There are three primary topics of conversation occurring in the broader market right now: interest rate direction, last week’s pullback in the S&P500, and the presidential campaigns. Let’s take a look at them one by one, giving you what’s important, why it’s important, and what the potential impacts are.

The Impact of Inflation on Interest Rates

Headline consumer prices fell by a tenth of a percent month over month, which is the first time that’s happened since the inflation cycle began in 2020.

Due to the rate of change in inflation slowing in June, the probability of an interest rate cut before the election went up. Many people are wondering if the Fed will make such a change to their policy before the big presidential decision, and the answer is they have done it many times before (2008, 1992, 1984, 1980, and 1976) so it shouldn’t be a surprise if they decide to do so now as well. In fact, the market is pricing in nearly a 92% chance that the Fed will cut rates by 0.25%. My take on this is that while a decline in interest rates is generally received as a welcome change by the public, especially those who would like to borrow money to finance a big purchase, it may not be the best thing to rejoice. Generally speaking, the Fed cuts interest rates because the economy is doing poorly as reflected by their mandate to keep inflation low and employment high. If you think about the years I listed above in which they cut rates, the economic picture was not good. Just take a look at the chart below and note the Fed Funds rate in purple with recessions in grey. When rates go down it’s usually because a contraction is occurring.

It’s important that we don’t project today’s environment onto a future date off on the horizon, where many other factors may be at play that we are completely unaware of today. That’s why diversification is so important, and with the Fed all but telegraphing their next move, the bond market is looking more and more attractive. Remember, when rates go down, bond prices go up. With a shift in policy in the near future, it’s a great time to explore your capital preservation strategy. Of course, things can change (they always do).

Stock Market Takes a Slide

On the other side of the bond market is the stock market, which has been experiencing its own change in prices. Last week both the Nasdaq and S&P500 posted their worst week since April, with lows as deep as -3.98% and -1.95%, respectively, on the week (Nasdaq in orange, S&P500 in purple).

It was interesting to see people begin to panic in both traditional and new media (social, podcasts, etc.), which I thought was more revealing in itself. As Warren Buffet said, you never know who's swimming naked until the tide goes out, and right now I have a feeling that many market participants are overweight stocks that are overbought, and by overbought I mean they are so overpriced it requires a certain degree of mental gymnastics to continue to buy them. Of course, there is nothing wrong with holding speculative positions as long as the position is sized appropriately in relation to your other investments. Overall, this pullback was small and nowhere near a healthy correction of 10% which tends to occur more often than people realize. In the last four trading years, there has been one in all except 2021. Stocks are for the long run, not the short run. My take is that if last week made you feel queasy, it’s time to reevaluate your financial plan, not your portfolio. If your financial plan permits you to take the risk, then don’t sweat it. If not, then the next step would be to take a look at the portfolio and determine if you are in the right position with a strategy you can stick to.

Trump Confidence Soars as Biden Steps Down

I don’t have much to say here except wow, what a shift in sentiment among the political class since the debate. Take a look at the chart below showing the betting odds of presidential candidates. Confidence in Trump’s ability to secure the White House seems like it could not be higher, especially considering the terrible circumstances of the assassination attempt.

Generally speaking, the stock market goes up when either a Democrat is elected or a Republican, which is good (see the chart below).

My take is that it’s far too early to call with certainty who will win the election, but it’s interesting to see how world leaders begin to position their alliances as the probability of Republicans winning the executive branch in this year’s election increases. Either way, while history is an average of all years, each year is different, and we are continuing to research and plan potential investment risks and rewards if Trump is elected.

If you have any questions or would like to keep the conversation going, feel free to reach out.

Make it a great week!