Forget the Myths and Focus on What Matters: Your Income
It’s that scary time of year again, and you might find it especially scary this year if you believe in certain myths about the financial markets. So, I’ll start by dispelling some of those myths, then I’ll share my expert perspective on where we are and where we’re headed early in this final quarter of 2024.
One popular myth, of course, is that October is always a bad month for the markets. This stems mainly from the fact that some of the most infamous drops in Wall Street’s history have, indeed, occurred in October. Apart from that, though, the idea that October is “cursed” is a myth, and the reality is that June and September are both worse months for the markets, historically speaking.
The other myth is that the coming presidential election is – depending on the results – likely to trigger a market crash. I’ve heard the same fears expressed ahead of the last five presidential elections. The fact is the markets typically do well after an election regardless of the winner because investors like certainty as much as they dislike uncertainty.
So, forget about all the myths and focus on what matters, which is this: the markets are stable, the Fed has started lowering interest rates, and the inflation rate is almost back down to 2%. Now let’s take a closer look at these points one by one.
Up, But Overvalued
As for the stock market, after some big bouts of volatility to start August and September, Wall Street finished both months strong, and at the end of September, the S&P 500 was up by 20.8% for the year, the NASDAQ by 22.3% and the Dow Jones Industrial Average by 12.3%.1 That’s good, but even the most bullish stock fan (including our own Chief Investment Officer in charge of equities) will admit the market is probably overvalued. What’s the primary reason for this overvaluation? That brings us to point two: the Fed.
As noted, in September the Fed finally started lowering short-term interest rates for the first time in over four years. The half-percent cut was even bigger than expected and brought the Fed’s benchmark rate down to around 4.9%. Most experts believe they will keep cutting at least until the rate drops to 3%. If so, that should continue to bring down long-term rates, which, based on the 10-year government bond, have dropped from 4.4% in early Q3 to 3.7% as of early October.2
And it’s not just our own Federal Reserve. Other central banks around the world are also lowering rates, including now China.3 If the trend continues, it’s good news for investors overall because, as Warren Buffet observed, falling interest rates increase the value of all assets.
All of this, I believe, has a lot to do with why the stock market is overvalued. Remember, the market is forward-looking, so investors are already pricing in where rates are probably headed as opposed to reacting to where they are.
But why is the Fed lowering rates now? Well, remember they began raising them in 2022 in response to the inflation rate, which was at a 40-year high of around 8%. Their goal was to bring the rate back down to a so-called “normal” level of 2%. Based on the latest data, they’re now very close to the target, with the Consumer Price Index at 2.5% year-over-year, and the personal consumption expenditure (PCE) at 2.2%.4 That’s good, but at the same time, the economy has shown numerous signs of slowing down in recent months, so much so that fears of a possible recession have resurfaced among some economists.
Considering all these factors, the Fed is also trying to be forward-looking by starting its rate-cutting cycle now while the economy is still relatively healthy, and the markets are stable. Many feel they waited too long to start raising rates two years ago, and they don’t want to make the same mistake again, especially when the consequences might be a recession.
Your Portfolios
Now, here is the main thing that matters most to you right now as income investors. As of the end of Q3, our conservative portfolios of bonds and bond-like instruments were up by about 9% on average for the year. That’s 9% total return, and it’s an average that, of course, depends on your individual holdings. But it’s also an average that is three to four percentage points higher than our target range of 5-6%, which means you’re ahead of the game and have a cushion on the off-chance that something does happen to shake up the markets before year’s end.
Despite the current stability and the Fed’s proactiveness, the possibility of a sudden downturn still exists, especially considering all the geopolitical turmoil taking place now in the Middle East and elsewhere. In fact, the possibility of a sudden drop always exists, and it’s important to remember this if you should start feeling a twinge of “FOMO” about the stock market being up by 20%. That 20% gain could just as quickly become a 20% loss, or worse, at any time, which is why you made the switch to investing for income in the first place. With an income-first approach, your value fluctuations up or down are largely irrelevant because your interest and dividend return remain steady and unaffected.
Still, it always feels better psychologically to see those values growing instead of shrinking. I get that, which is why I’m always happy to be able to report good news about the markets instead of bad. And for all the reasons I just discussed, we should be well-positioned for more good news as the year winds down. And even if things turn bad due to a “black swan” event, remember you’re ahead of the game right now and have that cushion.
With all this said, although there may not be any urgent reason based on the markets right now to make changes in your portfolio, you might still want to make an adjustment based on a change in your goals or situation. If so, of course, give our office a call at any time to schedule a meeting!
1 “US Equity Market Attributes, September 2024,” S&P Global, Oct. 2, 2024
2 MarketWatch.com
3 “China’s Central Bank Unveils Most Aggressive Stimulus Since Pandemic,” Reuters, Sept. 24, 2024
4 Bureau of Economic Analysis, BEA.gov
Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm.