Stock and bond markets have risen significantly this year, and that growth continued in the second quarter. Many markets are flirting again with all-time highs after falling sharply at the end of last year and every asset class is rising this year. That feels good in the moment, but it does not help the valuation picture, where everything remains expensive, historically-speaking.
Some of the advance is certainly a result of central banks, particularly the U.S. Federal Reserve, becoming more accommodative again. The Fed came into this year projecting three rate hikes. Instead they have not hiked rates at all, and are now contemplating cuts in the face of a slower global economy. Bond prices have risen in anticipation of those potential cuts, and that anticipation has probably contributed to higher stock prices too.
The last time the Fed cut rates with stocks near all-time highs was 1996. According to William Watts at Marketwatch, the Fed has done so 17 times since 1980, and the stock index was higher a year later every single time. That said, the Fed has never done so with interest rates this low, or with unemployment rates this low, or with the manufacturing index still showing expansion, even if it is just slightly. So the economic environment is certainly different this time, which may limit the economic benefit of such a cut. Yet, even if the economic benefit is limited, central bank easing does provide a psychological benefit and is more likely than not to stimulate the market. Of course if the Fed fails to deliver on its expected cuts, that could sap some of the market’s enthusiasm.
Meanwhile, there is no doubt that the global economy is slowing. Global manufacturing indices flipped from accelerating to decelerating in June, and even though the U.S. manufacturing index remains slightly positive, projections for GDP growth here have dropped into the 1%-2% range. Many economists, including Raymond James own chief economist, Scott Brown, acknowledge the rising risk of an economic downturn, but believe that a recession is still unlikely in the next 12 months. Given that the Leading Economic Indicators (LEI) were trending higher up until May, that is probably correct. However, the LEI index dropped in June, and if that decline were to continue it could indicate a more imminent recession risk.
And maybe that is what central banks are looking at and trying to head off with a so-called “insurance” interest rate cut. Again, that is likely to boost security prices in the short term, but the central bank’s ability to actually stop a global recession through such action is highly debatable. Instead, rate cuts may feed into the risk, mentioned in last quarter’s Musings, of a “melt-up” in prices, which could exacerbate the eventual downturn.
Also, this is now officially the longest economic expansion on record, and economic expansions have always come to an end one way or another. It remains a strange market environment, and one where you want to make doubly sure your investments match your goals, your time horizon, and your own personal risk tolerance.
Leading Economic Indicators are selected economic statistics that have proven valuable as a group in estimating the direction and magnitude of economic change. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. The S&P 500 is an unmanaged index of 500 widely held stocks.
The information above represents the opinion of financial advisor Travis Rus, and is not necessarily that of RJFS or Raymond James. It is not a complete summary of all available data necessary for making an investment decision, and does not constitute a recommendation, nor is it a complete description of the securities, markets, or developments referred to herein. Opinions are subject to change without notice. Information has been obtained from sources considered reliable, but we cannot guarantee that it is accurate or complete. Past performance does not guarantee future results. Investing involves risk and you may incur a profit or loss.
