After a bit of roughgoing in early August, the U.S. stock market has been riding high.
SMI's executive editor Mark Biller explained why investors are bullish last week on Faith & Finance. And he discussed market prospects for the rest of 2024.
Click the play button below to listen. Scroll down for the transcript.
Faith & Finance with host Rob West airs weekday mornings on American Family Radio. A different version airs weekday afternoons on Moody Radio.
(More radio appearances by members of the SMI team are posted on our Resources page.)
Transcript
Rob West:
Hi, I am Rob West. We're so glad you're along with us today!
What does it mean when the Fed raises or lowers interest rates? In this case, the Fed has been cutting, and what does that mean for you as an investor?
Well, Mark Biller is here to explore all of that with us today. And we'll look forward to diving into your questions as well at 800-525-7000. This is Faith & Finance on American Family Radio — biblical wisdom for your financial decisions. (opening music ends)
Well, our guest, Mark Biller is the executive editor at Sound Mind Investing, an underwriter of this program. Mark sometimes shows up to tell us what we think we know may not necessarily be true! We'll see if that holds true today.
Mark, great to have you back.
Mark Biller:
Thanks, Rob. Good to be back with you.
Rob West:
All right, Mark, in mid-September, as you well know, the Federal Reserve cut the Fed Funds rate by half a percent, which was seen as an aggressive amount for a first cut. You wrote an article recently that points out that what investors broadly believe about rate cuts may not always be right. So share that with us.
Mark Biller:
Yeah, sure. So let's start with a popular phrase that many of your listeners have likely heard before — that is, "Don't fight the Fed." Over the last few decades, this has really become the guiding principle for a lot of investors.
And the idea behind it is simple enough — that is, that when the Federal Reserve is raising interest rates that's intended to slow the economy, and investors should be bearish or cautious about stocks as a result. On the flip side of that coin, when the Fed is cutting interest rates, that's meant to stimulate the economy and investors should be bullish or optimistic on stocks.
Now over the last 15 years or so since the Financial Crisis, faith in this idea that Fed policy is really the key driver of investing markets has grown exponentially. And that's because the Fed has intervened in the markets fairly regularly. So more, often than not, those who didn't fight the Fed found themselves on the right side of the rising market.
Rob West:
So, investors have learned to be bullish when the Fed cuts rates — clearly.
Mark Biller:
Yeah, that's right. And it's been a great strategy in recent years. But it hasn't always worked historically and that's the tricky thing that we're trying to highlight in this article that we're going to be discussing today. So if we go back to 2001 and again in 2007, the Fed started big rate-cutting cycles right into the teeth of bear market recessions that resulted in stocks falling by about 50% each time. So those were big, fairly recent examples where rate cuts didn't help investors all.
So with a lot of the U.S. economic data slowing in the months leading up to September's rate cut, some investors were looking at those 2001 and 2007 examples, and they were wondering if the same thing was about to happen again. In other words, were these rate cuts kind of a premonition that we could have a recession on a bear market in the future?
Rob West:
Yeah, meaning we can't assume that rate cuts will keep the bulls running on Wall Street every time.
Mark, tell us about the historical evidence you wrote about in this article we're referring to today.
Mark Biller:
Yeah, it's really important to look closely at each individual example because the average experience of what happens after rate cuts can be kind of misleading.
When we looked at the data we saw there are two distinct paths. About half the time we ended up with a recession, and in those cases a new rate-cutting cycle did not help stock investors. So in 1980, 2001, 2007, — in the 12 months after the first cut,s tocks were down 17% to 30%. Didn't help to have those rate cuts.
On the other hand, we had three cases where rate cuts did provide the tailwind because we didn't get a recession. In those cases, stocks were up 15 to 25% in the year following the first cut.
So it's really clear that recession is the big variable. We either had big gains or big losses, and the key was whether there was a recession or not.
Rob West:
So then the million-dollar question is, are we on the recession path now? Mark will answer that question. Back with much more after this.
Rob West:
Mark, you were sharing before the break, and I want to just have you summarize this, and then we'll talk about where we go from here. But what you were saying was we can't always see Fed cuts as a predictor of a market bull run. It really has to do, at least historically speaking, with whether or not that cut was followed by a recession.
Mark Biller:
Yeah, that's exactly right. We set up, Rob, how cutting rates should be stimulative to the economy — in theory. But the reality is that there are bigger forces in the economy, that if the economy is breaking down into recession, those factors overwhelm the positive impact of lower interest rates.
