What's Going on in the Markets March 30, 2025

Consumers continued to sour on the economy in a week when the only components heading north were market volatility, precious metals, and energy prices. The stock market struggled to sustain positive momentum early in the week following its sharp drop into correction territory (1) earlier this month.

For the week, the S&P 500 index lost 1.5%, the tech-heavy NASDAQ slid 2.6%, and the small caps shrunk almost 2%. Even bonds of every kind showed weakness, which is uncharacteristic of a weak stock market, where treasury bonds tend to see an inflow of capital to “safety.” Institutions continued to press the sell button in a re-acceleration of distribution (2).

CONSUMERS LOSING CONFIDENCE

Economic news didn’t help things much last week.

New Home Sales from the U.S. Census Bureau rose marginally. However, the inventory of unsold new homes also increased to 500,000, the highest level on record outside the last housing bubble. Worse yet, most new homes for sale are still under construction, while only a quarter of the unsold new homes are completed.

This is a concerning sign for homebuilders that the inventory glut will likely continue to grow, and elevated inventory often precedes housing market slowdowns and economic downturns.

Pending Home Sales for Existing Homes from the National Association of Realtors also ticked up slightly, though they remain near the lowest level in the series' history.

A confident consumer is a consumer who is willing to spend money, and spending money keeps the economy strong and helps to create new jobs.

Unfortunately, Consumer Confidence tumbled to 92.9, falling below its 2022 low. Most concerningly, the most significant drop was in the leading Future Expectations Index, which plummeted to 65.2, its lowest since 2013 and well below the Conference Board’s Recession Warning Threshold of 80.

The final reading for March’s Consumer Sentiment confirmed the crumbling of consumer attitudes, also declining more than expected. The Overall Index dropped to 57, its lowest level since 2022. It also showed the greatest weakness in the leading Future Expectations Index, which fell 11.4 points to 52.6 in its most significant single-month drop since August 2022.

A leading reason for the sharp reversal in consumer psychology is a concern over reheating inflationary pressures. Consumer Sentiment Inflation Expectations for the year ahead jumped from 4.3% to 5%, logging a third month of significant increases of 0.5 percentage points or more.

These inflation fears were validated on Friday as the Federal Reserve’s preferred inflation measure exceeded expectations. The Core Personal Consumption Expenditures (PCE) Price Index rose to 2.8% following an upwardly revised reading last month. This remains stubbornly above the Fed’s 2% target, indicating a reheating of inflation pressures and further complicating the Fed’s battle.

The administration’s trade and tariff battles will not help with inflation, which also weighs on the minds of consumers and businesses of every size.

GOOD RIDDANCE 1ST QUARTER OF 2025

With one trading day remaining in the first quarter of 2025 (Monday, March 31), besides a robust rally in precious metals and overseas markets, there’s not much to celebrate in U.S. Stocks.

After a solid 2024 (and not counting Monday’s trading activity), the S&P 500 index is on track to shed 5.1%, the NASDAQ will slide 10.3%, and the small caps will show losses of 9.6% for the first quarter of 2025. It’s not the start to the year that most were expecting with the optimism in the new incoming administration.

Energy and healthcare are the two strongest sectors year-to-date (up 8% and 5%, respectively), while technology and consumer discretionary, two of the largest sectors, are the weakest (down 12% and 11%, respectively).

In a sharp reversal from 2024, the United States is one of only six major global markets down year-to-date. Twenty-two global markets look to show gains, with ten up double-digit percentages year-to-date (Spain, Italy, and China are the best, while the United States, Taiwan, and Turkey are the worst).

Diversification outside the United States (and, for that matter, outside of domestic big cap technology) over the past couple of years has been a headwind, but it has now turned into a tailwind.

IS THERE ANY GOOD NEWS?

The good news is that we are entering the month of April, which tends to have market tailwinds at its back and is one of the most frequently positive months of the year (especially when January is positive, which it was). We also have signs of oversold conditions, but not overly so. But first, we must see the market show signs of stabilization and a let-up in the selling.

So far, what bounces have come along have been sold as investors sell first and ask questions later ahead of the April 2 “Liberation Day,” when many new tariffs are expected to take effect.

