This Week's "Noise"
The Federal Reserve and the first potential rate cut of this cycle are this week's noise and will overshadow any other economic data. This is a challenge, with many calling for a 50bps cut and some insisting a 25bps cut is enough of a signal. Many are worried a larger cut signals extreme weakness in the economy while a smaller one will show nuanced strength. No matter what the Fed does, half the people will likely be disappointed. Finger-pointing is inevitable.
The 2-year & 10-year yield curves have become un-inverted for the first time since July 2022 earlier this month (FactSet). On September 3rd, the S&P and Russell index trackers made a momentous announcement about potential changes to index calculations due to overconcentration. (see below)
Current Market Outlook (6 to 12 months)
Market
The Dow Jones Industrial Average hit a new all-time high amid the recent S&P 500 pullback. A key theme we have mentioned several times in person and on our Thursday calls is how these concentrations from the largest companies will inevitably violate SEC, FINRA, and IRS guidelines. The S&P and Russell investment index providers have both proposed changes to the methodologies in index calculation to align with the Investment Company Act of 1940 and the Federal Internal Revenue Code.
Economic
The yield curve (a chart of U.S. treasuries by length and current yield) returned to normal (un-inverted) last week for the first time since July of 2022 (the 2-year & 10-year rates). The inverted yield curve (lasting for just over 2yrs) indicated lower expected future growth rates; thus, shorter-term bonds unintuitively have higher annual rates than longer-duration bonds. Eventually, we expect to move to a more normal yield curve environment where short-term bonds have lower annual rates, and the curve becomes “steep” as longer maturity bonds have higher yields. These shifts are important indicators of future growth expectations. As of this week, we expect 200bps or 2.00% Fed Funds rate cuts over the next 18 months. As previously stated, a soft landing is underway. The latest data and comments have indicated that the Fed may have a path to cut rates. We don’t expect the Fed to return to near 0% after that 18-month stretch. If that is the case, the economic picture is much worse than anyone expects.
Long-Term View (4 to 7 years)
Long term we believe the US economy will continue to outperform other world economies. This is supported by a combination of re-shoring manufacturing, new investments resulting from the Inflation Reduction Act, US energy independence, and higher productivity due to the implementation of Artificial Intelligence (AI) software/systems.
We started 2023 predicting the broad stock market would return to the old highs in one to two years. It took only one year. We believe the US stock market should be 40% to 60% higher by the end of 2028. A S&P 500 index of 7,000 to 8,000 appears possible.
Bonds have re-emerged as an important part of asset allocation as yields have risen. We expect a diversified bond portfolio to produce returns 3% to 5% above inflation for the next 5 to 7 years.
“Things that have never happened before happen all the time.”
? Morgan Housel, The Psychology of Money
See important disclosures below:
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.
Any opinions are those of John O’Hare II and not necessarily those of Steward Partners. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
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