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Have you heard of Wall Street’s fear index? The CBOE Volatility Index tracks fluctuations in the market. The higher it is, the more volatile the markets are. On regular days, this index is around 13 or 15. But just days before the election, this “fear index” peaked around 23. This isn’t new – Election years are rarely quiet for the stock market, and they have been historically turbulent compared to non-election years. A change in administration could lead to policy changes, different taxation rules, and modified regulations. Investors hate this uncertainty, and this is reflected in the market’s volatility.
But while pre-election jitters are common, market volatility often stabilizes once results are in. Now that America has decided that Donald Trump will be the 47th President of the United States, attention is already shifting from the election to economic policies. And the Federal Reserve’s recent rate cut is the top concern on investors’ lists. The Fed's rate cut from 2.75% to 2.5% marked the end of one of the most restrictive tightening cycles in history. This has broad implications across the board — from stocks to real estate and even the value of the US Dollar. In this week's newsletter, let’s look at why the Fed decided to finally cut rates and what it means for you.
The ‘i’ word
The entire decision on interest rates hinges on a single word: inflation. Although we’ve seen substantial improvement from the 9% inflation peak in 2022, the current rate stands at 2.4% — still higher than the Federal Reserve’s target but on a downward trend. Recently, prices for items like energy, used cars, and even lettuce have all declined, signaling that inflationary pressures are easing.
However, the story isn’t that straightforward. Prices remain considerably higher than they were a few years ago, which has led to an increase in debt delinquency to its highest level in 12 years!
The White House contends that, excluding housing, inflation is actually under 2%. This discrepancy arises from the way inflation is calculated. One-third of the overall metric comes from “owner’s equivalent rent,” where homeowners estimate how much they would charge to rent out their homes. Apart from housing, food and medical prices are still on the rise. This means that while some prices, such as gasoline and vehicle prices, are falling, inflationary pressure still exists, which is why the Fed could have reduced short-term rates.
How Does This Rate Cut Impact The Stock Market?
In the past five years, the S&P 500 has doubled in value, but these returns are far from typical. Historically, the S&P 500 has delivered average returns of around 6.5% annually or 10% with dividends reinvested. Goldman Sachs predicts that the next decade could see significantly lower returns — potentially as low as 3% annualized. The primary reason? The market’s recent growth has been driven by just seven companies: Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla.
Goldman Sachs suggests that these sky-high valuations could mean sub-optimal returns in the coming years, while other firms like DataTrek argue that economic conditions do not currently resemble past periods of severe downturns, such as the Great Depression or the 2008 financial crisis.
Schwab and BlackRock forecast 6.2% and 5.2% annualized returns, respectively, indicating a more modest outlook but not necessarily a dramatic drop. Regardless, it’s essential to understand that recent high returns may not be sustainable, and expectations should be adjusted accordingly.
The Rate Cut’s Impact on Housing: What’s Driving Higher Mortgage Rates?
Surprisingly, existing home sales are on track for their lowest levels since 1995, and mortgage rates remain high despite the Federal Reserve’s recent rate cut. This is because mortgage rates are tied not to short-term borrowing rates (which the Fed influences) but to the 10-year Treasury yield (Which the market dictates). This yield has remained elevated, signaling investor concerns about prolonged inflation, high debt, and the government’s borrowing needs.
These factors have driven up mortgage rates, despite the Fed’s efforts to bring down interest rates overall. The market, therefore, remains challenging, especially for first-time buyers. Zillow predicts only a 2% increase in home sales in 2024, with prices expected to remain relatively flat as inventory grows and housing affordability issues persist. More inventory means fewer homes are being sold above listing prices, and rent growth has also slowed.
Employment Trends and the Future of Rate Cuts
The Federal Reserve’s mandate is twofold: price stability and maximum employment. While prices are cooling, the job market appears to be slowing down. The latest jobs report showed that only 12,000 jobs were added in September, signaling a weakening employment trend. Although unemployment remains relatively low, the Fed will be closely monitoring these numbers in the months ahead. With inflation easing but employment weakening, we might see additional rate cuts in 2025, especially if the job market continues to soften.
The Election’s Impact on Markets: Should You Be Concerned?
When it comes to elections, it’s worth noting that historically, stock market returns don’t differ significantly depending on the political party in power.
Yes, let that sink in.
While it’s only natural to think that some companies do well under a Republican administration and some do well under a Democratic administration, data shows otherwise. The overall stock market returns since 1933 had no significant difference between the terms of a Democratic president and a Republican president (if there is a mixed congress).
Ultimately, regardless of who’s in office, long-term market returns are generally positive.
So, instead of focusing on election outcomes, it’s probably more productive to focus on what you can control:
- Maintaining a steady income,
- Living below your means,
- Saving and investing regularly.
The Takeaway
The Federal Reserve’s recent rate cut marks a pivotal shift after years of aggressive rate hikes. The impacts are already starting to ripple through the stock and housing markets, and the economic outlook over the next decade may be more modest than recent history would suggest. Still, inflation is under control, and more rate cuts could be on the horizon if employment trends weaken.
As always, stay disciplined, focus on long-term goals, and be prepared for whatever comes next. In the long run, the market has only rewarded disciplined investors.
That's it for this week. I hope you enjoyed this article. Let me know your thoughts by responding to this email - I read every single comment :)
Stay safe, stay invested and I will see you next week – Graham Stephan.
113 Cherry St #92768, Seattle, WA 98104-2205
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