A New Normal

With the Federal Reserve preparing to cut interest rates and the U.S. economy on solid footing, the S&P 500 continues to rise. Only three months into the year, the index is up over 10%, with more stocks getting in on the early year surge. The coming election is sure to bring some anxiety. However, investors remain optimistic about the underlying strength of the economy, bolstered by the potential upside of artificial intelligence. The bottom line is that employment has not wavered in the face of higher rates. Consumers are still spending, which matters most in an economy fueled by consumption.

The Fed Funds rate has been above 5% for the last nine months and while the effects of monetary policy are long and variable, the economy has shown remarkable resilience as inflation has receded. Certain sectors such as manufacturing and housing appear to be picking up as the rapid increase in interest rates over the last two years is looking less like the catalyst for a recession that economists had feared. Rather, businesses and consumers are settling into a new normal of higher interest rates and inflation when compared to the last two decades. With greater convergence between the market and the Fed on the path of interest rates, uncertainty is fading. In many ways, we are returning to business as usual.

For companies, this is welcome news. With less handwringing about the macro environment, there is greater focus on the day-to-day business operations. With the help of a strong economic base and an AI-driven push for efficiency, the S&P 500 earnings growth targets of 11% for 2024 and 2025 seem within reach. For markets to sustain this momentum, it is vital that consistent progress is made on these targets.

A second wave of inflation could derail this narrative, but the Fed is keenly aware of this risk. In their most recent commentary, the committee indicated that conditions are appropriate to consider cutting rates over the course of the year. While there is certainly a possibility of cutting rates too soon, the Fed is taking a measured approach. Given that the Fed Funds rate now sits well above the rate of inflation, a few cuts would not dramatically alter the policy stance. We remain vigilant, but the current environment appears to be favorable for stocks.

Thanks,
Preston May, CBE®
Research Analyst