3 Lessons for Investors from This Summer’s Market Volatility
As we enter the final quarter of the year, it’s a great opportunity for investors to reassess market trends and update their financial strategies for the remainder of this year and the next, especially in light of the Federal Reserve’s recent rate changes and emerging economic data. Despite August beginning with the sharpest market declines in two years, major indices have recovered, with the S&P 500 once again reaching record highs.
In its September meeting, the Federal Reserve implemented a 50-basis point rate cut, ending its longest policy pause and most aggressive rate-hiking cycle in over 40 years. With inflation continuing to trend downward and the broader economy remaining resilient, September has brought significant new developments. It’s crucial, however, for investors to maintain a long-term perspective amidst these changes.
Markets have rebounded over the past month
In particular, investors should always be prepared for volatility, especially with possible market-moving events in the coming months. Although the recessionary scenario is partially neutralized with Fed easing on the policy rate, there is still uncertainty around the upcoming presidential election and the ongoing geopolitical risks. What lessons can investors learn from the past few months as they navigate these events and focus on their long-term financial goals?
First, despite recent market swings, the S&P 500, Nasdaq, and Dow have gained 20.78%, 20.22%, and 13.21% with dividends this year, respectively. Bonds have faced challenges for much of the year due to persistently high interest rates. However, the recent 50-basis point rate cut by the Federal Reserve, alongside indications of further reductions in the coming months, has led to a notable improvement in returns. These are both examples that, while market volatility is never pleasant, it is important not to overreact to short-term events.
The stabilization in the stock market has shifted investor focus back to fundamental factors, particularly corporate earnings. This is because the stock market tends to mirror the trajectory of corporate profits over time, which in turn rises alongside the economy. Current earnings projections are positive with an expected growth rate of 10% in 2024 and nearly 14% over the next twelve months.
The rationale behind Fed rate cuts is important
The Fed typically lowers interest rates in response to a weakening economy, since doing so makes it cheaper for individuals and companies to borrow, while also increasing the incentive to spend rather than save. In theory, this boosts growth and supports the financial system, especially during recessions and financial crises. Over the past few decades, the Fed made dramatic rate cuts during the early 2000s dotcom bust, the 2008 global financial crisis, and the pandemic in 2020.
Today, the Fed is not battling a sudden economic collapse or financial crisis but is instead navigating a period of steady but slowing growth with improving inflation and a weakening but still strong labor market. In other words, the current situation is quite different from periods of emergency rate cuts. This is why the rationale for lowering rates matters when considering how they might impact markets in the months and years ahead.
Perhaps a more applicable example is the 1994-1996 rate cycle, when the Fed raised rates to combat inflation fears before lowering them again shortly thereafter. Periods like these are often referred to as “soft landings” since the Fed arguably managed to cool the economy without triggering a recession. While there was a significant shock to the bond market – just as there was in 2022 – markets eventually responded positively to rate cuts once the economy stabilized.
Bond yields are adjusting to rate cuts
Finally, with Fed rate cuts now in play, market-driven interest rates have also adjusted accordingly. As the accompanying chart shows, not only have yields moved lower, especially on the short end of the curve, but the yield curve is no longer inverted. The spread between the 10-year and 2-year Treasury yields has flattened in recent days due to the expected trajectory of rates. Historically, yield curve inversions precede recessions since they typically occur later in the business cycle when the Fed has overtightened. While a recession is always possible, this time could be different since higher short-term yields were the result of inflation shocks.
While nothing is certain, lower rates could be positive for economic growth, especially in rate-sensitive areas such as real estate, technology, small caps, and more. As discussed earlier, bonds have benefited from improving rates as well, partially restoring their traditional role as portfolio diversifiers.
We maintain a balanced approach between equity and fixed income investments to capitalize on a declining interest rate environment for the benefit of our long-term investors. This strategy allows for equity exposure to participate in global business growth, while our fixed income allocation helps mitigate downside risk.
The bottom line? The uncertainty experienced by investors during the summer is a reminder to always stay focused on the long run as they work toward their financial goals.
Continue to watch our updates for more investment and financial strategy advice. If you have further questions, email us at PrivateWealth@clarienbank.com.
This publication contains general information only and the Clarien Group of Companies, which include Clarien Bank Limited, Clarien Investments Limited, Clarien Trust Limited, Clarien BSX Services Limited and Clarien Brokerage Limited (collectively referred to as the “Group”) is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as the basis for any decision or action that may affect your business or your personal investment decisions. Before making any decision or taking any action that may affect your business or your personal investment strategy, you should consult a qualified professional advisor. The Group shall not be responsible for any loss sustained by any person who relies on this publication.
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