On a positive front, some think April 2nd will be a “buy the news” event after “selling the rumor.” Indeed, we should have more clarity after that date than now, and markets often celebrate less uncertainty.

The President’s announcement last week of 25% tariffs on all imported cars certainly didn’t help consumer sentiment or inflation expectations. But it did create a rush to car dealerships this weekend, where I imagine scenes akin to Black Friday sales to get ahead of the tariff deadline. That’s one way to pull forward car demand into a busy (springtime) month and quarter end. I don’t think these tariffs are going away.

If you’re in the market to sell your used vehicle, waiting a week or two could yield a higher selling price. On the other hand, if you’re in the market for a used vehicle, you may want to speed up that process because used car prices will likely move upward as new auto tariffs go into effect.

It’s widely cited among investing professionals that the bond market is smarter than the stock market. And if there are genuine recession or growth fears, corporate bonds certainly aren’t showing them, at least not yet.

One measure of bond sensitivity to economic conditions is the yield spread between the lowest-rated investment-grade bonds (AKA Incremental BBB-rated US corporate bonds) and yields on the Investment-Grade aggregate index. That differential is still quite low at 23 basis points (3). So, while stocks show signs of a growth scare, the corporate credit market does not, and that’s a positive for the markets overall.

SO WHAT SHOULD I DO NOW?

It’s often said that Wall Street is the only place on the planet where they throw a sale, and people run the other way. Not only that, but they line up at the return desk, toss their undesired merchandise at the clerk, and are willing to accept much less than they paid for the same merchandise still in its original packaging. Yes, I’m talking about stocks.

If you consider yourself a long-term investor and are not taking at least a slight advantage of the (10%-30% off) sale on Wall Street, then are you a real investor? Many of the market’s hottest stocks are selling for 10%-30% off. Will you regret not buying some of them when you look back 12-18 months from now, especially if April 2nd turns out to be the bottom?

Sure, the markets can go lower, and they will probably do so in the short term. But in six months or more, will you remember why you even thought of shedding most of your portfolio or couldn’t pull the trigger on some new buys? And if you look smart selling today and the market goes lower, when will you know it’s safe to return? Trust me; it’s a lot harder than it sounds.

We’ve been buying stocks and doing additional light hedging for our client portfolios. It’s not easy, but sometimes you have to hold your nose, close your eyes, and buy something good.

TURN OFF THE BOOB TUBE OR THE IDIOT BOX

If you’re watching or listening to the carnival barkers on financial media, they will try to scare you witless.

When you tune into the weather channel, are they interviewing people basking in the Hawaiian sunshine, smiling and sipping on a Mai Tai? Or are they looking at the worst weather disaster in the nation and making you feel like your region is next to get hit, only to try and keep you glued to your seat?

That’s right. Sounding pessimistic, forecasting market crashes, predicting a currency crisis, or warning of a deep financial depression ahead might keep you tuned in endlessly, but all it will get you is depressed and won’t make you a dime.

Besides, if things were ever as bad as they make them sound, do you care if your portfolio heads down another 5%-10% in the short term if you zoom out 6-18 months on any long-term index chart?

I don’t. And neither should you.

Disclaimer: None of the foregoing is a recommendation to buy or sell securities. Please consult with your financial advisor before taking any action.

(1) A correction is a pullback in a stock market index closing 10% or more below its all-time high.

(2) Distribution refers to selling or transferring large quantities of stocks or other securities by institutional investors, such as mutual funds, hedge funds, or pension funds.

(3) A basis point is 1/100th of a percent. One percent, therefore, equals 100 basis points.

Sam H. Fawaz is the President of YDream Financial Services, Inc., a fee-only investment advisory and financial planning firm serving the entire United States. If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fiduciary financial planning firm that always puts your interests first, with no products to sell. If you are not a client, an initial consultation is complimentary, and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client and their financial plan and investment objectives are different.

Sources: InvesTech Research and The Kirk Report

What's Going on in the Markets March 16, 2025

All the major indexes, including the Dow Jones Industrial Average (30 stocks), S&P 500, Nasdaq, Russell 2000, and even the Wilshire 5000, closed at new 6-month lows on Thursday before a robust bounce on Friday.

