CWS Market Review – September 24, 2024

(This is the free version of CWS Market Review. If you like what you see, then please sign up for the premium newsletter for $20 per month or $200 for the whole year. If you sign up today, you can see our two reports, “Your Handy Guide to Stock Orders” and “How Not to Get Screwed on Your Mortgage.”)

The Federal Reserve Cuts By 0.5%

Last week, the Federal Reserve voted to lower interest rates by 0.5%, although I think it’s more accurate to say that the Fed undid some of the historically aggressive rate hikes it deployed in 2022 and 2023.

Over a 16-month period, the Fed hiked short-term interest rates a total of 525 basis points. The aggressive rate hikes were intended to combat a nasty bout of inflation. At one point, inflation was running at more than 9%.

Now, more than a year after the last Fed hike, and with inflation trending below 3%, the central bank decided to slash rates by 0.5%.

I admit I didn’t think the Fed would go through with a rate cut that large. So far, Wall Street seems quite pleased with the move. Today the S&P 500 closed at another all-time high, its 41st of the year. The Nasdaq was up as well but it’s still below its high from more than two months ago.

Overall, this has been a good year for the stock market. The S&P 500 Total Return Index, which includes dividends, is up 21% this year. We’re about to close out Q3, and the S&P 500 is on track for its fourth quarterly gain in a row.

It looks like this will only be the first in a long series of rate cuts. For the November meeting, traders are evenly split on whether the Fed will cut by 0.25% or by 0.50%. That meeting will be shortly after the election.

While the exact plans are in doubt, the overall strategy is clear: the Fed is leaning towards cutting rates. Over the next four meetings, traders expect the Fed to cut interest rates by a total of 1.5%. That makes sense if you believe that inflation has been whipped.

Still, this is an unusual rate cut because it’s happening while unemployment is still low (but rising) and the stock market is strong. I have my doubts that we can easily settle back into the economic environment we had before the last bout of inflation.

It’s also unusual that the financial markets are seemingly unbothered even though there’s more evidence that Americans are apprehensive about the future. A good example is that earlier today, shares of Lowe’s (LOW) and Home Depot (HD) both reached new all-time highs. I highlight the home improvement duo because they’re a good indicator of what the economy is doing at the ground level.

Other industrial stocks like 3M (MMM), Caterpillar (CAT), Sherwin-Williams (SHW) and Carrier Global (CARR) also hit new highs.

What’s Next for the Fed?

In last week’s Fed decision, the only dissenting vote came from Michelle Bowman. What makes her dissent noteworthy is that Bowman is a Fed Governor, not a regional bank president. Typically, Fed Governors vote in line with the Fed chair. Bowman’s dissent is the first for a Fed governor in nearly 20 years. She believes that the Fed should be cutting by only 0.25%.

Earlier today, Bowman spoke before a group of bankers in Kentucky where she had a chance to explain her decision. She said that the Fed’s big cut “could be interpreted as a premature declaration of victory on our price-stability mandate.”

There’s also a basic thought that inflation, however you want to measure it, is still not at the Fed’s target rate of 2%. The rate cut assumed that inflation will safely glide itself into port. Bowman also believes that a cut of 0.5% would signal to the market that the economy is in greater peril than it truly is.

The two-year Treasury yield has a decent track record of running just ahead of the Fed on interest rates. Right now, there’s a big divergence between the two. Even after the rate cut, the Fed funds rate is still 1.2% above the 2-year yield. That’s a good sign that more cuts are coming.

Indeed, there are still worrying signs about the economy. Earlier today, the Conference Board said that its measure of consumer confidence dropped from 105.6 in August to 98.7 for September.

That was the biggest drop since August 2021, and it was below Wall Street’s expectations for 104. For context, before Covid, consumer confidence reached 132.6 in February 2020. Of the economic subgroups, the largest drop in confidence came among those making less than $50,000. Stocks are happy while consumers are tapped out.

Another good example of this was today’s Case-Shiller report which showed that home values hit another new high, but housing affordability, which adjusts for mortgages costs, is near the lowest on record.

Another troubling sign is that the price of gold has been rallying strongly. Typically, this is a crisis asset that investors flock to during turbulent times. Reuters reports that most banks expect gold’s run to last into next year. On Tuesday, the Midas metal got as high as $2,639.95 per ounce. Gold is having a great year.

On Thursday, the government will offer its second revision to the Q2 GDP report. The last report said the economy grew at a real, annualized rate of 3% during the second three months of the year. I’m curious how well the economy did during Q3. For now, Wall Street is sounding optimistic. The Atlanta Fed’s GDPNow model estimates the economy grew at a 2.9% rate for Q3. Goldman Sachs said it expects growth of 3.0%.

Typically, as the economy gets weaker and the Fed lowers rates, we can expect that defensive stocks will do well. Over the summer, many defensive stocks started to perk up and outgained the rest of the stock market.

Here’s a chart of the S&P 500 Consumer Staples ETF (XLP) and the S&P 500 Healthcare ETF (XLV) divided by the S&P 500 ETF (SPY).

You can see how the market changed its mind. At one point, no one wanted anything to do with defensive stocks, but this summer, they got hot again (although they’ve been slipping back down lately).

I think this trend has more room to run. Defensive stocks offer more stability and often higher dividends than the rest of the market. Also, many defensive areas of the market have fallen to favorable valuation metrics.

On our Buy List, this means stocks like Hershey (HSY) or Stryker (SYK). For income investors, that means utilities like American Water Works (AWK).

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on September 24th, 2024 at 5:52 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.