2nd Quarter Update: Tariff and Inflation risks remain, Summertime doldrums arrive at high market valuations.

The economy continues to soften but does not yet appear to be reaching a tipping point. Employment remains durable if not robust and consumer confidence together with consumer spending continues unabated. Housing however is beginning to show signs of weakness as more homes come on the market and prices have dropped modestly for the first time in many years. The technology sector has experienced some volatility as it navigates a path forward with expected trade deals and tariffs still in a state of flux. The AI and robotics sectors show no signs of slowing down.

The markets however seem to have entered a period of the summertime doldrums and appear to be drifting upward perhaps due in part to the exhaustion of getting whipsawed from the on again off again tariffs and trade deals. And it is true that several important trade agreements have been finalized with some of our important trading partners.

Year End Summary 2024 – Ongoing Modest Growth

Last quarter we wrote that the economy was sound on a solid growth path. Now despite recent volatility, we believe the markets too will continue to grow, that volatility will subside and growth will be modest. The sector rotation out of the high P/E growth tech stocks and into the smaller stocks in the broad market is ongoing, however, tech is, and always will provide higher growth ‘over time’. Inflation is slowly approaching the two percent target and interest rates are slowly falling, but as described below may remain at these levels for some time. Absent a credit crunch on the horizon, we no longer see a return to the historically low levels of the past decade.

2nd Quarter Update: Interest Rates Turning Down

The markets have entered a new period of high volatility and economists and market analysts are having a hard time coming up with a reason for it. We began the month of July with the markets racing ahead with 6% to 7% gains reaching an all time high, only to fall back drastically erasing most of the gains of both June and July. Our accounts all still have sizeable gains on average near 40% so far this year. We believe the markets will stabilize barring any major disruptive economic developments. We expect relatively modest market growth through the remainder of this year. There is evidence of market sector rotation happening whereby institutional investors are rotating out of the high P/E, high growth tech giants and back into smaller stocks in consumer, financial and utility sectors. The current market is probably not like the vulnerable tech boom of the late 90’s (yet) as this market, despite the recent high valuations has much more support from higher and growing revenues and earnings.

Year End Summary 2023- Goldilocks Economy, Not too Hot, Not too Cold

In recent days, the stock markets have surpassed the previous all-time highs achieved in December of 2021. As the Fed increased short-term interest rates during 2022, the stock market likewise went straight south. It took all of 2023 to regain that lost ground. Now in 2024, the economy appears to be in a Goldilocks condition, not too hot and not too cold. Inflation has subsided to levels that will make the Fed’s target of 2% achievable within coming months. The labor market is as strong as can be with wages rising and unemployment less than 4% for two years running. The economy has not been this productive for 50 years. Help wanted signs are still everywhere. It is becoming apparent that even without new fiscal or monetary stimulus from either Congress or the Fed, as is likely, the previous trillion dollar covid stimulus money is still circulating and accommodating consumer demand that is more than enough to keep powering the economy forward for some time to come.

3rd Quarter Update Summary – Yield Curve Trauma

Some aspects of the economy are quite strong and steady, however, there are some new developments with an as yet unknown impact. What appears to be resolved is that inflation continues to retreat approaching the Feds’ goals albeit more slowly than desired. Employment and consumer spending remain steady, and together with expanding manufacturing is sustaining the economy on its current strong path. Residential and commercial construction remains steady despite a very slow resale market.

What is new this quarter is that long-term interest rates (bond yields) have begun rising sharply. The Fed sets short-term interest rates but the bond market determines long-term rates. These rising long-term rates have been putting pressure on the stock market as well raising mortgage rates to 8%. This will certainly affect the housing resale market and eventually new construction. Another effect is that without any new intervention from the Fed, the closely watched yield curve is no longer inverted but has reverted to a flat profile. The yield curve has been a historically accurate predictor of economic growth. Depending on the future path of long-term rates, the Fed may choose to reduce short-term rates much sooner than they had planned and let higher long-term rates do the hard work on inflation.

Year-end Summary 2021

Our accounts have performed very well again this year. Despite economic headwinds from Covid related restrictions, distribution channel disruptions and labor shortages, the economy ended the year very strong albeit with some inflationary pressures. The Federal Reserve is becoming increasingly concerned that this inflation is not merely a temporary transitory effect from supply disruptions, but that we are running the risk that inflation is becoming entrenched.

The Fed has been quite vocal that in the near future it will be winding down its quantitative easing monetary stimulus operations and will also start to raise interest rates possibly as soon as March. The strong reaction from the markets in response to these comments indicates that these anticipated monetary tightening actions will likely result in severe negative market and economic consequences beyond taming inflation. Intuitively, it seems unwise to try to contain inflation shortly after a massive Omicron surge that has already been a disruption to the economy and a cause of some degree of the inflation. As long as the Fed persists in its projected course of action, we believe the markets will continue to be highly volatile.

Market Meltdown? Foreshadow? Not Likely…

The market meltdown in the previous few days was unmistakably a reaction to sharply rising bond yields which previously were rising slowly if at all in response to Fed rate increases. It was not likely a response to inflationary fears as leading inflation indicators (metals and commodities) were unmoved if not down. Add it all together and present value theory of stock prices required a downward move in prices in response to those bond yields. The consequence? The Fed, now chaired by a Wall Street insider, has no reason to be too aggressive in raising short rates and may even temper its planned sales and reductions of its massive bond portfolio.