Although at its worst moment on Thursday, the S&P 500 index was down almost 10.5% from its recent 52-week high, it managed a decent bounce on Friday but still closed down 8.3% from that peak. Year to date, the index is down 4.1%.

For the week, the S&P 500 lost 5.3%, the NASDAQ dropped 5.8%, and the small caps continued their persistent weakness, falling 5.5%.

Market leadership, especially among technology stocks, showed further deterioration this week, and bearish distribution (institutional selling) continued accelerating. By the end of the week, investor sentiment bordered on extreme fear, one element in the making of a robust market rally.

Though there’s not much to be happy about as an investor, keeping the current pullback in perspective is essential. The S&P 500 index is trading back where it was in mid-September 2024, a mere six months ago. The S&P 500 is still 60% higher than the low made at the start of the current bull market (uptrend) in mid-October 2022.

IT’S THE ECONOMY

Not helping things last Tuesday, the Small Business Optimism Index from the National Federation of Independent Business (NFIB) fell to 100.7 for February (from 102.8 in January and 105.1 in December). The Uncertainty Index rose to its second highest level in the series history—just below the reading reached in October last year.

Uncertainty on Main Street has led to fewer small business owners viewing this as a good time to expand or expecting better business conditions. Enthusiasm over the Trump administration's expected pro-business policies has faded quite a bit.

More favorably, the Bureau of Labor Statistics's Consumer Price Index (CPI) and Producer Price Index (PPI) came in slightly cooler than expected for February, reflecting inflation easing. However, underlying data in both inflation measures indicate that the Federal Reserve’s preferred inflation measure, the Core Personal Consumption Expenditures (or PCE, which comes out at the end of the month), will likely continue to be stubbornly elevated.

Consumer Sentiment drives consumer spending and buoys corporate earnings. Confident consumers are essential to a strong economy, or at least one that can avoid a recession.

Friday’s Overall Consumer Sentiment Index report from the University of Michigan fell dramatically (down 6.8 points to 57.9) for the third consecutive month on concerns ranging from personal finances and the stock market to inflation and labor markets. The Current Conditions Index slid to 63.5, and most concerningly, the Future Expectations Index tumbled 9.8 pts to 54.2, its lowest level since July 2022. Year-ahead inflation expectations spiked to 4.9%, the highest since November 2022.

All three sentiment indexes are now at historically low levels rarely seen outside of recessions. The rapid decline in Consumer Sentiment reflects increased uncertainty about individuals’ perceptions of their financial situation. Uncertainty regarding the future can quickly materialize into a slowdown if consumers cut back on spending or delay big purchases.

This sentiment report marks the most significant two-month increase in inflation expectations since 1980. Consumer attitudes have rapidly changed since the end of last year, and this report headlines the collapse of speculation and exuberance that drove the stock market last year.

IS EVERYTHING BAD OUT THERE?

By most measures, the current pullback has been somewhat orderly, with few signs of investor panic or institutional wholesale dumping of stocks. Some would prefer to see signs of investor panic and some kind of “whoosh” to the downside to signal that a bottom might be in. Instead, what’s happened is a slow “drip” lower akin to water torture that persists for an unknown duration.

As optimistic and pessimistic investors pray for a sustainable bounce, they tend to have opposite objectives. The optimist wants the market to go up to validate their “buy the dip” mentality and produce profits as rewards for their bravery. The pessimistic investors recall past severe market cycles and feel trapped in the market. They will use any bounce or rally to sell stocks and perhaps declare, “Never again!”

These opposing forces are at play on any market day. Still, when the markets decline persistently, as we’ve seen since February 20, the battle between optimists and pessimists can bring about strong emotions and perhaps opposite actions or reactions to the fear, uncertainty, and doubt surrounding a weak market.

So how has this resolved itself in similar scenarios in the past?

A COUPLE OF QUANT STUDIES

We can look to quantitative (quant) studies to help answer the foregoing question.

Analyzing past market historical statistics, often called quantitative analysis, can lead one to believe the market is predictable by studying past patterns. Nothing, and I mean nothing, has definitive predictive power, but humans tend to repeat behaviors repeatedly, making some of these quantitative measures somewhat valuable for review and consideration. They are mere data points in a collection that make up the bulk of market-generated information.

