Market Update from Foundation Wealth and Tax

In the last week, the financial markets have seemed to catch up to all the geopolitical volatility with some volatility of its own.  Most of the current market volatility can be attributed to a combination of factors, each contributing to investor unease and uncertainty. The economic landscape, both domestically and globally, presents several challenges that are expected to continue influencing market behavior into August and beyond.

Firstly, economic data has been consistently slowing across various macro indicators. This trend has heightened fears among investors that these might be signs of a recession. The latest jobs report for July, which fell short of expectations, has added to these concerns. The persistent sluggishness in economic performance is causing apprehension about the broader economic outlook.  One can’t help but notice that economic data is consistently revised down after initial preliminary release. I wrote about this in a blog earlier this year.

Secondly, there is a growing belief that the Federal Reserve might be lagging in its response to current economic conditions due to the absence of a policy-setting meeting in August. This has led to speculation and nervousness in the markets, as investors now see over a 30 percent probability of a 50 basis point rate cut in September. The uncertainty surrounding the Fed’s next moves is contributing significantly to market volatility.

The geopolitical environment has also become more uncertain, both at home and globally. Political tensions and conflicts are creating a backdrop of instability that is affecting investor sentiment. This geopolitical uncertainty is another layer of complexity that the markets are trying to navigate.

Moreover, the recent actions by the Bank of Japan have added to the volatility. The Bank’s decision to increase rates and reduce bond buying, effectively moving away from its long-standing yield curve control policies, has disrupted currency, rates, and risk asset markets. The Japanese yen, traditionally a funding currency due to Japan’s prolonged zero rates policy, has strengthened sharply. This has caused institutional investors, who had leveraged the yen to purchase risk assets like U.S. technology stocks, to unwind their positions, further contributing to market turbulence.

Despite the sharp rise in equity markets since October 2023 and the recent significant drop in yields, our investment professionals remain cautiously optimistic. They anticipate short-term volatility but maintain a long-term strategy that advocates buying on market weakness. The team’s confidence is rooted in a few fundamental reasons.

First, corporate profits remain robust. Our various investment resources expect the S&P 500 to achieve a low double-digit growth rate this year, with continued attractive growth in the mid to high single-digit range in 2025. Healthy corporate earnings provide a strong foundation for equity markets.

Second, while a rate-cutting cycle typically induces above-average market volatility, we view the current environment differently. We believe the anticipated rate cuts are part of a normalization process, reflecting favorable inflation trends rather than a panic-driven response to recession fears.

Third, the potential long-term benefits of generative artificial intelligence (AI) across various sectors are just beginning to unfold. We are optimistic about the significant productivity gains and positive operational leverage that generative AI could bring in the coming years. Advances in healthcare, infrastructure, and other areas driven by AI innovation are expected to support a more substantial corporate growth outlook than currently anticipated.  I am beginning to use it in my own accounting and advisory business to improve productivity.

To be completely frank (and redundant if you’ve read all my writing the last year), I believe we have already been in a recession.  In nominal terms, we are not in a recession based on the data that’s come out (Q2 GDP was 2% GDP growth).  The problem in this all is how government spending is accounted for.  The deficit is running at 6% of GDP.  That borrowing is included in GDP.  In other words, if you were to balance the budget we would have -4% GDP growth. This is not sustainable and at some point, the bill is going to come due.  If you were to ask me “is this a good economy” I would have to say it’s not awful, but there are unsustainable factors giving a tailwind now that become a headwind in the future.

Overall, while the market is expected to remain choppy in the short term due to the rebalancing of short-term exposures, we advise long-term investors to use this volatility to their advantage. By focusing on corporate profits, the rationale behind rate cuts, and the transformative potential of technological advancement, investors can navigate the current market landscape with a strategic, long-term perspective.  As of this writing, no clients have reached out regarding going to cash or timing the market.  At least annually I like to review why that is.

1. Market Timing is Largely Ineffective: Historically, even professional investors have struggled to time the market successfully. Attempting to predict short-term market movements often leads to poor investment decisions and underperformance.

2. Long-Term Perspective: Long-term investing is the only sensible approach. Staying invested in the market over the long term allows investors to benefit from the overall upward trend of the market, despite short-term volatility.

3. Emotional Decisions: Market timing often leads to emotionally driven decisions, such as panic selling during downturns or buying during peaks. These emotional responses can result in significant losses and missed opportunities.

4. Compound Growth: Staying invested allows investors to benefit from compound growth. Frequent trading or trying to time the market disrupts this compounding effect, potentially reducing overall returns.

5. Historical Evidence: Historical market data shows that missing just a few of the best days in the market can dramatically reduce long-term returns. Staying invested ensures that investors don't miss these critical periods of growth.

6. Cost and Tax Implications: Market timing involves frequent trading, which can incur higher transaction costs and tax liabilities, further eating into potential returns.

A long-term investment strategy is more likely to lead to financial success than trying to predict short-term market movements.  For those retired or near retirement, we will continue to manage bonds and cash closely to ensure we have liquidity when we need.  For now, let’s try and enjoy the rest of the year and hope it’s not as eventful as the last 3 weeks.

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