Western films, which depicted life in the American West and the new frontier in the late part of the 19th century, reached their pinnacle of popularity between the mid-1940s and mid-1960s. In most of the films, a hero came up against a villain with the scene being a gunfight or stand-off taking place in the middle of a frontier town where each was staring at the other, waiting to make a move, with tense music playing in the background. The Fed has been in an ongoing fight with inflation, which now seems to have reached a point where they are staring each other down waiting for the next move before taking further action.
The Fed held interest rates steady last week, but in post meeting comments emphasized this was merely a pause (or a “skip”) and not necessarily the end of the interest rate hiking cycle. They also released updated economic forecasts in their quarterly Summary of Economic projections, including its “dot-plot” which indicates where Fed members expect interest rates to be in the future. This forecast indicated that Fed members expect two more rate hikes before the end of this year, higher than projections made in March and a contradiction of previous market expectations of a drop in rates by year-end. Projections also showed expectations for inflation peaking higher than previously anticipated.
The monthly Consumer Price Index (CPI) inflation report last week showed that headline inflation cooled to 4% with core-inflation (excluding food and energy) remaining “sticky” at 5.3%. A large driver in the headline number was a pullback in energy prices, which tend to be volatile especially on a month-to-month basis. The Fed Funds rate is now equal to the inflation rate for the first time this cycle. Historically the Fed has never lowered rates while the Fed Funds rate is below the inflation rate, so it is little surprise the Fed has not considered lowering rates thus far. Year-over-year inflation peaked in June of last year so inflation readings for the remainder of this year could be interesting since they are a comparison to 12 months prior. It seems CPI is on a downward trajectory and if it continues, the Fed has been successful reigning in inflation while achieving a soft landing in the economy; a feat that looked extremely unlikely a year ago. But that being said, some economic indicators are showing a slowdown, so it remains to be seen if we are truly able to avoid a recession.
The Magnificent Seven
Considered one of the greatest films of the Western genre, the Magnificent Seven tells the story of how seven gunfighters are hired to protect a small Mexican village from a group of marauding bandits. We’ve seen something similar emerge in the stock market this year with a septet of big tech firms driving markets higher while the remainder of the market has contributed little to this year’s market gains. In the 1970s there was the Nifty Fifty, the late 90’s brought the “Four Horsemen” and more recently there were the FAANGs (Facebook, Apple, Amazon, Netflix, Google) which has morphed into the newly coined “Magnificent Seven” consisting of the same companies, minus Netflix, with the addition of Microsoft, Tesla and Wall Street’s latest darling, Nvidia. These stocks have helped propel the S&P 500 into a new bull market, being up some 26% from its low last October. However, it still remains 8% below it’s all-time high reached in November, 2021. Some other names have performed well, but the rally has not been as broad based as the index performance would indicate.
Markets rallied last week on the heels of the Fed pause and enjoyed their best week in over three months. There appears to again be positive momentum in the markets. However, we remain cautious on some of the names mentioned above as they perhaps have gotten ahead of themselves with valuations well above historical averages. Current stock prices are factoring significant growth which seems overly optimistic in our view. We remain more positive on the remainder of the market as we see signs of a rebound in the making. This is especially true of small cap stocks which seem to be enjoying a recent resurgence.
As we near the end of the first-half of the year we can reflect on what has occurred and look ahead to what the second half might bring. Despite overwhelming expectations and forecasts of a recession, this year has brought a welcome surprise in the equity markets. Overly cautious investors and those trying to time the market have missed out. That is not to say the market will not dip in the future, which it undoubtedly will at some point as it goes through its usual gyrations, but this again is evidence that predictions, both positive and negative, from even the most well-regarded “experts” are often not realized when it comes to investing. There are two full weeks remaining in the quarter, but it seems the market has positive momentum heading into the second half of the year. We will be watching the usual economic indicators but have an especially keen eye on inflation and earnings. The biggest risk we see to the markets in the second half is an earnings recession.
Even if the Fed does not take additional action, monetary policy remains tight since interest rates are much higher than they were just 18 months ago. We remain constructive yet cautious, on the equity markets and while fixed income instruments are producing the highest yields seen in 15 years, they are still subject to fluctuations in prices from swings in interest rates, giving us reason to pause in the current environment. For those worried about what the equity markets might bring, our preference is for other types of protection strategies. If you are staring down your retirement and trying to decide the next move, let us help you make the right move to win the fight.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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