The last day of October, Halloween, “spooked” investors in big cap tech stocks with The Wall Street Journal headlining its coverage of that day’s market action “Big Tech Earnings Drag Down Stocks” with the first sentence of the accompanying story reading “Disappointing quarterly results from big technology companies pushed stocks lower Thursday sending the S&P 500 to its first monthly loss since April.” Year to date “The Mag 7” have been carrying the rest of that index on their back but, after having cheered the spending of many billions of dollars pursuing the magic of AI, investors are showing signs of becoming nervous about how soon the promise will become the reality. The experience of the day though was at variance with that of the month as October’s -.91% return of “the 500” was materially better than that of the average stock in the index declining 1.63%, small cap stocks –2.64%, and foreign developed market’s -4.36%.
The financial markets which are the canvas upon which investors paint their perception of the future have certainly undergone a dramatic change in two years' time. As 2022 wound its way to its end investors were looking at near 20% losses in both their equity and fixed income investments. The inverted yield curve was a signpost pointing towards recession, falling earnings and even lower stock prices with expectations of persistent and elevated levels of inflation and a Federal Reserve keeping interest rates elevated as it struggled to put the inflation genie back in its bottle. Today, that canvas is painted with colors of a distinctly different hue. Inflation has declined to close to the Federal Reserve’s target but may be poised to begin to rise. The economy may have slowed a tad, but its rate of growth too is possibly preparing to accelerate. The Fed’s ½% cut in rates is September was likely excessive and additional rate cuts may not be warranted and, if the stock market is not inexpensive, it is supported by next year’s 12% expected increase in earnings on a year over year basis.
Charts detailing US economic growth rates often indicate the times of economic recession with shadings of gray. Overlaying a history of the level of the Federal Reserve’s Fed Funds Rate to that chart and back dating it to the onset of the 21st century, it is difficult to avoid the observation of a correlation. Every economic recession, and there have been three this century to date, has occurred after a time in which the Federal Reserve concluded a cycle of raising interest rates. Each cycle of rate increases resulted in a recession and an equity bear market. Each recession and resulting equity bear market was preceded by a rate tightening cycle. We’ll discard the pandemic of 2020 as a unique event, but it may be a useful exercise for investors in equities to ask themselves if this time will be different and, if so, why this time will prove itself to be the exception.
Interest rates are the cost of borrowing, and it would seem to make a certain amount of sense that the greater amount of the debt and the larger the extent of the interest rate increases the greater the impact of those interest rate increases on the underlying economy. From March 30, 1999, to May 15, 2000, the Fed took its discount rate from 4.75% to 6.50%. The market peaked March 24, 2000, and would subsequently decline 49.15%. At year end 1999 total debt in the US was 189% of GDP. From May 4, 2004, to June 29, 2006, the Fed took the discount rate from 1.00% to 5.25%. The market peaked on October 9, 2007, and then declined 56.77%. At year end 2007 total debt in the US was 237% of GDP. From March 17, 2022, to July 26, 2023, the Fed took the discount rate from 0.25% to 5.50% with the total rate increases of 5.25% exceeding the rate increases of 2004 to 2006 by 1%. The total debt of the US is now 261%.
As mentioned above, markets at year end 2022 were “all in” on the prospects for economic recession but markets have become increasingly comfortable with their adoption of the view that “if it hasn’t happened yet it’s because it isn’t going to” but that may be a wager investors exercise care in wagering. Darker clouds even now may be starting to come into view. The US economy, with its very high levels of fiscal stimulus; the mirror image of a very large and growing federal budget deficit, has been a notable outlier in a world economy that, this year, is experiencing sequentially lower rates of growth. This is now leading to rising market-based interest rates both in the US and globally and a stronger US dollar. Foreign counties, with much of their debt valued in those same dollars, and with much weaker economies, are responding by aggressively lowering interest rates set by their central banks leading to a widening spread in their interest rates vis a vis a those set by a still very cautious US Federal Reserve. The result is a negative feedback loop creating an even stronger US dollar and the application of an increasing amount of stress upon an increasingly fragile global financial system.
With the lowering of our expectations of positive equity markets we are adjusting the model portfolio of interest from 60% equity, 40% fixed income and cash to an equal weighting of 50% each. October created a 1 3/4% negative return leaving portfolio returns +11.18% year to date. Equities returned -2.35% with large cap US equities down near 1% but foreign markets returning -6%. And small cap US -3%. The 50% fixed income and cash returned -1.15%.
Mark H. Tekamp/November 3, 2024
Many of our fellow citizens and this may include yourself, are rubbing their temples to encourage blood flow to minds...
Read More
Like a patron of the local pub no doubt financial markets would have much preferred to pass around the hat...
Read More
The stock market’s 20% + return in 2017 led investors to approach 2018 feeling optimistic about the probability of...
Read More
For the past eight years anyone with a relationship with the economy and the financial markets of the United States,...
Read More
First there is watching grass grow. Then there is watching paint dry. But right behind is the stock market. Ten...
Read More
Yesterday (Wednesday) the US stock market (as measured by the Dow Jones Industrial Average) was seemingly on its way to...
Read More
