By Kenneth N. Green, CPA, MBA
Interest Rate Cuts
As 2024 began, the consensus among investors was that the Federal Reserve would cut interest rates three or four times this year, starting in June. Given that the last mile in the inflation battle is proving nettlesome, we have to consider that we may get just one, or perhaps no cuts in interest rates this year. Rather than fret what the impact of higher-for-longer interest rates might be, we believe that the markets will be positive for the balance of 2024 even with no cuts in rates. This is not to imply that there will be no volatility along the way as volatility is the price we pay for long-term gains.
If the Fed does not cut interest this year, it will likely be because inflation is not falling as quickly as they thought. Much of the recent decline in inflation has occurred in the consumer goods sector, where prices have been falling at the fastest pace since before the Great Recession of 2008-2009. This is not sustainable, especially since the dollar is no longer getting stronger which has kept import prices in check. Also, housing prices, the largest component of the Consumer Price Index, have been getting stronger. This will eventually feed into the CPI through a weird statistic known as Owner Equivalent Rent. Although on one actually pays O.E.R., it impacts the CPI with an approximate twelve-month lag.
The Fed took its target interest rate over 5% a year ago this month, a level many experts thought would hurt both the US and global economy. Instead, US economic growth didn’t just continue but accelerated as 2023 wore on, extending the expansion that persisted throughout the Fed rate-hike cycle starting in March 2022.
The markets have been fine with the higher interest rates since the start of 2023. Markets do not require rate cuts to do well. U.S. and international stock markets hit record highs in the first quarter of 2024. The April pull-back, largely due to inflation and geo-political concerns, has been erased as we write. Over the past several decades, stocks and bonds have done well following a Fed rate-hiking campaign, with the exception of the 2000-2002 bursting of the Technology bubble.
Although markets can react negatively at the beginning of a rate-hiking campaign, they tend to adjust to the new environment and resume their long-term growth as markets are influenced more by corporate earnings and economic growth than by Fed policy.
The bond market is currently pricing in one or two rate cuts by year-end and the Fed appears to be leaning toward doing so. Still, investors need to consider that in light of current healthy economic growth, and no recession in the forecast, that we may not get a rate cut in 2024, and that now is still a good time to invest good quality equities, as well as bonds, while maintaining a long-term outlook.
Market Risks
The S&P 500 finished April on a downbeat of -1.6%, and ended down 4.1% for the month, its worst monthly performance since June 2022. June 2022 was the month with peak inflation in this cycle as the annual change in the CPI was about 9%. Today the situation is better however, the rate of the decline in prices has stalled. The April sell-off may well have been due to investors’ taking profits after a strong five-month run from November 2023 to March 2024.
One concern is the current environment as it pertains to the housing industry. Interest rates and mortgage rates are tied to Fed policy. Housing activity is below normal due to high prices and high mortgage rates. In order for this to change, both prices and mortgage rates will have to decline. But in order for this to occur, the Fed has to be confident that inflation is declining and that it can lower interest rates. Housing is one-third of the CPI and this was at a 5.7% annual rate in March. Rents are high because home prices are high due to existing owners not wanting to give up their 3% mortgages of just a few years ago. The supply of homes available for sale is very tight and more families are competing for a limited supply of rental units. How we get off this hamster wheel remains to be determined.
Another concern is the Leading Economic Indicators, (LEI) which is down 24 of the past 25 months. The only time longer was during the financial crisis 2008-2009. Still, we are not in a recession and this does not appear imminent for 2024. The current market valuation is a concern whether we look at Price-to-Earnings, Price-to-Book Value, or dividend yield. Stocks have rarely been this highly valued. Much of this can be attributed to the concentration of performance in the largest capitalization Magnificent 7 stocks. Another risk is Commercial real estate. Vacancies are high, as much as 20% and there is $1.2 trillion in mortgages that has to be refinanced this year and 2025 at higher rates. This presents a risk for the largest and some regional banks. In this environment we like stocks that sell at attractive price-to-earnings and price-to-cash flow. Healthcare, utilities, and select Industrials offer such selections.
Market Opportunities
The USA is the world leader in innovation. The manufacturing industries that dominated the economy just a couple of generations ago such as textiles, televisions, and even automobiles have gone overseas where labor and material costs are lower. Still, the U.S. economy has expanded remarkably well. If U.S. corporations were not innovating and creating new products like vaccines, artificial intelligence, and cloud computing, the economy would not be growing and capital would not be coming to the U.S. at the rate that it has been.
U.S. GDP was approximately $1 trillion in 1930. It was almost $28 trillion at year-end 2023. Yet, the U.S, population has grown from 120 million to just 332 million, less than three times. The difference in these growth rates has been driven largely by innovation. Innovation is the key to our future and no other nation does it as well as we do. Companies such as Apple, Amazon.com, Alphabet, and Nvidia have invented new products and have perfected old processes. As this continues, the U.S. will continue to attract capital and will lead the rest of the developed world in economic and stock market performance.
Based on our evaluation of sectors with favorable growth rates and valuation metrics, along with other factors, we like Technology, Healthcare, Communication Services, and Utilities. Technically, the outlook for stocks remains bullish as most indices are at new all-time highs and market breath has been widening. Historically, this has meant further gains over the ensuing six to twelve months. All-time highs are usually bullish, at least until we come to the last one.
Kenneth N. Green is the Senior Vice President and Director of Investments at Marc J Lane & Company, the investment affiliate of The Law Offices of Marc J. Lane, P.C.
If you would be interested in having the professionals at Marc J. Lane & Company confidentially evaluate your investment strategy, please feel free to reach out to Marc Lane at mlane@marcjlane.com or 312/800-372-1040.