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I’ve been reflecting a lot lately. I’ll chalk it up to the four-year anniversary of the Covid outbreak. It’s comforting for me to contemplate how far we’ve come in such a short time. A weight was lifted when I no longer had to make parenting and investment decisions in the throes of a pandemic.
My unquiet brain has also been ruminating over the period before the Global Financial Crisis. No, I don’t believe we’re heading towards a leverage-driven calamity. Rather, I’m reminded of the period in the spring and summer of 2007 when oil and copper prices spiked,1 inflation climbed,2 and the 2-year U.S. Treasury rate surged by over 60 basis points to hit 5%.3 I vividly remember being told by many that the U.S. Federal Reserve was going to have to raise rates again. That hasn’t aged well. Unfortunately, it’s all too familiar to what I’m hearing in certain corners now. I’m not buying it this time either. Policy tightening operates with variable lags. A hard landing for the U.S. economy is unlikely, but a slowdown and coincident easing cycle are likely coming.
As an investor, I prefer to not fight the Fed.
“We’re waiting to become more confident…when we do get that confidence – and we’re not far from it – it’ll be appropriate to begin to dial back the level of restriction.”4
– Fed Chair Jerome Powell
That’s music to my ears. If the core Personal Consumption Expenditures index, which is the Fed’s preferred measure of inflation, has grown by only 2.8% over the past year,5 then why do we need a Fed Funds Rate of 5.25%?6 That feels unnecessarily restrictive, particularly for the nation’s regional banks, which could greatly benefit from the normalization of the yield curve.
…the evidence suggests that U.S. inflation will cool regardless of the “stickiness” seen in recent reports:
At the risk of being a broken record, there is too much investor focus on the U.S. presidential election. I’ve often joked that when the Levitt family goes to Washington, D.C., we don’t first go to the White House but rather to the Federal Reserve Building. That way the family can see where the decisions that truly matter for the financial markets are made.
Historically, presidents have been helped or hurt by whether the Federal Reserve has been working to ease or tighten financial conditions. As an example, Trump and Biden both experienced strong equity returns in their first years in office, only for the second year to be challenging as the Federal Reserve raised interest rates. In each case, third year returns were strong as the Fed backed off their tightening stances.11 By January 2025, the Federal Reserve is likely to be in an easing cycle. History suggests that may benefit the market regardless of who wins the election.
(Read more about why I believe investors shouldn’t worry about the election results.)
Q – Are you concerned that the U.S. equity market won’t perform well in 2025 if the corporate tax cuts of 2018 are allowed to expire?
A – First, it’s hard to be concerned when we don’t know what the outcome of the election will be. Second, let’s not assume that we know exactly what any administration will do. Remember the feared fiscal cliff in 2013? President Obama ultimately extended 82% of the Bush-era tax cuts.12 Finally, the corporate tax rate has increased five times since 1950.13 The U.S. equity market posted gains in each of those five years. The average return was 12.96%.14 Let’s not stress about this.
Interest rates have once again moved higher. Are you concerned that this is the result of investors losing their appetite for U.S. debt? I posed this question to Arnab Das, Global Macro Strategist at Invesco. His response:
No, fiscal concerns do not appear to be driving U.S. rates. Historically there has not been a clear relationship between the yield that investors require to hold a longer-term security and the fiscal status of the U.S. In fact, the additional real yield required to own longer-term bonds has been remarkably stable over time, suggesting that there is not a fiscal credibility problem.15 For what it is worth, the inflation compensation that investors require has also been stable over time, indicating that the U.S. Federal Reserve also does not have a credibility problem.16 Rather, the incremental yield demanded by investors to own longer-term security appears to be almost entirely driven by Federal Reserve policy.17 This suggests that the upcoming Fed easing cycle will likely drive interest rates lower across the yield curve, irrespective of the fiscal health (or lack thereof) of the U.S. government.
