Stoked stocks rallied into the nosebleed section because Powell was not as nasty as he could have been the day before – a celebration ensued. The Leading Economic Index declined less than expected which means things are still slowing, but not as fast as economists expected.
No rest for the weary. With the questions about rates out of the way for now, investors were cleared to ponder the rest of the universe yesterday… but first stocks breathed a LARGE sigh of relief, rallying broadly. Folks, I am a believer in a well-earned treat, be it a decadent dessert, a frothy, overpriced coffee concoction from Starbucks, or maybe a frosty cocktail. However, as a new day dawns, it is important to get back on ones’ feet, sharpen the eyes and get back to business, lest you may get flanked by the 1000 enemies that are out to end you. Wow, that sounded almost biblical, didn’t it? I felt it necessary to employ flowery, grandiloquent language in order to get the point across that thine enemies don’t rest, so you shouldn’t either. Now that we got that out of the way, let’s go.
The economy does not turn on dimes. Once it gets in motion, it tends to stay in motion like a really, really, big, overloaded cargo ship. It can turn, it can slow down, it can speed up, it can even stop, and it can reverse. However, changing course is a slow process and it takes patience. In other words, if the Fed lowered its key lending rate by ½ a point two days ago, it is not likely to have a material impact on the economy any time soon. The economy, by most measures, is slowing. It is moving forward but it is slowing. The slowing is the result of the Fed slamming on the brakes in 2022 through July of 2023 and holding them pressed tightly until this past Wednesday. It took that long to have the “desired” effect of slowing the economy to tackle inflation. Now, to be clear, the Fed’s rate cut, even though it was larger than many expected, is not the equivalent of mashing down on the gas pedal. No, the Fed simply let up on the brakes, SLIGHTLY. It is still braking! We can, therefore, expect the economy to continue to slow until the Fed decides to let up completely on the brakes and depress the accelerator. Here is the catch, nobody, not even the Fed, knows exactly at what interest rate level that is. Enter the elusive r*, or r-star. That is the unobservable rate at which the Fed interest rate policy is neither accommodative nor restrictive; it is neutral. The only way to get to this r* is through… feel. Now, I don’t want to get too far into that exciting academics (and me 🤓) debate, but I do want you to know that the economy is still under threat of contracting, and it will likely get worse before it gets better. Got it? Good, let’s move on.
Did you know that there is another potential Government shutdown in the months ahead? Indeed! The annual budget is due on October 1st, and it is required in order to fund the Government. So, either lawmakers need to agree on a budget by then, or they need to agree to keep the Government funded as they wrangle over a final budget. If lawmakers can accomplish neither, the Government will shut down. I know, I know, we have been through this so many times in the past, and somehow things always worked out. However, this time there are some unique circumstances. For one, we are rapidly approaching elections. That means politically charged behavior is… well, fully charged at the moment. I am not sure that any lawmaker wants to cause a Government shutdown, but we have seen some pretty destructive behaviors to get a point across recently. At this point we can only hope that Congress can agree to keep the lights on, because a Government shutdown during elections and transition is not exactly a healthy scenario. One which can surely affect investor confidence.
Now that we have touched the third rail of elections, try, though I have for these many past months, I like most of my colleagues are still unable to come up with a clear picture of what these 2 would-be candidates might do to positively and or negatively impact the economy and your portfolio. As we get closer to elections, the already cloudy picture gets cloudier yet. Both candidates have promised all sorts of tax cuts for all sorts of voting blocks. They, or at least one of them, have offered financial incentives. One is keen on helping American businesses remain competitive and profitable, while the other would like those businesses to pay for tax breaks. Did I mention inflationary tariffs? But the real question is how much, if any, of those promises will be kept. More importantly, can any of those offers be fulfilled by the President alone. Sure, there are some things that can be accomplished through executive order, but as we have learned recently, those things can be hampered by legal action. So, all these promises will ultimately be fought over in the chambers of Congress, or the court system. Which will even get through and what will they ultimately look like?
Finally, earnings season is just weeks away. It is clear that earnings growth has slowed and is expected to continue slowing. But that doesn’t necessarily spell disaster. Well-run companies can weather the ups and downs with deft. Which of our favorite companies will be able to navigate the downs? Earnings growth ebbs and flows naturally; there is no such thing in the natural world as ever-accelerating earnings growth. Investors are going to be faced with deciding what level of slowed growth is acceptable and under what types of circumstances. In this environment, companies are going to get stepped-up scrutiny. For example, simply stating that the company is pursuing AI initiatives is not going to be enough. Supply outages sometimes occur, but if they repeatedly occur, management will be questioned AND sanctioned. The point here is that this upcoming earnings season has the makings of being a tough one. Stocks are at or near all-time highs, the Fed has rolled over, regulatory interference is on the climb, the economy is slowing, Federal policy is unclear, and… the list goes on.
I didn’t write this piece to disturb your peace in the wake of the Fed’s gift earlier this week. I hope that you will recognize that even with the Fed now shifting its strategy it does not mean smooth sailing ahead. I want to underscore the importance of staying vigilant. It is difficult, if not impossible to “control” the economy. It is challenging to discern what policy promises are even real in a charged political environment. You can control what goes in and comes out of your portfolio, however. Unlike the economy, companies can turn on a dime and it is up to management to keep them on course. Are you done with that well-earned treat? Great, now put down the fork, glass, or mug. Sharpen your pencils, because the real work is ahead of us.
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