At the beginning of the year, we wrote about a few themes that we thought might indicate what was in store for 2024. We review those themes below in light of what has transpired in the first half of the year:
2024 Themes – Revisited
The Messy Middle: inflation range-bound between 2% and 5%
At the beginning of the year, it appeared that inflation was on a downward trend, though we speculated that the journey to the Fed’s long-term target of 2% would be bumpy. Despite alternating months of optimism and pessimism dominating the headlines, overall inflation appears less likely to accelerate significantly from here. It is becoming apparent, however, that a 2% inflation target may be overly ambitious, so markets may need to adjust to a structurally higher long-term inflation rate.
Prepare Not Predict: risks remain acute and market timing futile
With a widely predicted recession failing to materialize last year, many investors’ mentality has shifted toward risk. While neither we nor anyone else can predict when a recession will occur, one thing is certain: a recession will eventually happen. Accepting this inevitability allows us to think practically about risk and how to manage it.
Concentrated Consequences: narrow leadership creates both fragility and opportunity
As has been the case for the last few years, just a handful of stocks have driven a large percentage of the return for the domestic market so far this year. We know, however, that no stock, sector or country is immune to economic gravity. In other words, success may be significant and long-lasting, but it is not infinite. Although we try to avoid timing the shift away from the “Magnificent 7” stocks, we recognize that its eventual change will offer opportunities beyond a handful of securities and may allow for more broad-based returns.
Economic Backdrop and Potential for Interest Rate Cuts
The U.S. economy has remained resilient in the face of restrictive monetary policy with the Fed’s commitment to combat inflation over the last two years. While inflation is still above the Fed’s 2% target, it has moved considerably lower from its peak in 2022. Core personal consumption expenditures (“PCE”) inflation, the Fed’s preferred inflation gauge, landed at 2.6% year-over-year in May 2024, the lowest since March 2021.
Market expectations for when the Federal Reserve will begin cutting rates have been widely volatile in recent quarters, but the consensus is starting to land on the Fed’s September meeting for the first cut. The reduction in inflation is likely enough to justify cuts and, should we experience economic weakness and rising unemployment, the Fed would likely be supportive with cuts as well. And despite overall strength, there have been a few warning signs of economic weakness appearing: the manufacturing and services sectors have been in contraction territory for the first time in over a year and the unemployment rate recently moved above its 12-month moving average.
Interest rates have increased dramatically over recent years and the risk/reward trade off within fixed income has shifted. The downside risk and impact from higher interest rates has been reduced compared to two years ago and higher current yields provide a cushion. Moderating inflation and the potential for a slowing of the economy suggest the probability is greater for lower interest rates than higher in today’s environment. This leaves the Fed with multiple pathways for lower rates.
A Note on the Upcoming General Election
Since 1932, nine of ten incumbent presidents seeking reelection were successful if the economy was not in recession in the prior two years. Of the six that sought reelection and a recession did occur, only one was successful. For better or worse, the sitting president gets credit or blame for the current state of markets and the economy influencing their chance of reelection.
Many investors assume that general elections are bad for markets, so let us dive into the details. Since 1926, the average annual return during an election year is about 11.5% and 84% of the time the S&P 500 has posted a positive return in general election years. However, when compared to non-election years, the S&P 500 returned 12.4% on average, but only 70% of those years were positive. A modest argument could be made in both the “good” and “bad” camps as, statistically speaking, returns in election years and non-election years are very similar. Importantly, making a market prediction based on the four-year election cycle alone is akin to Punxsutawney Phil's shadow-based weather forecast. It is not particularly robust.
We hope the endless political ads and robocalls don’t overshadow the remainder of a great summer!
The views expressed represent an assessment at a specific point in time, are opinions only and should not be relied upon as investment advice regarding investments, strategies, sectors or markets in general.
The above commentary has been obtained from sources we believe are reliable, but we cannot guarantee their accuracy or completeness. Past performance is no guarantee of future results. This is not a complete analysis of every material fact. All expressions of opinion are subject to change without notice.
The information contained in this document does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Talk to your financial advisor before acting on information in this document.