Market Update – January 12, 2025
Clients have commented over the years that they receive written correspondence from me only when markets are “misbehaving.” And for the most part, that’s true. Volatility is largely the manifestation of investor anxiety and since Kavar’s clients are investors, our team has an interest in staving off reactionary activity that could undermine the attainment of their long-term objectives. Experience has taught me that the explanation of exhibited angst can soothe fears and confirm commitment to the cause.
So along those lines…..
What the heck happened on Friday? The Dow dropped almost 700 points and the S&P and Nasdaq each dipped over 1.5%. Add to that a spike in yields (and thereby a sell-off in bonds) and this ornery outburst induced inspection.
The primary trigger of the price dislocation was a stronger than expected employment report. Turns out that that more than 256,000 people landed jobs in the month of December….well in excess of the expectation of 165,000. Conventional wisdom would interpret this positively since more people with paychecks equals an elevation of economic activity. Furthermore, and transitively, profits grow, ownership claims on assets (stocks) ascend and the quality of life improves.
But, maybe not so fast…..
Coming off of 2 very solid years of stock index appreciation, fueled in large part by the speculation, confirmation and perpetuation of lower interest rates, this jobs report called into question the extent of the current monetary policy cycle.
Rates have recently dropped (by 1% in 2024) courtesy of the Federal Reserve Bank (Fed) as they traversed along the continuum of their dual mandate: to influence inflation and stabilize employment.
Rates began to fall last year after hitting multi-decade highs in 2022 and 2023 as post-Covid fiscal excesses were stripped from the economy. Known as a “loosening of policy” it is an initiative embraced positively by financial markets as a lower cost of capital can kick-up demand for goods and services and unleash animal spirits that are virtuously circular. That’s a fancy way of saying that cheap money fuels speculation across asset classes and price appreciation tends to follow.
The Fed cuts rates to heat up the economy and hikes rates to cool it. And when the wiring of the markets is set to one expectation, the sudden consideration of an alternate scenario tends to trigger some trepidation…..welcome to Friday.
When the Fed last met, on December 18th, they issued one of their silliest signals ever incorporated in this context: the Summary of Economic Projections (SEP). Consider this the Fed’s crystal ball as they offer foresight on certain economic indicators over the next several months and years. Trust me when I say that your local weatherperson possesses savant-like predictive powers when compared to the usable data disseminated by the SEP. And yet, the market gloms onto it as gospel.
The most recent SEP predicted 2 more interest rate cuts in 2025. And if you went back exactly one year, the SEP base-case called for 7 rate cuts in 2024….we got 4. (Technically it was 3, but one for ½ of 1% vs. the typical ¼ of 1% so we’ll consider it an extra).
So if the job market is as strong as the report showed on Friday and the Fed’s fallibility is factored, then perhaps it is wrong to expect that they’ll fulfill their intent to ease any further. And worse, what if things are strong enough that they’ll need to hike?! And if they hike, then is it feasible that we get a correlated correction across classes of assets a la 2022? The muscle memory and its recency bias alone are enough to cause concern. And while that’s not an unhealthy simulation to synthesize, let me suggest a better course of action: take a breath, do not overreact and consider some counterarguments.
First, good news is always good news. A healthy job market is critical to a well-functioning economy. The ability to earn, self-sustain and address your financial obligations promotes an elevation of living standards and lessens a reliance on entitlement programs. Favoring an elongation of low interest rates and excessive liquidity for the sake of tactical trading opportunities can lead to bubbles that often end with very loud pops…which is obviously undesirable.
Second, strong employment in the US improves discretionary cash flows for the worker-base, especially since inflation has dropped considerably off its highs (more on that in a minute). This can assist in paying down debt and funding future financial obligations (such as education and retirement).
As the chart below indicates, “real wages” (income above inflation) have remained solidly positive for well over a year now. Two benefits of this trend tend to be: improved worker morale and productivity.
Third, a growing tax-base in our country expands the possibility of deficit reduction – a woefully necessary undertaking given the precarious nature of the nation’s balance sheet.
Fourth, if the Fed is done lowering rates for now, what a gift to the investor who is content to clip bond coupons courtesy of competitive yields. What a gift to the saver, who can lock in positive real yields and preserve purchasing power. What a gift to the multi-national corporation that staves off profit-repatriation reduction due to a dropping value of the dollar.
There is temptation, much of it (social) media-fueled, to consider a piece or 2 of economic data in a vacuum. But the capital markets are the consummate dynamic system. As such, they deserve broad consideration for the implications of the information impacting them.
No doubt that a day like Friday was unpleasant as, again, there was really no refuge from the negativity. But a well-designed asset allocation is fortified for the future, has a long-term time horizon and emphasizes 3 D’s: Dollar-cost averaging, Diversification and Discipline. Orienting around these areas allows days like the last to be leveraged and not loathed.
As with all incidents, we’ll keep in close touch as we analyze their extent and influence on your portfolios.
We are keeping our clients and friends in Southern California in our hearts as they deal with the ravaging wildfires. We are so hopeful for reprieve from the winds.
Have a great rest of your weekend, dc
The views expressed herein are those of Doug Ciocca on January 12th, 2025 and are subject to change at any time based on market or other conditions, as are statements of financial market trends, which are based on current market conditions. This market commentary is a publication of Kavar Capital Partners (KCP) and is provided as a service to clients and friends of KCP solely for their own use and information. The information provided is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy, or investment product, and should not be construed as investment, legal or tax advice. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s investment portfolio. All investment strategies have the potential for profit or loss and past performance does not ensure future results. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. The charts and graphs presented do not represent the performance of KCP or any of its advisory clients. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. There can be no assurances that a client’s portfolio will match or outperform any particular benchmark. KCP makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based on information that KCP considers reliable, it is not guaranteed as to accuracy or completeness. This information may become outdated and KCP is not obligated to update any information or opinions contained herein. Articles herein may not necessarily reflect the investment position or the strategies of KCP. KCP is registered as an investment adviser and only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.