Fixed Income & Equities Markets Week in Review

The equity market’s hopes were fulfilled this week when the Federal Reserve (Fed) lowered interest rates after concluding its Federal Open Market Committee (FOMC) meeting on Wednesday. The Fed lowered rates by 0.25%, to 4.00%-4.25%. Fed Governor Miran, the newest member, was the only one who dissented, in favor of a larger 0.50% cut. Importantly, the Fed’s dot plot (the chart that shows each Fed member’s projection for short-term interest rates) indicated that there could be another 0.50% of rate cuts over the remainder of the year in addition to the Wednesday 0.25% cut. The market took this news as a dovish lean. The statement also included some verbiage that the market viewed as dovish. The statement noted that “job gains have slowed and the unemployment rate has edged up,” and that “downside risks to employment have risen.” The line about the labor market remaining “solid” was also removed. Fed Chair Powell’s press conference did not hold a great deal of compelling information. He characterized the Wednesday cut as a risk management action. He did note that there was not widespread support for a 0.50% rate cut at this meeting. He also commented that labor demand has softened and that job creation appears to be running below the breakeven rate, along with highlighting lingering risks surrounding inflation.

Stocks moved up on Thursday in the aftermath of the FOMC meeting, particularly the interest rate sensitive small cap index, the Russell 2000. There was a flurry of discussion about how the resumption of Fed rate cuts has historically been a tailwind for stocks. For instance, Bloomberg, citing Ned Davis Research data going back to the 1970s, noted that the S&P 500 has moved 15% higher, on average, a year after cuts resumed following a move to the sidelines of six months or more. A number of Wall Street strategists also increased their forecasts for market gains in the Fed meeting aftermath. Historic market actions do not necessarily mean that the same thing will happen in the future (and there are some unique circumstances in the current period, including outsized performance contribution from artificial intelligence (AI) related technology companies) but the market’s trajectory in this renewed monetary easing period will bear watching.

After the February 19th – April 8th market correction (Dow down 15.4%, S&P 500 down 18.7% and Nasdaq Composite down 23.8%), these indices have staged an impressive rally. Between April 8th and September 18th, the Dow has risen by 23.6%, the S&P 500 is up 33.9% and the Nasdaq Composite is up a breathtaking 47.6% on the back of several tailwinds. This spectacular rally has propelled the S&P 500 and Nasdaq Composite to a parade of all-time-highs, the latest one occurring yesterday, September 18th. But, with the rally has come a rich valuation level. The market is now trading at a price/earnings (P/E) multiple of 22.6x forward 12-month earnings estimates, well beyond the 10-year average of 18.5x. As a result, the market is what many refer to as “priced to perfection.” This level of elevated valuation leaves very little room for disappointment relative to expectation. Rate cuts will be supportive but other areas, including company fundamentals and the macro landscape, among other things, will have to play well in the sandbox.