Artificial Intelligence, Interest Rates and Politics
In the first six months of 2024, investment markets were driven by the rise in the use case of Artificial Intelligence (AI) and the seven largest cap stocks in the S&P 500 dubbed “the Magnificent Seven” (Nvidia, Apple, Microsoft, Alphabet, Meta, Tesla, and Amazon) were the leaders of that AI investment theme. These seven stocks drove the S&P 500 to return double digits for the first half of the year, while the remaining 493 companies in the S&P 500 lost 1.2% in market value. While we positioned Riggs clients to take advantage of the Artificial Intelligence investment theme, as risk managers, we were uncomfortable with the narrowness of the market.
As the calendar turned to July, the market began to shift. With inflation falling and the Federal Reserve softening its position, the market started focusing on when it would make the first cut to the Fed Fund's short-term interest rate and anticipated that time may be near at hand. Areas of the market that are interest rate sensitive, such as small caps (companies that carry higher debt levels), banks, and real estate, began to move higher. The once narrow market rally began to broaden. This was a healthy development.
Next week, the Federal Reserve will meet and share its perspective on the economy, inflation, and employment. With inflation cooling, seeing the Fed cut rates at their July or September meeting would not be surprising. Remember, Federal Reserve Chair Jerome Powell has reiterated that the Federal Reserve will cut rates in 2024. Research firm Ned Davis Research analyzed historical data around Federal Reserve Rate cuts and found that the Dow Jones Industrial Average typically experiences a 15% increase in the first year following the Fed’s initial cut. If the cut coincides with economic strength and no recession, the Dow has surged 24% on average.
We will get the June CPI reading on Friday. If inflation continues to fall, the Federal Reserve will have the confidence to begin cutting rates. All eyes will be on the Federal Reserve next week during their Federal Open Market Committee on July 31st for any announcement of when they will begin to cut rates.
This focus on rate cuts is important to equity markets and the U.S. bond market. We have systematically been extending the duration of our bond holdings. When the Federal Reserve begins to cut rates, those with longer-dated bonds with higher yields should get a pop in the price, giving you both yield and price appreciation. We see opportunities in mortgage-backed bonds, intermediate and longer-term Treasuries, and corporate bonds. Importantly, those using money markets as a bond proxy may want to lock in higher yields with individual bonds. Money market rates are keyed off the Federal Reserve Funds rate, so as the Fed begins to cut, the yield on money market rates will decline.
As we move into the fall, the Presidential election cycle will take more of the market’s attention. As the uncertainty of the election's outcome develops, that uncertainty will be reflected in the markets, and the markets will become erratic. This is where “crowd psychology” begins to affect the investment markets.
The more uncertain the crowd, the worse the markets tend to behave. Conversely, the more certain the crowd, the better the markets tend to behave. During Presidential election years, this is amplified as the market reflects the mood and psychology of the American people.
Once the election uncertainty is cleared, you typically see a robust year-end rally in relief. With a solid first half driven by AI-related stocks, a likely strong summer driven by the anticipation of the Federal Reserve cutting interest rates, a pickup in volatility as we get closer to the election, and then a relief rally once the election is complete, 2024 has some strong tailwinds that will likely result in a very good year for investors and Riggs’ clients.
If you have any questions concerning the investment markets or how to structure your money market investments, please do not hesitate to contact us.