Summary, Last Quarter:
Inflation was the story heading into 2024, and the worry was that the Federal Reserve would aggressively raise interest rates to the point of tipping the U.S. economy into a recession. The Fed has hiked interest rates and this appears to be taming inflation with no signs of a recession so far. According to the Bureau of Economic Analysis, the core personal consumption expenditures deflator (PCED)—the Fed’s preferred inflation gauge—fell to 2.6% year-over-year in May, down from 2.8% in April. Unemployment—the other half of the Fed’s dual mandate in addition to inflation—rose to 4% last quarter, which is the Fed’s exact employment target. Meanwhile, a low personal savings rate has raised some concerns about the strength of the American consumer.
Our Commentary:
Inflation appears to be heading toward a “soft landing.” If the core PCED continues on its May trajectory of 0.08% for the next seven months, the index would reach 2.0% year-over-year by the end of 2024. A targeted 2% inflation rate is the other half of the Federal Reserve’s dual mandate. Given that unemployment has already hit 4%, accomplishing one of the Fed’s two mandates, we don’t see any reason for the Fed to change its course over the third quarter. Shelter, which refers to housing and rents in economic circles, has traditionally been a slower-moving data point. Housing inflation, a component of the PCED, is down to 5.5%, falling slowly as lagging rents catch up to market rents. Excluding rent prices, the core PCED is already at the Fed’s 2.0% target. Putting it all together, unemployment has reached the Fed’s target, PCED minus rent prices is at the Fed’s 2% target, and staying on this course should get the core PCED to the 2% target.
We previously mentioned the worry about a low personal savings rate. By itself, a low savings rate can be worrisome. However, the economy is never as simple as one data point. Taken in context with other data points—specifically real disposable personal income, inflation, and rising asset prices—a low savings rate isn’t necessarily a red flag. The personal savings rate actually increased in April from 3.7% to 3.9%. Normally, we would want to see that rate at 4% or above, but taken in context with inflation continuing to be outpaced by personal income growth, we aren’t too worried about it, especially with inflation heading lower.
The equity (stock) markets had a good second quarter led by strong investor appetite for technology stocks, specifically artificial intelligence (AI) stocks. Of the traditional benchmarks, the NASDAQ 100 is viewed as a representation of technology-related stocks. That benchmark was up 8.05% for the quarter according to Morningstar. By way of comparison, the S&P 500 was up 4.28%, while the Dow Jones Industrial Average was slightly negative for the quarter. The Dow Jones represents the 30 largest companies traded on the New York Stock Exchange. Those companies are large, established businesses that aren’t growing as quickly as technology stocks. We believe investing in the NASDAQ alone is not a prudent way to invest, and looking at one quarter of performance doesn’t tell the whole story. That’s why our strategy is to examine all stocks and identify those with established and durable competitive advantages trading at fair prices. We have some exposure to AI stocks, but we also have some blue chips; all must pass our investment requirements before entering our strategies.
The second quarter was more of the same for bond markets. Short-term bonds continue to pay strong yields relative to all other bonds, due to the Fed raising short-term interest rates. Until that dynamic changes, there doesn’t appear to be a reason to move away from the short end of the curve. That said, a change in U.S. president could alter fiscal policy and bonds could theoretically be affected more than stocks. Until that becomes clear, we will stay the course.
Until next quarter,
Leelyn Smith Investment Committee
Bond Disclosure:
Fixed income securities carry interest rate risk. Fixed income securities also carry inflation risk and credit and default risks. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Forward-Looking Statements:
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.