Changing Themes
Fall is here and depending on where we live has different meanings or experiences as to the seasonal change for each of us. How we all look at seasonal change can be calming or stressful. We have heard from many investors that this year packs a punch with two wars, inflation, interest rates, the economy and a historic election less than a month away. Although we can’t categorize any of these concerns as seasonal, they are normal occurrences that we face. How we prepare our portfolios for what is next is the cornerstone of why diversification works over a long-term view within the context of change.
The past two years we have experienced change in leadership from the Magnificent 7 stocks (Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta and Tesla). These seven stocks dominated the investment landscape and continue to perform, evidenced by the S & P 500 gains for the fourth straight quarter moving up 5.5% and 21% for the first three quarters. However, we are beginning to see a greater participation in broader sectors such as small and large cap value stocks, as well as small growth which have outperformed large cap growth stocks.
Jared Franz, economist with the Capital Group believes that instead of the four-stage business cycle- early, mid, late and recession, the economy is transitioning from late-cycle characteristics of tight monetary policy (rates are higher) and rising cost pressures (inflation) back to mid-cycle, where corporate profits tend to peak, credit demand picks up and monetary policy is neutral (interest rates are lower and inflation lower). Franz points out that if the US economy is mid-cycle, then we could be on the way to a multi-year expansion period. In the past this type of economic environment has produced stock market returns in the range of 14% and conditions for bonds were favorable.[1] Whether Franz is correct in his assessment is yet to be determined and time will tell. However, this is a shift or change in normal patterns of the business cycle.
We have experienced the long-awaited rate cut by the Federal Reserve (Fed) which the market has welcomed. Historically when the Fed cuts rates it is generally a red flag, meaning the economy is slowing. However, since the pandemic Liz Ann Sonders, Managing Director and Chief Investment Strategist at Charles Schwab has emphasized that we are experiencing rolling recessions whereby various sectors of the economy are going through recession-like business cycles at different times which in turn has kept the overall economy on solid ground.
It takes time for a rate cut to flow through the economy and there are additional rates cuts being anticipated by many market experts. Investors are aware that no matter who wins this year’s election, there is the potential for sweeping changes. However, if you look at the past with campaign promises from either candidate it is very difficult to get sweeping changes. Last quarter we referenced the fact that both parties have been good for our portfolios, yet investors worry. Over the last few decades, we have experienced political gridlock, and it appears that we may see a split government which narrows the potential for wild policy swings.
We believe that we need to focus on the fundamentals of what we know and not speculate on what may or may not occur. Although markets may be volatile up to and through the election, keep in mind that the anticipation of sweeping changes is more emotional behavior in the markets. What we know is that changes are forthcoming and diversification within your portfolio keeps you well balanced to absorb volatile times no matter what the case may be. The past few years we have experience positive returns in our portfolios. Taking profits is prudent and reallocating the profits to areas that are in line with your needs and asset allocation helps smooth out the downside risks associated with volatility. In the months ahead stock market volatility can be unnerving, but a normal feature of long-term investing. They're not fun, but you can expect to see market declines periodically. Staying the course is not just a phrase, it is sound advice if you are well-balanced in your investments.
We welcome your thoughts or concerns as we embrace the changes ahead. We look forward to our next discussion. Enjoy the Fall! We appreciate the continued trust and confidence you place in us.
[1] Capital Group: Welcome to the Benjamin Button economy: Jared Franz, Economist September 30, 2024
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