Here are summaries of a couple of quantitative studies from Carson Investment Research:

Quant Study 1: Since World War II, the S&P 500 index has experienced 48 market pullbacks of 10% or more (a 10% pullback is called a “correction” by many). If you subscribe to the notion that a 20% pullback constitutes a definitive bear (downtrending) market, then 12 of those 48 pullbacks (25%) went on to pull back 20% or more. That means that 75% of the time, a 10% pullback did not lead to a bear market.

Quant Study 2: In addition, if we are heading for a 20% pullback, this would be the third 20% pullback in less than five years, something that has never happened since 1950 (which doesn’t mean it can’t happen). Going back to 1950, the last time we had three bear markets this close to each other was between 1966 and 1973, a period spanning 6.9 years. So, another bear market in 2025 would be pretty rare.

So, while most 10% corrections don't evolve into bear markets, the hot money traders' continued complacency and quick-bounce expectations can often precede more significant downturns. Buying the dip, which has worked for years, works until it doesn’t.

GREEN SHOOTS OR BROWNOUTS?

Friday’s bounce notwithstanding, the current price action favors more potential downside unless the market immediately follows through on Friday’s rally to the upside. The market is now significantly oversold, which is historically associated with strong bounces or significant trend changes (from downside to upside). In addition, March corrections frequently stage oversold bounces into recoveries into the end of the calendar quarter.

On another positive note, the next few weeks are seasonably favorable for a continued bounce or rally. This means that historically, this time of the year has been favorable for the markets. If Friday was the spark for a bounce, it could entice more participants to join so they don’t miss the bounce. After all, a rout we’ve seen over the past four weeks deserves more than a one-day wonder rally like we saw on Friday. Indeed, we’ve seen strong reactions to past selloffs comparable to this one. But as they say, “past results don’t guarantee future performance.”

WHAT NOW?

If you’ve been anxious or nervous about market action over the past few weeks, you likely have too much exposure to the stock market. Therefore, it’s prudent to talk to your financial advisor about reducing your overall risk to the “sleeping point.”

If you are the chief investment advisor of your portfolio, take advantage of any rally or bounce to reduce your exposure to better suit your overall risk tolerance. (1)

I won’t repeat everything I said in last week’s What’s Going on in the Markets March 9, 2025. But it bears repeating that we anticipate having a correction of 10% or more at least 1.1 times per year, so this lousy action is normal and shall eventually pass.

A 10% correction turns into a 15% correction about every 40 months (0.3 times yearly). So sure, it could get worse before it gets better, but I’m still not seeing wholesale evidence of a full-on recession or bear market headed our way. We don’t yet have enough proof of that.

If this turns out to be a garden variety correction, and I think it is, taking advantage of the opportunity will pay off for those who have a long-term investing time horizon and are brave enough to step up and buy (it’s never easy to do so, but we did some light buying for our clients last week.) (1)

One of my favorite financial advisors, Keith Fitz-Gerald, often says, “History shows very clearly that missing opportunity is more expensive than trying to avoid risks you can’t control.”

I agree wholeheartedly. Focus on what you can control, and don’t miss the opportunities.

(1) Disclaimer: Nothing in this article recommends that you buy or sell any security. Please consult with your financial advisor before taking any action.

Sam H. Fawaz is the President of YDream Financial Services, Inc., a fee-only investment advisory and financial planning firm serving the entire United States. If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fiduciary financial planning firm that always puts your interests first, with no products to sell. If you are not a client, an initial consultation is complimentary, and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client and their financial plan and investment objectives are different.

Sources: InvesTech Research and The Kirk Report

What's Going on in the Markets March 9, 2025

The stock market experienced significant volatility this week, with the S&P 500 dropping 3.1%, its largest weekly decline since September, driven by concerns over tariffs and uneven economic data.

The S&P 500 index had its worst weekly loss since last September, as tariff headlines and uneven economic data are causing investors anxiety. The index lost 3.10% on the week, the tech-heavy NASDAQ lost 3.45%, and the small caps lost 4.3%. The S&P 500 index is 6.1% away from the last all-time intraday high made on February 19.

It’s helpful to remember that, on average, markets have two or three pullbacks from a peak measuring 5% or more each year, and you can expect a 10% pullback once every 11 months. This pullback feels worse than it is, perhaps due to the relatively smooth upward ride we enjoyed for most of 2024.

