Contributed by: Angela Palacios, CFP®, AIF®
Contributed by: Nicholas Boguth, CFA®, CFP®
When the circumstances change, our perspective evolves. This anthem of the past year highlights the importance of adaptability and openness to new information. But as much as things have changed this year, much has stayed the same. Megacap tech stocks are still driving the S&P 500 gradually upward for the year. The S&P 500 has had the best start to a presidential reelection year by logging 31 record highs this year and low volatility. Interest rates are still high. Stocks are performing better than bonds, while the U.S. continues to trounce international and large company stocks, which continue to beat small company stocks.
Elections
The remainder of the summer and fall will surely be dominated by election headlines. Because elections can be divisive and unnerving, it's important to remember that markets are often resilient even in the face of the most unsettling election scenarios. Watch for an invitation to our upcoming election event to hear more details on this topic, but here are some quick observations:
U.S. stocks trend upward on average in election years regardless of which candidate wins the White House
Balanced portfolios historically help investors meet their financial planning objectives while managing risk over presidential terms
It's time in the market and not timing that matters the most for an investor; sitting on the sidelines with long-term assets sitting in cash can be costly to a long-term investment strategy
If you look at average and median returns through a presidential cycle, you can see that election years tend to be strongly positive. Historically, median returns are over 10% in an election year, with average returns over 7% in an election year.
Returns also tend to come more strongly in the second half of the election year, as shown in the chart below. This year has broken the mold with strong returns through the first half of the year. Usually, when this happens, there tends to continue to be strong returns also through the second half of the year.
What Has Led to These Strongly Positive Returns?
While higher interest rates and high inflation seem like a staple part of the economy now, it is easy to forget that we enjoyed decades of low interest rates, low inflation and globalization that drove those trends.
Inflation has resumed its slow march downward despite a small pause this year and some numbers that had looked like they might be turning back upward. It seems unlikely that inflation will accelerate and should continue to resume the disinflation trend. Now, most of the inflation comes from shelter costs, and we have seen rent prices level off and slow slightly. Rent prices starting to come down should help this source of inflation. You also may have noticed your insurance rates increasing. Car insurance has contributed notably to recent inflation numbers.
Many consumers still feel the sting of higher prices because slowing inflation only means prices aren't going up at the pace they were. The price increases we experienced over the past several years are here to stay and will need to be permanently factored into budgets going forward. Many households have found substitutes by shopping around at bargain retailers, and some have been lucky enough to experience wage inflation (although not enough to offset economic inflation.
Interest Rates and The Fed
It is hard to talk about inflation without discussing The Federal Reserve and the current interest rate environment. As of the end of the quarter, the 1-year treasury rate was ~5.1%, and the 10-year treasury rate was ~4.4%. You are still getting paid MORE in short-term bonds than you are in longer-term bonds – that is strange! In a normal interest rate environment, you would get a higher coupon from longer bonds because, in return, you are taking on more risk and uncertainty from the longer time until maturity.
This environment has made it much more attractive to hold money market funds, CDs, and other short-term instruments, BUT those are not without risks of their own. If the 10-year rate falls, for example, then the risk of being in the short-term bond is that you will miss out on the price gains of the 10-year bond, and if short-term rates fall as well, then you will have to reinvest your money at a lower interest rate once your bond matures. Without knowing the path of interest rates going forward, there is no way to know with certainty which type of bond will outperform. However, we are here to help make sure your portfolio is positioned well for YOUR financial plan.
Speaking of the path of interest rates, despite inflation heading in the direction that the Fed wants, they kept the Fed Funds rate steady at the same rate as it has been for almost the past year: 5.25-5.5%. There are advocates on each side of the argument saying that they should have cut rates already OR that they should even keep further hikes on the table. Jerome Powell continues to stress data dependence and their commitment to the 2% inflation target, and this sentiment is shown in bond rates as rate cut expectations have continually been priced out of the market year-to-date. No one has control over inflation numbers, the Fed, interest rates, or the stock market – you have to invest given the hand you are dealt.
AI and Meme Stocks
Several investment crazes have filtered into this stock market rally; some have long-term validity, and some don't. The evolving landscape surrounding artificial intelligence has strongly impacted any company investing heavily in it. Nvidia corporation has been the poster child of a rally surrounding artificial intelligence, which has been up very strongly this year, even though it has recently pulled back some. Nvidia is viewed as a pioneer in the space as its business shifted from gaming consoles to data centers where its chips now power large language models like ChatGPT. Meanwhile, Gamestop found itself in the middle of the meme stock craze again. While returns attributed to meme stock hype are usually short-lived, the idea of social media heavily influencing trading performance is something the markets are still trying to make sense of. While investing in a long-term productivity enhancement like artificial intelligence can drive long-term fundamental returns, meme stocks are more about hype and short-term volatility.
Hopefully, you take a few moments to check out the Olympics this month. I am often in awe of the amazing talent seen from around the world. That kind of talent comes from a lifetime of diligence and hard work, much like successful investing. Natural ability or luck can only take you so far and can't be counted on. Athletes must train in various muscle groups and mental stamina to be successful. Much like athletes rely on diversified training in investing, we rely on asset diversification, good investor behavior, and consistent saving over time to reach our finish line. We are here to help ensure your investments are helping you reach the finish line no matter what the market environment looks like. Don't ever hesitate to reach out with any questions you may have.
Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.
Nicholas Boguth, CFA®, CFP® is a Senior Portfolio Manager and Associate Financial Planner at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.
Any opinions are those of the Angela Palacios, CFP®, AIF® and Nick Boguth, CFA®, CFP® and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not a guarantee or a predictor of future results. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.