My recent travels took me to Greenville, South Carolina. I was told by a client that the audience was impressed by the number of charts that I had brought with me. I quipped that I’m paid by the chart. He said, “Maybe you should be. Perhaps you could advise one of the candidates. Provide them charts for the campaign trail, like Ross Perot had in 1992.” He then asked if I could give each campaign one chart then what would it be? Oh boy. Dangerous ground. Here goes:
Did I handle that well? I’m not sure if I pleased everyone or upset everyone. I will not be seeking Invesco approval to have an outside business interest of providing charts to politicians. I doubt this election will be won by the stat keepers anyway.
Welcome to April. Spring is here!
Brian Levitt is Global Market Strategist at Invesco and cohost of Invesco’s “Market Conversations” podcast.
Notes
1. Source: Bloomberg.
2. Source: US Bureau of Labor Statistics. The US Consumer Price Index climbed from September 2006 to November 2007 from 1.4% to 4.3% on a year over year basis.
3. Source: Bloomberg. The 2-year US Treasury climbed from 4.5% in March 2007 to 5.1% in June 2007.
4. Source: CNBC, “Powell says the Fed is ‘not far’ from the point of cutting interest rates,” March 7, 2024.
5. Source: Bureau of Economic Analysis, 1/31/24.
6. Source: US Federal Reserve, 3/18/24.
7. Source: Federal Reserve Bank of Atlanta, 2/29/24. Based on the Atlanta Wage Growth Tracker, which uses census data to measure wage growth of individuals in the US.
8. Source: Federal Reserve Bank of New York 2/29/24. Based on US inflation expectations for one-year ahead.
9. Source: Drewry World Container Index, 3/14/24. Based on the World Container Index Composite Container Freight Benchmark Rate per 40 Foot Box. The index reports actual spot container freight rates for major East-West trade routes.
10. Source: S&P CoreLogic Case-Shiller, 2/29/24.
11. Source: Bloomberg, 2/29/24. Based on the S&P 500 Index. Returns in 2017, 2018, and 2019 were 21.8%, -4.4%, and 31.5%, respectively. Returns in 2021, 2022, and 2023 were 28.9%, -18.1%, and 26.3%, respectively.
12. Source: US Treasury Department
13. Source: US Treasury Department, 12/31/23.
14. Source: Bloomberg, 12/31/23. Based on the annual returns of the Dow Jones Industrial Average in 1950, 1951, and 1952. Based on the annual returns of the S&P 500 Index in 1968 and 1993. The Dow Jones Industrial Average was used in 1950-1952 because the S&P 500 Index didn’t go live until 1957. The Dow Jones Industrial Average is a price-weighted index of the 30 largest, most widely held stocks traded on the New York Stock Exchange.
15. Source: Bloomberg, 2/29/24. Based on the components of the US Treasury term premium.
16. Source: Bloomberg, 2/29/24. Based on the components of the US Treasury term premium.
17. Source: Bloomberg, 2/29/24. Based on the components of the US Treasury term premium.
18. Source: Organisation for Economic Co-operation and Development, 12/31/23. Based on growth in gross domestic product from Q4 2019 to Q4 2023.
19. Source: US Federal Reserve, 2/29/24. M2 is a measure of the US money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers' checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds.
Disclaimer
© 2024 by Invesco Canada. Reprinted with permission.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
The opinions referenced above are those of the author as of March 25, 2024. These comments should not be construed as recommendations, but as an illustration of broader themes. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
Forward-looking statements are not guarantees of future results. They involve risks, uncertainties, and assumptions; there can be no assurance that actual results will not differ materially from expectations. Diversification does not guarantee a profit or eliminate the risk of loss. All investing involves risk, including the risk of loss.
Diversification does not guarantee a profit or eliminate the risk of loss.
All figures are in U.S. dollars.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
All investing involves risk, including the risk of loss.
Past performance is not a guarantee of future results.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or from Invesco Canada Ltd.
Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that any fund or security will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
Image: iStock.com/crbellette
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