Despite universally bullish and euphoric forecasts by all the major brokerage firms entering 2025, the S&P 500 index is now down 1.9% year-to-date. On a more positive front, the domestic Dow Jones Industrial Average Index (30 stocks) is up 0.6%, international stock indexes are up—some double-digit percentages, and dividend-paying stocks and bonds of all kinds are also still up year-to-date. Got diversification?

Downside leadership in the form of institutional selling of stocks (distribution) intensified last week and could be worrisome for the intermediate-term uptrend (bull market) if it doesn’t subside soon. Towards that end, signs that the markets are oversold emerged last week, raising the possibility of a robust bounce back in the coming weeks.

A COMING RALLY?

Indeed, the market indexes closed up with a bounce on Friday, which is uncharacteristic of the markets lately. Recent Fridays reveal five down Fridays out of the last seven, with fears of potential weekend headlines bringing a down opening for the markets the following Monday.

While Friday’s rally is a good start, we need a strong follow-through rally day to mark the return of investors’ appetite for domestic stocks and lay the path for a sustainable bounce or rally.

So far this year, the markets have followed the script for higher volatility during the first year of a new presidential administration. A consolidation (i.e., “digestion” of significant gains by stocks) is expected following more than two years of double-digit gains since the uptrend started in October 2022. Momentum-driven artificial intelligence stocks have been hit the hardest in this pullback.

You can attribute some of this volatility to the tariff wars’ tit-for-tat action, the ongoing peace negotiations for Ukraine and the Middle East, or deteriorating economic data, but regardless of the news headlines, we knew 2025 would not be the smooth ride we experienced in 2024.

RECESSION AHEAD?

While a recession and a bear (downtrending) market usually go hand in hand, there’s not enough evidence to say we’re definitively heading for a recession. While some Gross Domestic Product (GDP) estimates indicate an unexpected contraction in the first quarter of 2025, the quarter isn’t over yet. And, to declare an “official” recession, there must be two quarters of negative GDP, so we won’t know until mid-year.

Bloomberg’s Recession Probability Forecast just edged up to 25% after residing at a very low 20% for much of January and February. Of course, the current projection is right at the average for the measure dating all the way back to 2009. The odds of a contraction stood at more than 50% for much of 2022 and 2023, yet two quarters of negative GDP growth never materialized.

CORPORATE EARNINGS STRONG

The latest quarterly corporate earnings have held up great, and while there may be some deceleration in profits in the second quarter of 2025, the back half of 2025 looks to have earnings re-accelerate.

The main concerns cited by CEOs in their earnings conference calls are the uncertainty about tariffs and the new administration's ever-fluid policies, which affect their planning for the future. Hence, their profit outlook was less ebullient than usual.

Certainly, earnings expectations will be tempered should the latest tariff skirmish be long-lived, but Corporate America is generally in good financial shape, and management teams have experience navigating prior levies.

There’s a saying in this business that “corporate profits are the mother’s milk of stocks.” If corporate earnings remain strong, that will lead to the return of strength in stocks.

ECONOMIC DATA MIXED

Jobs and housing data have lost some steam over the past several months, and they bear monitoring in the short term. While this slowdown could be an ominous sign, the economy may be experiencing what some call a “mid-cycle growth scare.”

The February ISM Manufacturing Purchasing Managers Index (PMI) ticked down to 50.3. However, the Prices Index increased significantly, and the Employment index dropped by 7.5 percentage points. This combination of stubbornly rising prices and falling employment indicates that the Federal Reserve’s battle with inflation is far from over.

The ISM Services PMI for February increased fractionally from 52.8 to 53.5. Like the Manufacturing PMI report, the Prices Index increased to 62.6, marking its third consecutive monthly reading above 60.

Respondents from both surveys expressed major concerns surrounding tariffs, government spending cuts, and heightened uncertainty ahead.

Friday’s February jobs report from the Bureau of Labor Statistics came in below expectations, while the unemployment rate ticked back up to 4.1% from 4.0% in January. Though the addition of 151,000 new jobs was better than many had feared, the recent government layoffs will likely not appear in the data until the coming months.

