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“Life moves pretty fast. If you don't stop and look around once in a while, you could miss it.”
— Ferris Bueller
Once upon a time, July and August were considered the quiet time in our business. Folks took off for summer vacations to relax and recharge their batteries. Hopefully, many still take the time to do so. But we now live in a world where the news cycle is 24/7, and the capital markets never seem to go quiet.
So, in honor of Ferris, let’s take a step back and review some of the concerns raised in recent posts here on the blog.
Inflation, Economic Data, and the Fed
Equity and fixed income investors cheered last week’s Consumer Price Index report for June. It showed moderating inflation, with the month-over-month report down 0.1 percent. Once again, the markets believe the Fed is ready to cut interest rates and will likely do so in September. But will the Fed cut? That remains to be seen. Remember, when we entered the year, markets thought the Fed would cut rates six times in 2024. That hasn’t happened. We will get more color when the Fed meets at the end of the month.
At the same time, the economic data tells the story of a middling economy. Service sector confidence and consumer confidence both fell in June. Still, the labor market remains strong, with 42 months of job creation. Fulfilling the adage that if people have jobs, they have money, and if they have money, they spend it, retail sales in June exceeded forecasted expectations. This provides further evidence that the consumer-driven part of the economy remains on solid footing, despite the impact of inflation.
U.S. Election Takes Center Stage
After a very quiet first half of the year on the political news front, the past several weeks have seen one headline after the other. The first presidential debate took place on June 27, with President Biden’s performance coming under scrutiny from the media and his own party. Over the weekend, there was an attempted assassination of former president Trump. While little is known about the whys of the attempt, it shook up the news cycle once again. And this week, it was announced that Senator J. D. Vance will be the Republican’s vice presidential candidate, and the Republican National Convention has officially nominated the Trump-Vance ticket.
Prediction markets have moved strongly in the direction of Trump winning the November election. Polls have been less clear, although they seem to point to the former president currently having a lead. Recent RealClearPolitics swing state polls, while all very tight, lean toward the Republican as well. But three and a half months is a long time in the political cycle. Indeed, there have been numerous candidates who were perceived to be the winner in July but didn’t end up winning in November.
There are policy differences between the two candidates, most notably on the views of the sunsetting of the Trump tax cuts and, on a relative basis, trade wars and tariffs. But large transformational changes would require one party to have the White House and large majorities in Congress. Even with joint control, there are many different philosophies within each party that make passing legislation difficult in the current political environment.
As we have pointed out previously, in the long term, it doesn’t matter that much to markets and investors as to what the power-sharing agreement is in Washington. There is a sell-off every year at some point, no matter who is in charge. And over the long term, looking at past stock market performance, stocks have gone up no matter who is in charge.
Historical Stock Market Performance Under Different Political Party Controls
Sources: Truist IAG, Strategas
An Eye on Earnings Growth
In his recent blog post, my colleague Rob Swanke provided a valuable discussion on current earnings growth. It is an important topic for markets but is also a driver of asset allocation decisions. Large-cap growth has been the best-performing asset class for several years because large-cap growth has had the best earnings growth over the past several years. Yet we have seen and continue to see other asset classes rally strongly for short periods as the outlook for interest rates changes. But for other asset classes to have a sustained period of outperformance, they need to deliver strong business fundamentals that lead to better and improving earnings growth. The key to this happening will most likely be lower interest rates and a continued strong economy, as small- and mid-cap markets have a value lean whereas large cap is almost two-thirds growth (see chart below).
Large-Cap, Mid-Cap, and Small-Cap: Growth Vs. Value
Analyst estimates for the S&P 500 call for 15 percent earnings growth. For this to come to fruition, we will need to see growth across most sectors and industries. This should improve breadth in the large-cap part of the market and bode well for small- and mid-cap asset classes as well.
Stay the Course
The best way to navigate all these uncertainties is to stay the course. Remain calm. Be diversified across asset classes and styles. Any potential volatility could be seen as an opportunity to reposition portfolios to add value over the long term.
