By Dr. Charles Lieberman, Co-Founder & Chief Investment Officer
A month ago, I wrote: “It may take months, possibly even quarters, to answer the question of whether we will have a soft or hard landing. Near term, I still expect solid growth to continue. But the good news is that it will take time for that question to be answered, so investors can refocus on the recovery taking place in corporate profits and don’t need to be quite so concerned about surging interest rates, at least for now. This makes me hopeful for a rise in stock prices into the end of the year and a somewhat less volatile bond market.” In fact, both stocks and bonds surged dramatically. Can this continue? Yes, although not at the pace just experienced.
Investors are (overly) excited that growth has slowed and inflation has moderated, so they are now waiting with bated breath for the rate cuts that are now thought to lie immediately ahead, perhaps as early as March. This is unrealistic, yet the Fed’s public admonitions that rates will remain higher for longer are increasingly ignored. Historically, the Fed has invariably reduced policy rates within 3 to 6 months after the peak in rates. Since many Fed officials have commented that inflation is declining and growth is slowing, they offer a tantalizing prospect that they may not need to hike rates any further. Their notes of caution, that inflation might revive or not come down close to their targets, are readily ignored or dismissed.
In fact, growth remains quite solid. GDP rose more than 5% in Q3. Employment gains slowed to 150,000 in October, the weakest increase in quite some time, yet that’s still quite solid and above underlying demographic growth in labor supply. (The auto strikes may have also depressed job growth, so we expect a stronger increase for November.) Holiday shopping appears comfortably ahead of last year. And the decline in interest rates and rise in the stock market and household net worth risks a quick rebound in housing and other rate sensitive parts of the economy. Markets are way ahead of the data. Could the data fall in line with market expectations? Yes, that’s possible. It just isn’t overly likely.
It is the slower pace of growth, more moderate hiring and a moderation in inflation that has enabled investors to extrapolate the data to hit the Fed’s target goals long before the Fed thinks it can achieve them. The Fed’s projections and comments suggest it does not expect to reach its targets before 2025. Yet investors have already priced as many as four rate cuts into bond prices for 2024. Either the market or the Fed will be proven wrong. It is also possible both will be proven incorrect if inflation remains well above the Fed’s 2% target in 2025.
As I suggested a month ago, it will take some time, several months or even a number of quarters, before we have the data to determine whether the Fed’s or the market’s forecasts are correct. Until then, the decline in interest rates and the recovery in corporate profits, reflecting the economy’s resilient growth, justifies the rise in stock prices. It’s happened a bit faster than seemed plausible a month ago, but it is certainly with reasonable valuations.
Even with the rebound in share prices in November, most stocks are still cheap. The forward-looking P/E multiple for the S&P is about 18.9, which is reasonable for the prevailing level of interest rates. But excluding the Magnificent Seven, the multiple for the ignored, maligned S&P 493 is about 17.2. That’s an attractive valuation for a market experiencing rising profits at prevailing interest rates. The merits of the Magnificent Seven can be debated, but it is hard to argue that the rest of the market is expensive, particularly as interest rates have retreated, while profits are rebounding. So, we think stocks can keep rising in price, albeit not at November’s pace.
The outlook for bonds is a bit less clear. Rates would certainly decline if growth approaches the Fed’s 2% target faster than expected, but that seems like a stretch. Still, bond prices should flatten out a bit as we wait for more economic data. But that also means investors can earn their coupons. The bond market’s nightmare of 2022 and early 2023 is over. And as recently noted by our fixed-income portfolio manager, Kevin Kelly, investors can earn a positive return even if interest rates rise a bit. This makes for a positive outlook for the end of the year.
The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.