INFLATION AND INTEREST RATES

Inflation pressures are weighing on the market, as is their effect on short-term interest rates. Coming into 2025, we were expecting one or two short-term interest rate cuts by the Federal Reserve (the Fed). Lately, speculation about whether it would be zero or only one rate cut (or even a rate hike) has also weighed on the markets.

But given policy uncertainty, Fed Chairman Jerome Powell soothed the markets a bit on Friday with a speech in which he implied that the Fed would be ready to act should administrative policies cause an unexpected economic slowdown. In other words, two or more rate cuts might be on the table for 2025 should conditions deteriorate faster or worse than expected.

CHOPPY WITH POCKETS OF MARKET STRENGTH

Overall, while March stock markets have felt awful, seeing pockets of strength in overseas markets, bonds, value, and dividend stocks says that institutions aren’t really that bearish and selling anything that isn’t nailed down. Indeed, if you look at the equal-weighted S&P 500 index, it’s still up 0.45% year-to-date and has held up better than the cap-weighted S&P 500. Even the equal-weighted NASDAQ Index is flat year-to-date.

For our clients’ portfolios, we have been trimming profitable stock positions, adding to other new ones, and increasing our market hedges in case this market pullback proves stubbornly persistent. While the current weight of evidence has not signaled the end of the long-term bull (uptrending) market, there are indications that the current weakness and choppiness may persist in the short term.

To be clear, that doesn’t mean we feel that bearish forces are dominant, given that the proverbial bullish baton has been passed to other market segments, which are now flourishing in an environment where some air has been let out of the technology stock bubble.

DON’T LET THEM SCARE YOU

Regardless, anything can happen as we go forward, and we know that trips to the downside are always part of investing. Still, barring any unforeseen shocks, I don’t expect this pullback to unravel badly enough to wreck the long-term uptrend and plunge us into a new bear (downtrending) market. The quality and magnitude of the next market bounce will tell us whether this pullback phase is over.

A reminder that volatility is the price we pay to enjoy the outsized returns in the stock market. Sure, you could sell everything and get back in “when the water’s safe,” but good luck with timing that (much easier said than done!)

In fact, this might be the time to take advantage of the pullback to buy or add to positions that were too expensive just a few weeks ago—if not now, when? Disclaimer: This is not a recommendation to buy or sell any securities.

Remember, as legendary Fidelity Magellan Fund portfolio manager Peter Lynch once said, “The secret to making money in stocks is not getting scared out of them.”

And whatever you do, turn off the news and the media, whose only job is to keep your attention glued to their every word for as long as possible. They’ll scare you witless if you let ‘em.

Don’t let ‘em.

Sam H. Fawaz is the President of YDream Financial Services, Inc., a fee-only investment advisory and financial planning firm serving the entire United States. If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fiduciary financial planning firm that always puts your interests first, with no products to sell. If you are not a client, an initial consultation is complimentary, and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client and their financial plan and investment objectives are different.

Source: InvesTech Research

What’s Going on in the Markets August 6, 2024

With the lazy, hazy days of summer come the doldrums in the stock markets—or so everyone thought.

July went out with a bang as the market rally broadened significantly to include small-caps and mid-caps, while the red-hot technology stocks took a breather. Sure, the S&P 500 index was only up 1%, but the small caps were up 11%, the mid-caps were up 7%, and even the bonds were up 3%.

But since then, if July was the lion, August has been the bear. The S&P 500 index is down 5% in just three August trading days, the small caps have given back almost 10%, and the tech-heavy NASDAQ 100 has slid 7.5%. In the digital age, markets move fast.

Now, mind you, the S&P 500 is still up about 15% over the last 12 months (and up 9.5% year-to-date), but every 10-12 months, we should expect a 5%- 9% pullback in the markets. We had a 5.3% pullback in April, but the last time we saw a pullback of this size ended last October. The markets have been remarkably calm over the past year, and we went 356 trading days without a 2% daily pullback in the S&P 500 index. That may be why this pullback feels so jarring.

Pundits and the media will posit several reasons for the pullback, such as:

·       The Federal Reserve is on the cusp of making a policy mistake by keeping interest rates higher for longer and is pushing the country into a recession.

