Executive Summary:
Stocks Higher in 2024: Most major market indices are continuing last year’s positive gains and are now in the double-digits for the year.
Inflation Moderating: The year-over-year increase in prices are once again near long-term averages.
Economy: The labor market has shown signs of normalizing, with fewer job openings and fewer employees voluntarily quitting their jobs in pursuit of better terms elsewhere. However, layoffs have been low and the unemployment rate remains at just 4.3%.
Earnings: S&P 500 earnings were once again positive and meaningfully outperformed Wall Street expectations for the second quarter of 2024.
Interest Rates: The US Federal Reserve has communicated its intent to begin reducing interest rates (finally).
August was a pivotal month for the financial markets as investors grappled with mixed economic signals and closely watched the Federal Reserve's annual Jackson Hole Symposium for insights into future monetary policy. There have been increasing signs that higher interest rates are having a slowing effect on the US economy, and investors in early August became concerned that restrictive monetary policy could push the US into a recession. The S&P 500 index was down more than 6% before recovering to earn 2.4% for the month.[1] But, investors ultimately got what they had been hoping for from Federal Reserve Chair, Jerome Powell, during his press conference on the morning of August 23rd when he made statements such as:
“The time has come for policy to adjust.”
“My confidence has grown that inflation is on a sustainable path back to two percent.”
“It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions.”
“We will do everything we can to support a strong labor market as we make further progress toward price stability.”
Our base case has remained that the Fed will achieve the rare “soft landing” (embarking on restrictive monetary policy to cool inflation without causing a recession). Only in the mid-90s was the Fed previously able to successfully tame inflation through higher interest rates without causing a recession. Nevertheless, we believed that unique factors to this economic cycle such as reduced frictions in the labor market via remote work, locked-in low fixed rate mortgages, and higher 401k balances would help households and the economy power through a purposefully restrictive period.
As is almost always the case, markets tend to overshoot during periods of optimism and pessimism. Markets rose sharply in the fourth quarter of 2023 as expectations for interest rate cuts in 2024 moved from 2 to 6 (a “cut” representing a reduction in the Fed Funds rate of 0.25%, implying that investors expected the Fed to reduce interest rates by 1.5% in 2024).[2] The S&P 500 climbed 12% in Q4 2023. But, as economic data proved stronger than expected in early 2024, rate cut expectations fell back to just one for the year, leaving many parts of the stock market flat or negative to start the year. Softening inflation data and positive rhetoric from the Fed has resulted in four cuts currently priced in by the end of year and the Fed Funds rate falling to 3% by the end of 2025 (soft landing scenario – base case).
However, it remains possible that the Fed will not be able to lower interest rates as fast as the market hopes given the still relatively healthy labor market, elevated home and 401k values, and the potential pent up demand for housing. In this scenario, we would not be surprised to see volatility reemerge in both stock and bond markets. A “no landing” scenario, one in which a reacceleration in inflation occurs, also remains possible. This would present challenges for rate sensitive investments, particularly bonds and other fixed income securities.
On a positive note, US companies (at least the largest ones) have been able to grow revenue and profits during the higher interest rate environment that we’ve experienced. 493 constituents of the S&P 500 index have reported results for the second quarter of 2024, with average sales growth of 5.2% year-over-year and earnings growth of 11.4% year-over-year.[3] Earnings growth rising faster than sales growth implies that companies are becoming more efficient as well, effectively transferring more revenue into profits through cost reductions and productivity gains. And, these companies outperformed Wall Street expectaions, on average, which allowed for the market to move higher over the last several weeks during earnings season.
On balance, the majority of the datapoints that we track in order to measure the overall climate for investing remain stable or positive. It is quite possible, in our view, that interest rates will be reduced more slowly than the market expects, which may be a source of volatility over the next six months. But overall, the environment remains generally healthy and trending in the right direction.
Asset Class Returns
Source: YCharts as of September 3, 2024. Annualized returns for data longer than 1 year
Outlook & Positioning Summary
[1] Bloomberg
[2] Source: Bloomberg, FHN Financial as of September 3, 2024
[3] Bloomberg as of September 3, 2024
Past performance may not be representative of future results. All investments are subject to loss. Forecasts regarding the market or economy are subject to a wide range of possible outcomes. The views presented in this market update may prove to be inaccurate for a variety of factors. These views are as of the date listed above and are subject to change based on changes in fundamental economic or market-related data. The ETFs presented above are not intended to be
benchmarks for performance. Rather, they are intended to be demonstrative of a particular sector or segment the investment universe discussed. Each ETF was selected as opposed to an index to more accurately reflect what an investor might experience. There are other ETFs or indices that might be representative of the same spaces. However, we believe the ones shown are sufficiently representative to assist us in explaining our investment thesis. Please contact your Advisor in order to complete an updated risk assessment to ensure that your investment allocation is appropriate.
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