In the three months ended September 30, 2024, equity markets continued their upward march. Interestingly, large cap tech stocks, which heavily influence both the Nasdaq Composite Index and the S&P 500, did not lead the charge. While the S&P 500 and Nasdaq indexes returned 5.89% and 2.76% respectively, the equal weighted S&P 500 (i.e., not capitalization weighted) and Dow Jones Industrial Average returned 9.59% and 8.72% respectively for the quarter.
We find this interesting because during the quarter it was widely anticipated by investors that interest rates had peaked. Indeed, by the end of the quarter the Fed lowered its benchmark Fed Funds rate by ½%. Generally, falling interest rates favor growth and tech stocks, as earnings in the distant future tend to have more value when interest rates are low. We attribute the quarterly returns to the possibility that such stocks, particularly artificial intelligence related stocks, got ahead of themselves. Meanwhile, it was perceived that lower interest rates would reduce the likelihood of a recession, which made the stocks of traditional economically sensitive companies more attractive.
As October is now upon us, we find investors generally have three major issues on their minds: the election, international tensions, and the resiliency of the economy. Let’s start with the election. Our advice is to ignore it. First, we don’t know who will win. A couple of months ago we were even wrong about who the presidential candidates were! Second, results are often counterintuitive. President Trump was considered pro fossil fuel while President Biden was considered pro alternative energy. Yet alternative energy stocks significantly outperformed traditional energy stocks during the Trump administration, while the exact opposite occurred during the Biden administration to date. Active traders might see opportunities. But we are long-term investors. To that extent, we suggest looking right through the election and any turmoil that might result in the short run.
The next issue is global instability and the possibility of war. We will not opine on the morality, human cost, necessity for or against, or appropriate strategies. Instead, we look at the implications for investors. As we write this, Iran and Israel may be on the verge of war, and the U.S. has stationed military assets in the region. Russia and Ukraine are still at war, and there are risks that NATO countries might become involved. China has flexed its muscles around Taiwan, and several incidents have occurred between China and the Philippines. Meanwhile, North Korea remains ever unpredictable.
We don’t know if any of these flash points will involve the U.S. in a significant way. And unfortunately, we can’t tell you the odds. These types of issues are always out there in the market. The best we can do is be prepared to shift our gears if the worst happens. In preparing for this possibility, we can make a few points.
War is generally inflationary. It can also be debilitating to a nation’s financial position. And while war can ramp up a nation’s economy, it can also result in a contraction of consumer demand. Given that the U.S. economy is moving forward, though not robust, and the federal debt is at dangerous levels (neither candidate seems to be addressing this), the involvement of the U.S. in a war would likely result in higher prices and a weak overall economy (other than defense). With respect to interest rates, the Fed would likely aggressively lower short-term rates. But longer term rates might not fall, and might in fact rise, due to the nation’s debt levels and fears of inflation.
The final topic we wish to discuss is the resiliency of the economy. Many had predicted that the economy would falter as inflation and then interest rates ramped up. While the housing market entered into a virtual recession, the rest of the economy moved forward. This was led by a strong job market and consumer spending.
Nonetheless, the economy’s growth has begun to slow in 2024. Job growth is off of its peak. But so too is inflation. The combination has convinced the Federal Reserve that inflation is not as big of a risk as a faltering economy. For this reason it has begun to lower interest rates.
In general, we don’t expect lower rates to significantly stimulate the economy – with one possible exception. As we mentioned, the housing market has been stuck. A combination of high prices and high interest rates has discouraged both buyers and sellers (who generally need to buy a replacement home). If housing prices fall slightly while mortgage rates come down, a flurry of economic activity could be unleashed. Like the risk of war, we are prepared for this. We think at this time that this remains a possibility as opposed to something that will likely occur in the near term.
Looking beyond the housing market, we believe the economy will be sluggish, but move upward. The millennial generation is reaching peak earnings power. While job growth isn’t strong, that is a far cry from a falling job market. Consumers appear to be confident. But we can’t help notice that they have been utilizing their credit cards to fund their spending. Late payments have been inching upwards. We can’t expect much help from overseas, as China is facing economic difficulties of its own. These stem from overbuilding and a declining population.
Our forecast is for slow economic growth. It would not be unreasonable to expect a quarter here or there of negative GDP growth. But we do not expect a recession. We expect the Fed to continue to lower rates. However, they only truly have power over interest rates with very short maturities. Interest rates on fixed income securities with longer maturities may fall as well. But we wouldn’t be totally surprised to see them rise, as the U.S.’s borrowing needs have become excessive.
Our advice to you is to diversify. We believe the easy money has been made, and it is excessively risky to invest in one theme only, such as artificial intelligence, to drive your portfolio. We do think there are plenty of stock opportunities among smaller cap stocks, and stocks of companies in traditional industries.
Likewise, we think fixed income investors should spread out their maturities among short, medium, and long term. Of course, all of this has to be done within the context of your risk profile. Please consult your advisor.
Past performance does not guarantee future results. Pinnacle Capital Management is an SEC Registered Investment Advisor and proud member of the Pinnacle Family of Companies, an organization designed to provide a full range of financial solutions to individuals, businesses, and institutions. For more information on our member companies, visit Pinnacle-LLC.com. Opinions are our own and do not constitute financial advice. Talk to your financial professional for any advice specific to your situation.