Don’t Fight the Fed

But don’t get too excited either – especially if you are a saver

By NIC LANCELOTTA

Sophisticated institutional investors pay close attention to the US Federal Reserve (the “Fed”). The longstanding Wall Street adage is “Don’t Fight the Fed,” meaning that investment strategies should generally align with the tenor of the world’s largest central bank. While this is usually sage advice, what underpins a major policy shift could be the more important question to consider.

Starting in March of 2022, Chairman Jerome Powell and the US Federal Reserve have been waging a war on inflation. While the reasons we have seen such extreme inflation in the last several years are debatable, the significance is beyond question. Everything Americans purchase and consume has been more expensive. To tamp down this self-reinforcing cycle, the Fed raised interest rates 11 times in 2022 and 2023. Thankfully, recent data suggests that inflation is starting to ebb, and on September 18th, the Federal Reserve announced a 50-basis point interest rate cut.

Historical market data generally supports the idea that lower rates (all else equal) are not only stimulative for the economy but are bullish for the equity market. Because money is cheaper, businesses and consumers are better positioned to borrow, grow and consume.  However, sometimes cutting rates can be a negative signal, and there are some questions about how stimulative the recent cut will be. Banks have been decidedly cautious, and the pace of lending has slowed considerably in the last year. There are also some credible market prognosticators that see the September cut as too little - too late.  With some signs of weakness in the labor market and arguable economic slowing (especially in certain sectors), there are concerns that the recent policy change may be evidence of a coming recession.

Given the above cross currents (including the upcoming election), it isn't easy to navigate this new era.  Having worked with some of the most successful investors on Wall Street, I will offer a few points to consider. First, treasuries and high-yield money market funds - while still comparatively “safe” investments - are simply less attractive. Savers that have enjoyed higher rates in these more stable allocations may want to look elsewhere for yield. Fortunately, there are a number of high-quality companies in the S&P 500 that pay dividends. For certain investors, there may also be select private investments (private credit, cash-flowing commercial real estate etc.) that could be an alternative source of yield. Second, I would encourage investors to be circumspect with the more expensive parts of the US stock market. I am a value investor at heart, and while the economy may prove more durable than the bears expect, there will be volatility if we see weak or mixed economic data. In times of uncertainty, more expensive “growth” stocks are often the first to be “right-sized.” The well-known “magnificent 7” (MSFT, AMZN, META, AAPL, GOOG, NDVA, TSLA) are all remarkable companies with higher-than-average margins and undeniable growth prospects. Yet, by almost any measure, current valuations for these equities are extreme, which usually comes with higher downside risk. Finally, ex-US stocks may be worth a fresh review. While I am not advocating for increased emerging market allocations, there are many high-quality companies in developed markets located outside the United States that are trading at attractive valuations. Because US interest rate cuts tend to weaken the US dollar (which has enjoyed a position of relative strength in recent years), any devaluation could also make ex-US equities more interesting.

While no one can predict the market’s path forward (and the yield curve has been sending mixed signals), a Fed pivot in an election year will almost certainly bring increased volatility. Current Fed policy encourages investors to move out of safer cash-like investments and into riskier assets. While there is some precedent for equity upside, to my view, the above ideas are more conservative in nature and—at least theoretically—less binary to any market move.

Early deadlines mean that I was not able to incorporate the ramifications of the recent election. I'll be back in the next issue with my thoughts about changes to the market that are inevitable following an election as consequential as this one promises to be. Nic

Nic Lancelotta is an investment manager who spent 17+ years working closely with large institutional investment managers in the US. Nic is the co-founder of Access Capital Management, LLC. accesscapital-llc.com

Note that all information contained herein is provided to you solely for informational purposes. This document does not constitute an offer to purchase any securities. This document does not create a client relationship with Access Capital Management, LLC or any of its affiliates. Note that Nic Lancelotta is an active investor in public and private securities and one or more conflicts may exist. Access Alternatives, LLC (“Access Alts”) is an alternatives focused investment manager. Access Investment Management, LLC (“AIM”) is an SEC registered investment advisor. Access Alts and AIM are separately owned and operated.

Information provided should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. Do not treat this information as advice in relation to legal, taxation, or investment matters. Please consult with your tax, legal and investment advisors.