pandemic forced a new tack.
Stocks: Lower interest rates are understood to support economic activity, so one would expect stock prices to increase. However, the market is forward looking – since this rate cut has been long expected, the potential gains from it may already be represented in current stock pricing.
What will likely be more evident is how lower interest rates help parts of the stock market bounce back from challenging conditions. Small- and medium-sized companies are seen as more reliant on cheap credit than large companies, so their stock prices have struggled compared to the mega-performant, mega-sized stocks at the top. Credit-sensitive sectors like real estate and utilities may also see a boost.
Bonds: Similar to interest rates in the retail credit market, bond yields will likely go down, but the slide may already be priced into the forward-looking market. Lower interest rates are a boon to institutional borrowers, but also to those who own bonds issued when yields were higher. The value of those higher-yield assets on the secondary market goes up as yields on newly issued bonds go down.
The economy: In the post-pandemic period, the U.S. economy has been unparalleled in its strength and resilience in the developed world. However, by the middle of this year, economic data started showing signs of a slowdown. Concurrently, the inflation rate continued to decrease after a first-quarter hiccup.
This gave Fed leaders the go-ahead to lower interest rates. By lowering interest rates now, the Federal Reserve is saying it’s confident inflation will continue to subside and they will attempt to cushion the slowdown in economic activity. This is meant to mitigate effects like slower job creation, slower wage growth and a loss in consumer confidence.
As we continue, we’ll see how the balance of these forces plays out. Despite the boost from lower interest rates, it’s likely the economy will continue to slow down, as monetary policy works with long and variable lags. However, currently, a dip into recession – a period of shrinking economic output – only seems like a narrow possibility.
Adjusting to new conditions
Changes in inflation and interest rates have the power to upend seemingly bedrock assumptions about the market, risk and opportunity cost. For example, changes in interest rates can change the math behind decisions to pay off debt ahead of schedule versus expanding an investment portfolio. Inflation and interest rates can also change the risk profiles of different types of investments, and left unchecked, can leave investors in a position far outside their comfort zone, with either too much or too little risk.
If it’s been a while since you’ve checked in, now might be a good time to sit down with your financial advisor and review your financial plan, particularly where it pertains to debt, risk and retirement timing.
Here is a link to the full article: What a lower interest rate means to the market
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