Stocks Can Go Down
After the S&P 500 soared more than four percent the week of the election (the best week of the year), there was some late week selling last week on worries over inflation potentially coming back, the Federal Reserve Bank (Fed) possibly not cutting as much as expected, and technology stocks lagging. Although any of those reasons could have contributed to the weakness we saw, we’d like to simply highlight that the S&P 500 is still up more than 23% on the year (after gaining 24% last year), so some type of periodic weakness or consolidation is perfectly normal. At the same time, we still expect to see additional gains in 2024.
Just how rare has this year been? With the S&P 500 up more than 23% so far this year, if the year ended right now it would go down as the second best election year since World War II, with only 1980’s 26% gain larger. In fact, the S&P 500 has hit a new all-time high 51 times this year. In addition, every month except those starting with an “A” (April and August) has seen a new high. 51 new highs is the most since 2021 and ranks as the seventh most ever, with this year the second most in an election year ever (1964 saw 65 new highs). Lastly, no year has ended with 51 new highs, but we had 53 in both 1961 and 2014, suggesting more new highs are likely this year with about six weeks still left to go.
Another Look at the Election and Stocks
We’ve written a lot about the election the past two weeks, but we continue to hear questions about the results of the election and stock market performance. The bottom line is if the economy is strong, earnings are expanding, inflation is under control, and the Fed is cutting, then stocks can do just fine regardless of who is in the White House. Fortunately, as we head into 2025, we think all of those market tailwinds remain firmly in place.
Since President Biden took office in January 2021, the S&P 500 has gained more than 52%, for a very impressive annualized return of 11.6%. Note the average year gains a tad less than 9%, so this is very solid. But looking back at the past six Presidents, the annualized return was double digits five times, with 15.2% under President Clinton the strongest. In addition, the S&P 500 was up 10.2% annualized under eight years of President Reagan, up 10.9% under President George H.W. Bush, up 15.2% under President Clinton, up 13.8% under President Obama, and up 14.1% during President Trump’s first term. If you simply sold because you didn’t like who was in the White House for any of those terms, then you missed out on great gains. Of course, stocks did fall an annualized 6.2% under President George W. Bush, but he had the misfortune of being in charge of our country under not one but two recessions and the stock market crashes that went them (the tech bubble bursting and the Great Financial Crisis). To reiterate, we do not see any major warning signs a recession or stock market crash is on the horizon.
Why We Think Inflation Has Normalized and the Fed Can Cut Rates
The October Consumer Price Index (CPI) data held no surprises for markets, either to the downside or the upside. Since inflation had already normalized, that means the latest data confirms the pre-existing trend. Headline CPI rose 0.2% in October and is up 2.6% year over year. Core CPI (excluding food and energy), which is typically used as a gauge for underlying inflationary pressure by the Fed, rose 0.3% last month and is up 3.3% since last year.
It probably sounds bonkers to say inflation has normalized when these numbers are clearly above the Fed’s target of 2%. The thing is, almost all of the “excess” inflation is coming from shelter prices. If you take out shelter inflation, which makes up about 35% of the CPI basket, headline CPI is up just 1.3% year over year. Even over the last three months, CPI ex shelter is running at an annualized pace of 1.3% versus 2.5% for overall CPI.
You may be thinking, “Wait! Housing is in fact a big portion of a household’s budget. You can’t just throw it out.” That is true, except the heat in shelter inflation actually comes from rent increases we saw in 2021, when rents surged. Official shelter data has significant lags to what we see in the private market real-time data. Private data (via Apartment List) indicates that rental inflation has slowed significantly, and new rental lease prices have been falling for over a year now. Our friends at WisdomTree have done one better, reconstructing CPI, but with more real-time housing price data. Based on their analysis:
- Headline CPI with real-time shelter inflation is up 1.3% year over year versus 2.6% for CPI with official shelter data.
- Core CPI with real-time shelter inflation is up 1.8% year over year versus 3.3% for core CPI with official shelter data.
Jeremy Schwartz, the Global Chief Investment Officer at WisdomTree, put it succinctly: “The Fed should continue recalibrating to neutral.” We couldn’t agree more.
The good news is that the Powell-led Fed seems inclined to do so as well. There’s been a question about whether the Fed should be cutting when economic growth and the stock market are running strong. But the Fed does not have a GDP mandate, nor do they have a stock market mandate. In fact, the Fed has historically cut rates several times with stocks near all-time highs (and stocks were higher 20 out of 20 such times a year later, with an average return of 14%). The Fed does have a stable inflation mandate and a maximum employment mandate. It’s pretty clear the former goal has been met. But there’s some risk to the latter, which the Fed seems thankfully aware of. As Powell said after the most recent Fed meeting in November:
The labor market has cooled a great deal from its overheated state of two years ago and is now essentially in balance. It is continuing to cool, albeit at a modest rate, and we don’t need further cooling, we don’t think, to achieve our inflation mandate.
In short, the Fed doesn’t want the labor market to get weaker. Their most recent unemployment rate projections (from the September meeting) confirm this – they projected the 2024 and 2025 unemployment rate to remain steady at 4.4% (it’s currently at 4.1%). As we wrote back then, the Fed is essentially putting a cap (to the degree it’s in their control) on the unemployment rate, or rather, a floor under the economy. Crucially, the fact that inflation has normalized is what allows them to do this. There’s good reason to think this dynamic will play out in 2025 as well, with shelter disinflation in the pipeline and continuing to put downward pressure on overall inflation.
To Powell’s point, the labor market does not need to cool further for them to achieve their inflation mandate. And it has cooled quite a bit. A good place to see this is with wage growth. The latest Employment Cost Index data for private sector service industry workers showed wages growing 3.6% since last year but slowing to a 2.7% annualized pace in Q3. This metric is historically correlated with services inflation, and it looks like there’s further moderation ahead.
This is further confirmation that the inflation problem should be over, and the Fed can normalize interest rates. Elevated rates are clearly having a negative impact on rate-sensitive segments of the economy, especially housing. The Fed’s latest survey of bank loan officers also showed much weaker demand for loans in Q3, despite a pullback in the net number of banks tightening standards. The net percent of banks reporting stronger demand for commercial and industrial loans pulled back from 0% to -21% for large and middle-market firms, and from 0% to -19% for small firms. This is not what you want to see if investment spending is to pick up.
Long story short, policy is too tight. But the Fed has a lot of room to cut because inflation has normalized, and the inflation outlook looks good as well.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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