After a hot first quarter, we’re left feeling that the market has begun to cool off just as the weather warms up here in the upper Midwest. With a mix of rising interest rates and tempered expectations for Federal Reserve rate cuts, we’ve begun to feel a slight market chill. Nevertheless, and despite some hubbub over inflation and interest rates, we believe the market will remain healthy. Our very own Chief Investment Strategist, Nate Zeller, breaks down why.
Q1 and Q2 In A Few Recording Breaking Numbers
Wall Street continued its hot streak in March, extending its rally to a fifth straight month. The S&P 500 returned over 10% in the first quarter of the year; the best first-quarter performance for the index since 2019!
The second quarter has gotten off to a cool start for stocks as interest rates moved higher. Following comments from officials at the Federal Reserve, expectations for the number of interest rate cuts this year were damped, sending bond yields higher. Yields on 10-year U.S. Treasury bonds recently touched their highest point in 2024.
What’s To Come of The Fed’s Hold Steady?
Investors remain cautious about the pace of the Fed’s rate-cutting timeline this year and how soon central bankers will be able to meet their 2% inflation target. As expected, the Fed held interest rates steady at their March meeting and officials have indicated they are in no hurry to cut as economic growth remains strong and inflation remains above target.
Many “experts” and prognosticators on television and the internet would lead us to believe that if the Fed does not cut rates this year it could spell disaster for the stock market. We do not think this is the case, and, in fact, believe the opposite to be true. If the Fed does not cut rates, it is because economic activity and the labor market remain strong. Economic growth generally leads to corporate earnings growth, helping provide a tailwind for stocks. The Fed cutting rates as a result of slowing economic growth could be a bad omen for the stock market.
An ideal scenario would be lower inflation while the economy remains healthy, but this may be unlikely since robust economic growth typically leads to inflation. There is also the prospect that inflation reverses course and moves higher, forcing the Fed to raise rates. While this may seem doubtful, it does remain a possibility, especially in light of the recent rise in commodity prices – namely oil.
An Overvalued Stock Market and Broadening Momentum
Indications signal the overall stock market is overvalued when compared to historical measures. The question is whether earnings will continue to grow to support lofty share prices or if prices will fall to be more in line with long-term averages. Nothing mandates that stock prices must trade at certain valuations and, as we know, the market can remain irrational for a very long time. However, over time, the market always seems to “revert to the mean”, so eventually, we are likely to see either a pullback in prices or an acceleration in earnings growth.
The emergence of the “Magnificent Seven” stocks last year led markets higher but not all stocks and sectors participated in the rally. The performance of the major market indices was primarily driven by these seven stocks which now make up a large concentration of cap-weighted indices. Currently, there is added risk in investing in passive strategies that track these indices, since they are heavily weighted to this small handful of stocks.
We are not necessarily expecting a pullback in these names, since most are very strong companies with solid and rapidly growing earnings, but we do anticipate a broadening of the upward momentum to include a wider array of stocks in sectors outside of technology which will provide opportunities for active management strategies.
Protection Strategies To Mitigate Your Investment Risk
With the stock markets trading near all-time highs and a sense the market is overbought, we fully understand there may be some trepidation amongst investors when it comes to putting new money into the market. Remember, stock market investing is a long-term endeavor and there are times of volatility. Historically, patient and disciplined investors have been rewarded. There are many protection strategies available which provide stock market participation while protecting against downside risk. If you’re interested in learning more about how various strategies might make sense for you, give us a call at 952-460-3290.
Nate Zeller
Chief Investment Strategist
Secured Retirement