·       The July monthly jobs report, which was out on Friday, spooked traders and investors as it came in much lighter than expected, and the unemployment rate ticked up. This fanned the fears that a recession was on the way (there’s always a recession on the way; the trick is knowing when we’re in one.)

·       Over the weekend, news broke that legendary investor Warren Buffet sold half of his stake in Apple during the past quarter and is stockpiling cash.

·       The possibility of a bigger, more freely spending government—regardless of party—is giving traders fits. The markets crave certainty, and summertime offers little of it in election years.

·       Escalating tensions in the Middle East.

·       The unwinding of a long-running Japanese Yen carry trade, in which traders sold the Yen and invested it in higher-paying countries and other opportunities for months if not years. Now, that trade is unwinding and directly affects the world’s stock markets.

You can cite any of the above reasons for the selloff, but the selling will stop when the fear that’s getting the better of so many traders and investors goes away. But certainty about the election is about three months away. Absent a market crash, any possibility of a short-term interest rate cut is about 45 days away. So, buckle up, meanwhile.

In our client portfolios, we’ve been getting defensive by taking some money off the table for weeks now. We are hedged with money market cash earning 5%, Treasury Bills, bonds, inverse funds, and options sold against our positions. We’re prepared to get more defensive if things get worse, but this is a time to look for quality stocks and funds that were too expensive about a week ago. We did some shopping for some clients last week.

We’ve had a fantastic start to the year, and historically, an election year tends to be volatile from the summer into September/October. Once the overhang from the election uncertainty is gone, the market should resume its uptrend by the end of the year.

In short, as I’ve repeated before, the secret to success in accumulating wealth is not to get scared out of your positions. It’s never about completely avoiding risk in the markets but reducing risk. If you’re losing sleep over your investments, consider reducing your exposure or contact us to help determine if you’re overly invested.

Meanwhile, try and stay cool!

If you would like to review your current investment portfolio or discuss any other retirement, tax, or financial planning matters, please don’t hesitate to contact us at 734-447-5305 or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client, an initial consultation is complimentary, and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client and your financial plan and investment objectives are different.

What Persistent Inflation Could Mean for the U.S. Economy

Economic reports of late seem to point to a weakening economy and stubborn inflation.

On April 30, the Employment Cost Index for the first calendar quarter of 2024 showed a 1.2% increase (4.2% year-over-year); that was 25% higher than the consensus estimate of 0.9%.

The FHFA House Price Index for February 2024 was much hotter than expected, coming in at 1.2% versus 0.1% expected (7.0% year-over-year.) Similarly, the February Case-Shiller 20-City Home Price Index came in at 0.6% versus 0.1% expected (7.3% year-over-year.)

At the same time, two more economic reports were released on April 30.

The Chicago Purchasing Managers’ Index (PMI) came in at 37.9 (versus 45 expected).

The Conference Board’s Consumer Confidence Index also came in far below expectations (97 versus 104 expected).

The stock markets were understandably confused: Normally, lower economic activity means lower inflation. Instead, what we got was higher inflation and lower economic activity.

In the stock markets, confusion equals selling now and asking questions later. That’s what we are seeing now.

Persistant Inflation

On April 10, 2024, the U.S. Bureau of Labor Statistics released the Consumer Price Index (CPI) for March, and the increase in CPI — the most commonly cited measure of inflation — was higher than expected. The rate for all items (headline inflation) was 3.5% over the previous year, while the "core CPI" rate, which strips out volatile food and energy prices, was even higher at 3.8%. The month-over-month change was also higher than anticipated at 0.4%. (1)

The stock market then dropped sharply on this news and continued to slide over the following days, while economists engaged in public handwringing over why their projections had been wrong and what the higher numbers might mean for the future path of interest rates. Most projections were off by just 0.1% — core CPI was expected to increase by 3.7% instead of 3.8% — which hardly seems earth-shattering to the casual observer. But this small difference suggested that inflation was proving more resistant to the Federal Reserve's high interest-rate regimen (raising interest rates is one of the most common ways to curb spending and corporate investing to reduce inflationary pressures.) (2)

It's important to remember that the most dangerous battle against inflation seems to have been won. CPI inflation peaked at 9.1% in June 2022, and there were fears of runaway inflation similar to the 1980s. That did not happen; inflation declined steadily through the end of 2023. The issue now is that there has been upward movement during the first three months of 2024.(3) This is best seen by looking at the monthly rates, which capture the current situation better than the 12-month rates. March 2024 was the third increase month that points to higher inflation (see chart).

