Making economic forecasts and stock market predictions can be humbling. It is especially tough when you expect stocks to go higher and get a big drop instead. The environment today is the opposite, but still tricky, as recession has not followed the chorus of predictions.
In some ways, figuring out what to do now that stocks have gone up is as difficult as considering what to do when stocks are down.
Even with the recent selloff in equities, and rise in rates, today’s more fully valued stock market is pricing in an increasingly optimistic outlook for economic growth and corporate profits, but the economy still faces challenges that have potential to lead to slower growth in the second half.
Staying true to your investment plan is important. We all know it’s difficult to time the market. We have seen this play out several times in just the past few years. For example, few
foresaw the strong market rebound that occurred as we came out of lockdown in 2020, or that inflation would become the ongoing problem that we are still dealing with today. We
saw it again this past spring – professional portfolio managers and investors alike were broadly pessimistic about the stock market, particularly in the wake of several bank failures.
Yet, stocks have gone virtually straight up since until this past week when we saw signs of exhaustion in the move higher. A period of consolidation in markets could be looked at as healthy, especially as the run up in stocks came prior to the reporting of second quarter earnings.
Another reason for optimism is recent and encouraging economic data, which supports higher stock prices as the odds that the U.S. economy achieves a soft landing have increased. The U.S. economy grew 2.4% in the second quarter, a solid pace for a typical economic expansion these days. The job market remains healthy with near record-low unemployment. A resilient economy has fueled better profits for corporate America than most expected, setting up a likely end to the ongoing earnings recession in the current quarter.
In addition, lower inflation may continue to support stocks in the months ahead as the Federal Reserve (Fed) winds down its interest rate hiking campaign. The Fed’s preferred
inflation measure, the core PCE deflator, dropped a half point in June to 4.1% and could potentially reach the mid-3s by year-end — not far from the central bank’s 2% target. Lower inflation may also be good news for bonds by enabling the Fed to cut interest rates in 2024 as most expect. Most recently, consumer prices and producer prices data releases for July showed lower than expected inflation.
Back on August 1st, Fitch, one of the three main credit rating agencies, downgraded the U.S. government debt to its second highest rating, AA+. This move was based on their
expectation for further economic deterioration of the next three years in terms of debt burden. The move was not a surprise after Fitch warned in June that a downgrade was an
option even after the debt ceiling resolution. The warnings from Fitch went back years, not just a couple months. But the move reminded investors of 2011, when Standard and Poors downgraded the U.S. debt to AA+ and the S&P500 sold off 19% peak to trough. Therefore, we understand why investors were jittery when they heard the Fitch news. But the market reaction was subdued with a selloff of 2% during the three days following the news, when many in the analyst community were already calling for a pullback.
This all begs the question, what is different this time? One reason, we have been here before, which should limit ripple effects in terms of further market reaction. Standard and Poors arguably carries more weight than Fitch and already made this move 12 years ago. Back then, S&P noted on the downgrade that the plan Congress and the Administration agreed to fell short of what, in their view, would be necessary to stabilize the government’s medium-term debt dynamics. This was said in 2012. While that development came as an initial surprise to markets back then, stocks recovered in short order with the S&P 500 Index rebounding and finishing up the year more than 12% off those lows before seeing more gains during the first quarter of 2012.
Finally, for those worried that gains in the broad market have been driven by only a handful of stocks, stock market leadership has started to broaden out. We believe that is a necessary
condition for the next leg of this bull market. Small cap stocks fared better than large caps in July and the average stock in the S&P 500 rose more than the index over the past two
months. We see areas of opportunity in sectors like industrials, energy, healthcare, and technology and we advocate for dollar cost averaging; simply investing at regular intervals
over a period of time. This is a great approach as it takes emotions off the table. Take advantage of dips that will inevitably come and use volatility as an opportunity to get back to
long-term target allocations. Again, stay true to your long-term goals and investment plan.
And always, stay safe, and stay the course.
Scott A. Shaw, CFA®, CFP®
CIO | Chief Investment Officer
40 E Montgomery Ave, 4th Floor Ardmore, PA 19003
Office Phone: 215-982-2743
Fax Number: 215-827-5814
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