By Matthew Gaude & Shawn McGuire
The Federal Reserve concluded their April 30th/May1st meeting by leaving interest rates unchanged per the headlines from www.cnbc.com:
Put differently, the market didn’t initially rally because Federal Reserve Chairman Jay Powell was dovish. Instead, the market rallied because investors convinced themselves prior to the Federal Reserve meeting that Powell could put rate hikes back on the table. That was never likely in reality, but that didn’t matter. On May 1st, Jay Powell said a rate hike was “unlikely,” markets cheered and stocks and bonds rallied. And I’m happy they did, but make no mistake: Nothing changed from a Fed standpoint and the outlook for stocks and bonds did not improve.
Legitimate fears of rate hikes are not the reason the S&P 500 pulled back -3.86% in April. The lack of rate cuts in 2024 is the reason the S&P 500 has pulled back; and if anything, Powell confirmed the market’s expectations for one (or no) rate cuts in 2024 is appropriate.
Why This Matters
The Fed not hiking rates was never a real risk and it’s not a sustainably bullish catalyst. I’d expect that idea to fade from investors quickly. It will likely be replaced by the reality that rates are not declining anytime soon (likely not until Q4 of this year, if at all), and that means that economic growth remains the key variable in this market. If growth can hold up, the market can withstand higher rates and stocks, over time, can trend higher. If growth begins to decline (and there is a growing list of indicators showing slowing momentum), then stocks have a significant problem, one that could potentially drop the stock market at least 10% from current levels.
Bottom line, the Fed decision on May 1st resulted in a stock market rally because Powell pushed back on rate hikes, but that’s not a surprise nor is it a reason to be bullish. The Fed was always unlikely to hike rates. However, Powell and the Fed did acknowledge that “higher for longer” is back and as such, economic growth is now key.
Investors cheered both Fed Chair Powell saying rate hikes were unlikely and almost universally disappointing U.S. economic data last week, but while that provided a boost for stocks and bonds, investors need to be careful what they wish for, because despite the late-week rally, the outlook for stocks got more concerning last week.
I say that for two main reasons. First, while Jay Powell pushed back on the idea of rate hikes, the Fed openly embraced higher-for-longer, and that means there are not going to be any near-term rate cuts, unless growth suddenly and abruptly collapses. Point being, imminent rate cuts were an important part of the October 2023-March 2024 rally, and the reality is that we likely are not getting rate cuts anytime soon.
Second, for the first time in several years, numerous economic indicators are pointing to slowing momentum. In April, we saw U.S. manufacturing decline, and if that continues for another two months, it’ll provide a very reliable signal that economic growth is slowing. But it’s not just manufacturing. Consumer companies’ earnings reports are flashing some warning signs on the consumer, and while still low historically, the unemployment rate looks like it wants to drift higher.
Consumer Spending Report Highlights
Following are some highlights regarding consumer spending reports on the most recent quarterly earnings announcements:
- Starbucks stock sank 12% due to weaker-than-expected quarterly earnings and revenue, fueled by a surprise decline in same-store sales. Starbucks also slashed its forecast for its fiscal 2024 earnings and revenue, predicting that its stores would keep underperforming for several quarters. In other words, consumers are not willing to continue to pay ever-increasing prices for coffee.
- Mondelez (maker of Oreos, Ritz crackers, cream cheese, among others) said lower-income consumers are focusing more on price points.
- Amazon said consumers are still shopping but remain cautious, trading down on price when possible, and seeking out deals.
- Clorox mentioned that consumers have been “quite resilient” but will be under pressure in the second half of the year.
- Colgate Palmolive mentioned higher prices of its oral and personal care products continue to weigh on sales.
- Home Depot has also felt a pullback in consumer spending, particularly on big-ticket items, as some families postpone discretionary purchases because of inflation, put off buying a new home because of higher interest rates, or choose to spend on experiences rather than goods.
- Yum Brands’ quarterly results missed profit estimates for the first time in two years as consumers with constrained discretionary budgets hunt for better bargains while dining out. “Probably more of an emphasis on value than there has been in past quarters,” said CEO David Gibbs on a post-earnings call, while adding that the KFC brand was struggling in the U.S.
- McDonald’s CEO said on a post-earnings conference call, “The consumer is certainly being very discriminating in how they spend their dollar…but it’s important to recognize that all income cohorts are seeking value.”
To be clear, none of these signals mean the economy is slowing right now. It is not. Growth is still positive; it just appears it is getting less positive than we’re used to.
Don’t Get Lost in the Inflation Debate
One of the few candidates that can truly stop this rally is a stall or contraction in the economy. Here’s the bottom line: Don’t get lost in the inflation debate. Yes, price pressures are sticky, but they may continue to drift lower (albeit slowly) over time, especially given it appears the economy is losing momentum. Instead, stay focused on growth.
Going forward, we’ll continue to watch economic data very closely and, again, at this point in the economic cycle, it’s not about inflation (that won’t rise especially if growth is slowing) or the Fed (they’re only cutting in the near term if growth slows). It’s about growth and it needs to remain resilient for the S&P 500 to hold current levels and, eventually, move higher.
As a result, the 10-year Treasury rate ticked down to 4.50 from 4.70%. In our 3/21/24 update, the 10-year Treasury rate was at 4.27%, an increase of ~.23% on the 10-year Treasury rate over the last 45 days.
What Does This Mean for Our Fixed-Income Investment Strategy?
1. The first part of our strategy has been buying 3-month, 4-month, and 6-month T-Bills. The following rates are from CNBC.com on 5/6/24. Short-term rates have held relatively steady and will until the Federal Reserve starts to cut interest rates. At one point last year, we were able to get over 5.50% annualized interest on a 6-month T-Bill. Now the 6-month T-Bill is at 5.37%. Our strategy has been when T-Bills are redeemed, we have been able to reinvest at the same to higher rates than before. Short-term rates will not be going lower immediately, but will be dependent on when the Federal Reserve cuts interest rates. T-Bills and money markets have been the fixed-income investment of 2023 for risk-free money and continues to be with over $6 trillion in money markets and cash equivalents. This will change, but not overnight. Risk-free rates at 5% are still attractive.
We have started to shift funds that are maturing from T-Bills into our core bond funds and other fixed-income ETFs. Duration is approximately 3 months in our Leader Capital High Quality Income Fund yielding 6.45% and between 1 & 5 years in the Allspring Short-Term High Income Fund yielding 6.34%. This also may provide us some capital appreciation if/when the Federal Reserve does start to lower interest rates.
Following are interest rates as of 5/6/2024. There has been very little change in short-term Treasury rates as the 3-month & 4-month have been around 5.36%-5.40% while longer duration rates have increased more substantially.
2. Intermediate-term (12-month) bonds. Since 2022, we have been purchasing high-quality bonds from banks such as JPMorgan, Wells Fargo, Bank of America, Citigroup, and Royal Bank of Canada. Unfortunately, there are very few quality bonds being issued currently. Those that are being issued are with interest rates between 5.2-5.3% over a 12-to-24-month time period. As these bonds mature, we are reinvesting in our core bond funds as well as several new fixed-income funds and ETFs that we have purchased.
3. The third part of our 3-pronged strategy has been our Leader High Quality Income Fund, and our Allspring Short-Term High Income Fund. They have been part of our core fixed-income portfolio and have performed very well.
We have also added some additional bond funds to your account, which we will discuss in more detail with you during our meetings. In the meantime, if you would like to set up a review, you can simply click here to schedule an appointment online.
About Matthew
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
About Shawn
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
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