I had a lot of great conversations on the economy and the markets. Given the recent volatility and the disparity in asset class returns, three issues arose more than any other: the Fed, the impact of policy proposals, and the case for international equities.
The economy drives markets, but the Fed and policy changes can impact that path and influence investors as they decide how to allocate portfolios. So, let’s unpack where we are on these three topics today and what to expect ahead.
On Wednesday, the Fed announced its decision to stand pat on interest rate policy. In his press conference, Chairman Powell mentioned that the “uncertainty around the economic outlook has increased.” This view aligned the Fed with investors and my conversations with advisors.
This uncertainty was apparent in the changes to the Fed’s outlook. Compared to its forecasts from three months ago, the Fed now sees economic growth slowing and the inflation rate increasing. Chairman Powell mentioned policies from Washington as the biggest driver of the current uncertainty, which led to these changes.
Source: The Daily Shot
Despite the uncertainty and the reduced economic growth expectations, the market rallied strongly. The reason? The Fed still expects to cut rates twice over the remainder of the year. The market has been looking for a signal from either the administration or the Fed that if the sell-off continued, something would change. They concluded that the Fed forecasting rate cuts despite an uptick in inflation was that sign. For the time being, however, the Fed remains data-dependent.
With policy changes impacting the Fed’s thinking on economic growth, understanding policy proposals will be key to navigating the path ahead.
During the individual stock investing portion of my career, we would always talk with the most bullish analyst and the most bearish analyst covering the stock before deciding to move forward with an investment. We needed to understand both sides to ensure we weren’t missing anything and to avoid groupthink. With that same approach in mind, I listened in to Treasury Secretary Scott Bessent’s appearance on the All-In podcast, where he laid out his 3-3-3 plan.
In short, the 3-3-3 plan is to grow real GPD by 3 percent per year, reduce the deficit to 3 percent of GDP by 2028, and increase U.S. oil production by 3 million barrels per day. In the podcast, he covered federal government spending, removing regulations, as well as trade and energy policy and how they impact affordability. He also acknowledged the struggles of timing these changes before the benefits they anticipate are seen. It is this uncertainty that the market has been wrestling with over the past month.
From an investment perspective, it’s important to understand what the goals of the administration are and assess how they might play out. Those two pieces of the puzzle will help determine the consensus views for economic growth over the next 6 to 12 months and how it could change. The economy drives markets, and those views will also help determine how to allocate capital going forward.
Last but not least, international stocks are having their moment in the sun. So far this year, the rest of the world has outperformed the S&P 500 by more than 1,000 basis points. This has certainly gotten the attention of investors looking for ways to add value to portfolios.
This rally comes on the heels of a multiyear period of underperformance. Besides some short fits and starts, U.S. stocks have been the best-performing part of any portfolio for the past 15 years. But this year, that has not been the case—and that doesn’t happen in a vacuum.
Cheap is not an investment strategy. But cheap with a catalyst? That starts to get interesting. If fundamentals improve in parts of the market that are relatively more attractively valued, then investors are likely to follow. If nothing else, international equities were cheap on a relative basis.
The driver of this rally is that the fundamental outlook has changed in international markets. Stimulus in China aimed at boosting domestic consumption and increased spending on defense and infrastructure in parts of Europe have led to an improving economic outlook. At the same time, American exceptionalism could be taking a pause. For the first time in quite a while, fundamentals in other parts of the world could be better than here in the U.S. Ultimately, the longevity of the improvement in economies overseas relative to the U.S. will determine the magnitude of the rally. For now, it is certainly attracting attention.
As we’re seeing, headlines move markets day-to day. But adjusting portfolios based on the daily headlines seems rather challenging. Guessing what the administration will do and what the impact will be, as well as betting on the Fed’s policy reaction, doesn’t seem like the best approach to investing to achieve long-term goals.
Our view has not changed despite the rally we have seen over the last week. Balance and diversification remain the best way to navigate the volatility that we anticipate will continue as policies are announced and implemented and the Fed continues to focus on the data.
The main risks of international investing are currency fluctuations; differences in accounting methods; foreign taxation; economic, political, or financial instability; lack of timely or reliable information; and unfavorable political or legal developments.