In other words, if you run a business rob and you're worried about whether you can stay in business because the economy is so bad and your business conditions are getting so bad, then you don't care if you can get an interest rate that's lower than six months ago on a new loan. You're not looking to borrow any new money anyway. You're just trying to ride out the rough economic times. So you can see why a recession just really just erases the positive impact of cutting interest rates.
Rob West:
Yeah, that's helpful. So then the big question here, Mark, is, "Are we on the recession path right now?"
Mark Biller:
Yeah, that's definitely the million-dollar question, right? And you can see why investors and economists spend so much time trying to figure this out.
Now, what we've been telling SMI members is it's clear that economic growth was slowing throughout the summer. You can see that in the data. But there's a big difference between slowing data and the economy actually being slow.
So just to put this in a little context for listeners, this is the third year in a row that expectations of a recession have snowballed as the end of the year approached. It happened towards the end of 2022. It happened again late last year, in 2023. And in both of those cases, this anticipated recession failed to materialize.
Now, I think that a big part of the reason why is that investors and economists have been interpreting slowing economic data as if we're in a normal economic business cycle. And what I think is going on, Rob, is that I think the slowing data is more a reflection of a normalization after the huge post-COVID economic spike that we had. So this slowing back towards normal isn't the same thing as slowing into a recession. But in real-time, you see the slowing data and it looks like the same thing, so we've had these repeated recession calls.
So we've been preparing SMI members for a repeat of those two last episodes, when recession fears eventually gave way to a realization that the economy really isn't in bad shape, it's in pretty decent shape.
And, really, that's what we've been seeing in the three or four weeks since the Fed cut rates back in September. We've had a little bit stronger jobs data, we've had a little bit stronger economic data the past few weeks.
And that has had a big impact on the interest-rate market. Rather than follow those short-term interest rates lower — like the Fed cut by half a percent — but what we've actually seen is longer-term interest rates have risen by about that same amount. Which seems really weird unless you factor in that the bond market and investors had pushed yields down so much anticipating a whole lot of future rate cuts beyond September because they thought the economy was so weak.
And, instead, now they're saying, "The economy doesn't look that weak, we're probably not going to get as many rate cuts as we thought." And so now they're pricing in less aggressive Fed cuts in the future. And all of this really has changed just in the past three or four weeks. So you can see how quickly expectations can change about this stuff.
Rob West:
Yeah, that makes sense. So what do you think then is really going on over at the Fed, Mark, to explain why they started the cutting cycle with this larger-than-expected 50-basis-point cut?
Mark Biller:
Yeah, it's tough to get inside their head, of course, Rob, and I'm not going to try to do that. But I do think that we can draw two really important lessons from the fact that they went big with this first rate cut.
The first thing is that we really see a switch in the Fed from a reactive policy response in the past where they would wait until conditions were really breaking down and then react to that with a stronger move. And we've switched from that reactive policy idea to more of a proactive policy.
So, in this case, there clearly was no crisis. Okay, we've got growth of 3% economic growth, unemployment is below the long-term average at 4.2%. We've got asset prices near all-time highs. There's no crisis that they're reacting to — and yet we get this really proactive, "We're going to cut big to try to head off any future problems." That's a fairly big change in how the Fed has approached things.
The second thing is it's pretty clear that the Fed thinks the inflation battle is won, so they're shifting their focus away from fighting inflation and towards supporting employment and the broader economy. That's not necessarily inappropriate because they do have a dual mandate: to fight inflation and keep prices stable, but also to encourage maximum employment.
So it's not inappropriate, but it does open the door to another leg of higher prices and inflation. If it's true that we avoid a recession and now we have the Fed cutting interest rates into a healthy economy, that's kind of like hitting the gas when the car really hasn't slowed down very much, and there is that threat that we could see another leg higher in inflation.
Rob West:
And, obviously, that would be "worst-case scenario" because then we start this cycle all over again.
Well, Mark, it sounds like, I guess — if I'm reading between the lines — that you think we're moving toward the non-recession path. Is that fair to say?
Mark Biller:
Yeah, I definitely think, at least in the short term, that non-recessionary path is more probable. Certainly between now and the end of the year. Next year after the election, into the first year of the new administration, that's kind of a different story.
But for the near term, we're kind of already seeing that. Like I said, we've had a little bit of a pivot in how people are thinking about this even in just the last few weeks. And we've been writing a lot about this, even leading up to that first rate cut, because of the election fear that's so prevalent.
We've seen investors in the past get really afraid about an upcoming election like this and sell their investments, and we think that there's a reasonably optimistic setup for markets between now and the end of the year. So we don't want to see people making bad decisions like that. So we've been talking quite a bit about this more positive, optimistic setup for markets as a result.
