To my clients:
It was an up week for North American stock markets with the Canadian TSX finishing up 1.3%; the U.S. Dow Jones Index up 1.6%; and the U.S. S&P500 up 1.4%.
The Federal Reserve did “as expected” and lowered rates this week. What was not so certain was the magnitude of the cut. It turns out to have been an aggressive cut of 0.50% and not a more garden variety cut of 0.25%.
As I said last week, the more important aspect to this week’s policy decision was not so much the magnitude of the cut, but the rationale accompanying it. On this front, I believe Fed Chair Jerome Powell successfully thread the needle of market expectations in that the cut was characterized as a “recalibration” of Fed policy and that “nothing suggested the likelihood... of a slowdown is elevated.” Referring to the interest rate cut as a “recalibration” is an acknowledgement by the Fed that rates were simply too high and too restrictive given consistently declining inflation. Further, by explicitly stating that risks of a slowdown were not elevated, the Fed countered concerns that a larger than 0.25% cut might feed fears that the economy is heading toward recession.
Of further note is that the projections of each of the individual Fed members indicate that the average expectation is for rates to decline a further 0.50% through year end and a full 1.0% more in 2025. Such loosening of policy will further support both the economy and markets. There is a maxim in investing that states “don’t fight the Fed” which means leaning toward full investment when the Fed is actively cutting rates is the path of least resistance and most likely to maximize investment returns. With so much room to cut, the Fed has lots of ammunition to fuel this typical outcome. Its worth noting also that market expectations are currently pricing in a further 0.75% in rate cuts through year end (0.25% more than the Fed is projecting), and 1.25% more through September of 2025 (i.e. 0.25% more, and 3 months faster, than the 2025 year end Fed projection).
The preceding all sounds good. Here though I will caution that markets have come a long, long way since January 2023 and have already priced in much of the aforementioned good news. Valuations in the market are notably higher than usual. Corporate North America will have to continue to grow its earnings to justify these higher valuations. With a rate cutting agenda now in place, corporate North America delivering higher earnings is entirely possible and, I’d argue, likely. But with valuations as rich as at present, I continue to remind clients that volatility is likely to remain elevated for the next several months.
That’s it for this week. All the best,
Nick
Nick Scholte, CIM, FCSI
Senior Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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