Linda S. Parenti, CFA
Chief Investment Strategist
The S&P 500’s sharp downturn during the month of May thankfully turned positive by early June, leaving the index up a still respectable 16.5% in total return year-to-date as of Thursday’s close. The rebound has been partly due to stock prices having reached oversold levels, and partly due to market participants having become convinced the Federal Reserve has no choice but to reverse course and start cutting interest rates this year in order to boost economic growth. The Fed’s current rate hike cycle has spanned three years and included nine increases, with the last one occurring in December 2018. Despite a lack of confirmation yet from Federal Reserve members, futures markets have priced in a nearly 90% chance of a rate cut in July and almost certain probability of multiple cuts by year end. Evidence of this outlook can also be seen in the bond markets, as U.S. Treasury yields have fallen abruptly over the past few weeks. Both equity and fixed income market strategists will be watching closely for any signs of validation from next week’s Federal Open Market Committee meeting.
Do we even want or need lower interest rates? The Fed lowers interest rates, specifically the federal funds rate, to help revive economic growth and boost inflation. Inflation has been curiously low, but steady and not considerably far from the Fed’s target. Economic growth is slowing, yet it remains in relatively decent shape in the U.S. and small business optimism has been rebounding each of the past four months. Mortgage rates have dropped dramatically from year ago levels, providing support for the housing sector. May’s jobs report was weaker than expected, however, unemployment and initial jobless claims continue to be at historically low levels. Overseas there have been recent signs of economic life in reports out of Japan and the Eurozone. Positive news from those regions is encouraging since Japan and Europe combined make up over 75% of the broad developed international equity indexes.
Eventually, either the Fed or the markets need to come around to the same thinking. Even if the Fed indicates they are open to lowering rates, do not be too discouraged if the Fed continues to remain on hold. Rate cuts do not always justify higher equity prices. It depends on if the reductions result in improved growth. The addition of the threatened tariffs would certainly be more damaging, but so far, the current tariffs have not been detrimental to GDP. It would be prudent for the Fed to wait for more clarity on the numerous trade issues before initiating a change in policy.
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.