Rob West:
Of course, a lot of our listeners are wondering about the election and its impact on the markets — where we might go from here.
In fact, Jack, I understand you're out there on the highway, a trucker — you've got a headset on, so you're nice and safe — but give us your question today related to the markets and the election.
Caller:
Yes, sir. I was just curious what impact Mark might think that the economy might take, depending on whether Trump won next year or Ms. Harris.
Rob West:
Yeah, Mark your thoughts.
Mark Biller:
Yeah, it's a great question, Jack, and I think that, initially, the markets are definitely going to have a more positive reaction to Trump winning than Harris. But I do think it's actually fair to wonder if some of the market strength that we've seen — say, in the last month or so — is actually the market already pricing in the improving odds that seem to be being telegraphed of Trump's improving odds of winning the election.
And if that's the case, sometimes you can get a situation where the market and investors have actually kind of "front run" the move that you would expect after the news event. And if that's the case, there may not be as much of a move as investors expect.
I think probably the most important thing, Jack, is — and the reason I'm a little hesitant to say much beyond the end of the year, I see a good run for markets between now and the end of the year, potentially a good setup. But if you look back historically, the first year of presidential terms tend to be really the weakest time for the markets. And that's because in either a Trump or Harris administration, they're probably going to try to do some of the tougher stuff — the stuff that hurts a little bit more the economy, and you have to get through that to get to the better results on the other side of these moves. They tend to do that stuff in year one, and so that's the reason why markets often will struggle in a new year one of an administration.
So I think that if there's a thing to be kind of wary about market-wise, I think that's really it. Probably less about a President Harris is going to wreck everything or a President Trump is going to borrow and spend and create a whole bunch more inflation.
There are these specific narratives that investors are digesting right now in either situation, but I think that really, in either case, we have to be a little watchful that markets — we've had a great year in markets, we've had really a year and a half of a very strong bull market — and we could see some digesting if not even pulling back at some point next year as some of these less popular adjustment policies come out from either administration.
Rob West:
Yeah, that's helpful. Jack, thanks for keeping our economy running out there on the highways today, my friend. We appreciate your call.
Mark, I know you say, and have said before, that we should stay "data-dependent" as we think about how we move forward from here in our own investment strategy. Unpack that for us.
Mark Biller:
Yeah, I think it's really important, and I'm a little biased because our strategies at Sound Mind Investing are trend-following. We use momentum indicators that tell us what's actually happening and we kind of try to follow along. And that's different from trying to predict what's going to happen six months down the road or 12 months down the road. That's a tough way to do it. So, of course, we're going to say stay data-dependent.
But I think you see this even in just the last, say six weeks, Rob. In the three weeks or so leading up to that mid-September rate cut, expectations of how much the Fed was going to cut rates in the year ahead were just soaring. There were all these rate cuts being priced in and bond yields were going really, really low as a result of that.
And [yet,] in just the three or four weeks since the rate cut, we've seen a whole bunch of that reverse. And so now bond yields have risen. The 10-year Treasury went from like 3.6%. It's at about 4.1% now. That's a huge move higher, even though they cut short-term interest rates last month.
So that's why we say it's so important to follow the data and not get hung up on what you think should happen or will happen. I think that's a big lesson for all of us. As we have this approaching election, we can get really caught up in what we think is going to happen, and sometimes the market will tell us, "No, you got that one wrong." And if we're really slow to respond to those signals, it can really cost us as investors.
And so I guess, Rob, to tie a little bow around that, at this point there's not much evidence to indicate that the economy is at risk of slipping into recession. And that doesn't mean that it won't say six months from now or sometime next year. It just means the data isn't showing that yet today. Now, if the data changes, we have to change our view, and we will, of course.
But at this point, it seems like the economy is going to stay resilient for a little while longer despite all the recession calls we've all heard the last few months. And as a result, we think there's a pretty decent setup for investors certainly between now and the end of the year.
Rob West:
Yeah, that's well said. And I think that really helps us think about where we might be headed now.
We've got just about 30 seconds left here. Mark, you mentioned what you all do there at SMI. How can you come alongside investors with the newsletter and your strategy there?
Mark Biller:
Yeah, well, I think just giving this kind of update on a regular basis, people can come alongside us and hear our views. And then we offer very specific recommendations based on how we're seeing the data come in that keeps people up to date in real-time.
Rob West:
Excellent. You can learn more at soundmindinvesting.org. While you're there, check out this article we've been talking about today, The Fed is Cutting Interest Rates: What Does it Mean for Investors?
Mark, always appreciate your time. We'll be right back, folks.
