Rate Cuts, Declines, and Fundamentals

Answer: Summer volatility like the activity on Friday, August 2nd isn’t unusual, especially when paired with major economic releases and hints of rate cuts. Before we delve into recent economic news and the stock market sell-off (down 6% from recent highs), it’s important to consider how quickly and dramatically the narratives can fluctuate. Just last January there were predictions for seven Federal Reserve (Fed) rate cuts this year, and shortly after that, many wondered if they’d cut rates this year at all. These examples highlight why it’s important to take market narrative with a grain of salt and look at the fundamentals when determining your outlook for the economy, financial markets, and your financial plan. We ultimately believe this soft patch of data will prove to be a growth scare,’ not a ‘recession reality.’ Here’s why: 

A 'growth scare' in the making?

The soft payroll report (~only 114,000 jobs created in July) with weak manufacturing data caused a strong market reaction with the market beginning to wonder if the Fed is behind the curve in lowering rates, and that a recession will result. Overreaction to any one report is misleading. Yes, the labor market has decelerated, and consumer spending slowed, but it hasn’t come to halt. Although consumption and job growth slowed, more workers are entering the job market and government spending should offset consumer slowdowns. 

The Fed’s overly restrictive policy of higher interest rates to slow inflation is no longer warranted and they may be a bit late to the party in lowering rates. Lower interest rates bring relief to businesses, consumers, and the housing market. We believe the Fed will do what it takes to avoid a recession. 

Expectations are for two rate cuts, one in September and another in November, but the Fed remains flexible. Two other scenarios are possible: if next month’s jobs numbers come in weak, it could cut 50 bps at the September meeting. If economic data deteriorates further sooner, it would not be unreasonable to see the Fed move intermeeting if the data warrants.

Equity weakness into perspective 

Market declines aren’t comfortable yet this current drawdown is part of a normal functioning market. Here are four factors to consider: 

1. The news: Second quarter growth suggested that growth was healthy while slower consumer spending, housing weakness and labor market softness implies weakness.

2. Valuations: Much good news was priced into the market. Any economic or earnings disappointments lead to greater volatility which we’ve seen the past few weeks.

3. Investor optimism: Have investors become complacent? The percentage of bullish investors rose above fifty percent, a level that has historically led to a short-term pullback.

4. Historical precedent: Markets typically experience three to four 4-5% pullbacks on average and a maximum intra-year drawdown of 13%. Up until this most recent pullback, the market had only had one pullback year-to-date of approximately 5%. Volatility isn’t unusual, just uncomfortable. The fact that it’s an election year just adds to the experience. 

What stocks tell us

Currently, the equity market is acting as expected with a ‘growth scare’ as the consumer discretionary sector is negative year-to-date. This is consistent with consumer weakness. Meanwhile, energy stocks sold off as oil prices moved to  $73/barrel in response to slowed growth concerns. Much of the market’s reaction aligns with a slowing economy, is not disorderly and is consistent with economic forecasts.

Where do we go from here?

When markets rose above target levels (irrational exuberance), caution came into view. Going forward, expect the recent weakness to continue as markets digest slowing economic activity and the impact on earnings. Expect uncertainty around the economy, earnings, and the upcoming election to lead to further volatility which is consistent with seasonal patterns displayed over the last 50 years. More downwards pressure could be a buying opportunity for investors (rather than traders). We’ve been on this roller coaster ride before. Fully understanding your unique financial plan designed and implemented with the assistance of your CERTIFIED FINANCIAL PLANNER ™ Professional may ease some of the angst caused by turbulence. Stay focused and plan accordingly. 

Data obtained from FactSet 08/02/2024