High for longer

While price increases hit consumers directly in the pocketbook, the stock market reacted primarily to what stubborn inflation might mean for the benchmark federal funds rate and U.S. businesses. From March 2022 to July 2023, the Federal Open Market Committee (FOMC or AKA the Fed) raised the funds rate from near-zero to the current range of 5.25%–5.5% to slow the economy and hold back inflation.

At the end of 2023, with inflation moving firmly toward the Fed's target of 2%, the FOMC projected three quarter-percentage point decreases in 2024, and some observers expected the first decrease might be this spring. Now it's clear that the Fed will have to wait to reduce rates. (4)(5)

Higher interest rates make it more expensive for businesses and consumers to borrow. For businesses, this can hold back expansion and cut into profits when revenue is used to service debt. This is especially difficult for smaller companies, which often depend on debt to grow and sustain operations. Tech companies and banks are also sensitive to high rates. (6)

As mentioned above, in theory, high interest rates should hold back consumer spending and help reduce prices by suppressing demand. So far, however, consumer spending has remained strong. In March 2024, personal consumption expenditures — the standard measure of consumer spending — rose at an unusually strong monthly rate of 0.8% in current dollars or 0.5% when adjusted for inflation. (7)

The job market has also stayed strong, with unemployment below 4% for 26 consecutive months and wages rising steadily. (8)

The fear of keeping interest rates too high for too long is that it could slow the economy, but that is not the case, making it difficult for the Fed to justify rate cuts.

What's driving inflation?

The Consumer Price Index measures price changes in a fixed market basket of goods and services, and some inputs are weighted more heavily than others.

The cost of shelter is the largest single category, accounting for about 36% of the index and almost 38% of the March increase in CPI. (9) The good news is that measurements of shelter costs — primarily actual rent and estimated rent that homeowners might receive if they rented their homes — tend to lag current price changes, and other measures suggest that rents are leveling or going down. (10)

Two lesser components contributed well above their weight. Gas prices, which are always volatile, comprised only 3.3% of the index but accounted for 15% of the overall increase in CPI. Motor vehicle insurance prices comprised just 2.5% of the index but accounted for more than 18% of the increase. Together, shelter, gasoline, and motor vehicle insurance drove 70% of March CPI inflation. On the positive side, food prices comprised 13.5% of the index and rose by only 0.1%, effectively reducing inflation. (11)

While the Fed pays close attention to the CPI, its preferred inflation measure is the personal consumption expenditures (PCE) price index, which places less emphasis on shelter costs, includes a broader range of inputs, and accounts for changes in consumer behavior. Due to these factors, PCE inflation tends to run lower than CPI. The annual increase in March was 2.7% for all items and 2.8% for core PCE, excluding food and energy. The monthly increase was 0.3% for both measures. (12)

Although these figures are closer to the Fed's 2% target, they are not low enough, given strong employment and consumer spending, to suggest that the Fed will reduce interest rates anytime soon. It's also unlikely that the Fed will raise rates.

The Fed seems poised to give current interest rates more time to push inflation to a healthy level, ideally without slowing economic activity. (13)

And since higher interest rates mean more competition for investment dollars and lower corporate earnings, stock markets don’t tend to react favorably, especially when 3-4 interest rate cuts were expected earlier this year.

The Fed issues its next interest rate decision on Wednesday afternoon, May 1, 2024. No change in interest rates is all but a given. However, what Federal Reserve Chairman Jerome Powell says about the recent economic data and the Fed’s stance on when future rate cuts are coming will no doubt be parsed word for word for clues when the press conference is convened.

Please pass the popcorn.

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Footnotes:

 1, 3, 8–9, 11) U.S. Bureau of Labor Statistics, 2024

 2)The New York Times, April 10, 2024

4) Federal Reserve, 2023

5) Forbes, December 5, 2023

6) The Wall Street Journal, April 15, 2024

7, 12) U.S. Bureau of Economic Analysis, 2024

10) NPR, April 18, 2024

13) Bloomberg, April 19, 2024