Don’t Fight the Fed – Don’t Lose Your Head

Troy Noor, CFA, CFP®

There is an adage among market participants – “Don’t fight the Fed”. In essence, what this means is monetary policy exerts enormous influence over market direction.

We saw this play out in November of 2021 as market participants started anticipating the Federal Reserve raising rates and small- and mid-cap stocks started their descent closely followed by large-cap stocks in January 2022. The Federal Reserves started their rate-hiking cycle in March of 2022 which led to the S&P 500 declining 25.4% by October 12th of 2022.

We have the converse in play right now. The Federal Reserve started its rate-cutting cycle September 18th of this year. We are anticipating two more rate cuts of a quarter of percent yet this year and four more in 2025. That is a decline in interest rates of two percent over a 15-month time horizon. This is like the Federal Reserve stomping on the gas of the economy to accelerate economic growth.

This force is being countered by geopolitical risk in the form of uncertainty around the election and escalating tensions in the middle east. The market does not like uncertainty, so this causes its participants to take a defensive stance when there are unknowns on the horizon. There seems to be a knee-jerk reaction of sell first – ask questions later. We saw this manifest last year with events of October 7th. From October 10th, 2023 through October 27th we saw the S&P 500 decline 5.9% only to have it subsequently return 39.7% by the market close on Friday, October 4th, 2024.

This reinforces that the market is mainly concerned about two things – the economy and earnings.

The economy is doing well with 2nd quarter growth coming in at 3% and 3rd quarter growth projected to 3.1% by the Atlanta Federal Reserve. This is against long-term averages 2.1%.

Earnings are also poised to do extremely well with enormous of amount of investment coming through into technology associated with artificial intelligence. In 2023 big tech invested $126 billion in artificial intelligence and this year it is projected to $192 billion follow by an estimated $218 billion. This is an enormous amount of spending and should drive earnings higher across companies. In fact, analysts estimate that S&P 500 earnings growth should come in 9% higher this year and 15% higher next year.

Between the Federal Reserve cutting rates to spur economic growth and the large investments in technology, we have an extremely constructive view of the market intermediate- and long-term. We would expect a drawdown between now and the election and then a rally into year-end as the uncertainty clears on the geopolitical front and we get back to business as usual. So again, don’t fight the Fed and don’t lose your head.