Quarterly Review and Outlook:
September 2024
A Look Back
I have to confess that I’ve been waiting to mix in this title for some time. Likewise, many market watchers have been waiting for the Fed to cut the short-term Fed Funds rate for quite a while as well. The song was originally written by Cat Stevens in 1967 and was most famously covered by Rod Stewart in 1977 and again by Sheryl Crow in 2003. His version reached #1 in the UK and #21 in the US, while Crow’s release reached #1 in the US adult contemporary category. As told by Stevens, the lyrics represented someone wondering if and how it is possible to love again after their first love was lost. Ultimately, that first disappointment could turn out to be the deepest. Of course, from the lyrics, they went on to try again! Stock and bond markets tried and succeeded in September, the third quarter, and so far in 2024. The large-cap S&P 500 was up over 22% in the first nine months of the year, and over 36% in the last year. The whisper of potential Fed rate cuts in the fall of 2023 has turned out to be quite the impetus for investors…especially those willing to take on more risk by owning stocks. After trailing the U.S. large cap index for years, U.S. small-cap and International stocks saw a rebound in the third quarter, with all three outpacing the S&P 500. Significantly, after negative returns over the first half of the year, core bonds (Bloomberg US Agg) delivered a 5.50% return in the following three months, which put the one-year total at 11.57%. We have been suggesting that bonds could give clients a double-digit positive return over a 12-month period, and it has finally come to be. Perhaps the potential death of the traditional 60/40 portfolio has been greatly exaggerated! In fact, every major asset class shown in the above table shows positive performance over the first nine months of 2024…and this is on top of a very healthy 2023.
After nearly 12 months of waiting since the Fed hinted at rate cuts, they cut the short-term rate by .5% in their September meeting. Although the first cut was expected, the .5% versus the consensus .25% caught some off-guard. Did the larger cut mean the Fed saw potential economic headwinds in the future? Were they late and trying to play catch-up? In Chairman Powell’s comments, he was careful to suggest the opposite…that they felt inflation was under control, and that they saw some slowing of the economy, but nothing to suggest imminent recession. In the financial world, short-term interest rates have been one of the main drivers of the overall economy here in the US for the last several years…and, if you really want to delve deeper, back to the Great Recession timeframe of 2008-2009. The Fed took the Fed Funds rate to zero to make money readily available to consumers in response to the Great Recession, and then again in 2020 to deal with the consequences of Covid. One can argue about the dramatic moves and the length of time of the tightening and easing cycles, but overall…results have been good.
The graph below shows the history of the Fed Funds rate over the last 20 years. There was the move down to 1% during the “Dot com” bust and then the unprecedented move as a result of the financial crisis in 2008. Finally, the sudden move down in 2020 in light of Covid…and the historic, steep rate-hiking cycle to combat the rising inflation born out of the Covid timeframe. It’s been a lot over the past decade and a half. I believe it’s fair to say that no one…including the Fed, likes the uneven and extreme look of this chart. It would be much better to see a fairly consistent one, where the rate hovers between 2.5-3.5%. Savers and borrowers could plan accordingly. That is exactly where the Fed would like to be, as shown by their projection by the end of 2025.
The chart below shows different looks at inflation over the last five to twenty years. In all cases, we can see how inflation peaked in June of 2022, as it became much more than transitory. In the upper right chart, not only can we see the dramatic rise and more gradual retreat, the components that make up inflation have changed. While the price of energy skyrocketed during Covid, it is now a small to negative portion of the current inflation increase, as shown by the orange bars. Now, the one thing we still need to point out…that big spike in the costs of goods and services doesn’t just go away. The strain on average Americans to afford shelter, food and other everyday services is real. Although wages are up as well, it has been uneven and depends on the specific industry and sector. We will continue to monitor, as we know that average Americans across the country are feeling the effects of these increased costs of daily life.
We show one more longer-term look at inflation with the chart below. It looks at the YOY (Year over Year) changes in inflation going back to the mid-1980’s and the gold horizontal bar represents the Fed’s historical target of 2%. With some notable spikes already mentioned, core CPI had been fairly benign for nearly 30 years…and importantly, fairly attainable. The trend down over the last two years is unmistakable. As we have discussed before, of all the economic indicators we look at, inflation and employment are what is most important to Americans…and what ultimately helps drive the overall economy…in either direction. So, this trend is indeed a welcome one.
A Look Forward
With the national election less than a month away, we thought it made sense to focus on a few items that we have all heard much about over the last several months. This is traditionally the time, every four years, where a lot of promises are made…on both sides of the aisle. Tax cuts, tax credits, cheaper medical costs, etc. Most individuals and corporations are never going to bemoan any of these promises that have the effect of keeping more money in their collective wallets. But, at what cost. Unlike us, the government can, and does, run large and long-lasting budget deficits. We can’t (or at least shouldn’t) go into our basement and just print more money. The government can…and does. The chart below shows the current dilemma in the U.S. With either party, we are going to need more revenue to make up the budget deficit. The last time we had a balanced budget was in the Clinton administration. We have been in a constant state of kicking the can down the road since…and at some point, some difficult decisions will need to be made…and some of the promises made, if realized, will have to be paid for.
We end with a couple of timely charts that should provide some sense of calm for voters as they go the ballot box. As always, there are certainly some very important policy differences, and unfortunately we seem to be more divided than ever on the best way to get from point A to point B. We remain optimistic and believe in the long-term strength and resiliency of our great country. We also know what the historical numbers show. The first chart shows how the S&P 500 has performed when financial conditions are easing…as they are now. The blue shaded area shows the strong performance under Presidents Clinton, Bush, Obama, Trump and Biden. In the end, the things that really matter to most Americans…do they have a good-paying job…can they afford to purchase a reasonable home. Are businesses and individuals able to secure reasonable levels of credit…
Probably the most consistent thing we hear is the difficulty in getting and keeping quality employees. These kinds of things are not normally the precursor for a serious economic downturn. But…that pesky inflation. We highlighted months ago that we believed it would be likely that the move from 9% inflation seen in 2022 to lower levels would be fairly straightforward. However, the move from current levels to the Fed’s preferred level of 2-2.5% could be much more sticky and problematic. We all have experienced the phenomenon of prices for goods going higher quickly and not coming down nearly as fast. Alas, that seems to be where we stand currently…and higher, stickier inflation takes a real toll on the average consumer, as they pay more for groceries and gas, etc.
The chart above below back further and shows the annualized GDP growth along with the stock market performance during their term. Again, there has been growth and positive market performance under both parties. We don’t want to underestimate the importance of any election, and certainly not this one. But, it is worth noting that we became such a great country because of our differences…not in spite of them…and as Rod sings, when faced with adversity…we try again!