In recent months, reports have indicated that the US economy has remained resilient and robust. The GDP growth for the second quarter was 2.1%, and the third quarter was 4.9%. According to the Associated Press, this growth was primarily driven by a significant increase in business spending and continued strength in consumer spending. Despite 11 Federal Rate hikes in the past 17 months, this has been achieved. Furthermore, inflation has continued to decline and is now down almost 50% in the past 12 months. Based on this data, I anticipate it continuing to drop to 1.9%, maybe as low as 1.8%, below the Fed’s 2% target.
As the wise John Templeton once said, “The four most expensive words in investing are: ‘This time it’s different’.” I wholeheartedly agree, and in this case, history is repeating itself. In October 2022, the stock market experienced a significant decline, but it has since rebounded considerably. This pattern is consistent with past slowdowns triggered by higher interest rates, inflation, and a sluggish economy.
The inflation rate increased significantly from 1.2% to 8.2% between 2020 and 2022. However, in 2023, it stabilized at around 3.7%, marking a decrease of over 50%. Two events contributed to the rise in inflation in recent years. First, decreased production due to the pandemic increased prices in many sectors. Secondly, the increase in money supply through stimulus credits also played a role in the spike.
Post-pandemic, we have experienced a decrease in unemployment, which fell from a high of 14.70% in 2020 to a low of 3.5% in 2023. The lower unemployment rate, together with the stabilization of the supply chain, has helped the USA to avoid a recession and enabled a steady decrease in inflation.
Interestingly, inflation was largely absent from 2010 to 2020 despite abundant money supply and a strong economy during that period. This begs the question, how did inflation remain so low? According to Goldman Sachs, two key factors were at play: firstly, the low cost of energy during that time, and secondly, continued technological advancements that drove down the cost of doing business. This combination led to a period of low inflation and low cost of borrowing, which was truly remarkable.
Many Americans are concerned about the possibility of a recession in 2024. Some believe that we may have entered a new economic norm. However, the impact of technological advancements like Artificial Intelligence (AI) should not be overlooked. These technologies can reduce costs and create new opportunities, industries, and jobs. While some jobs may be replaced, they are often replaced by more lucrative jobs. This trend is visible in the market today. Goldman Sachs provides data to demonstrate this phenomenon. In 1850, 66% of workers were involved in agriculture or food production, and malnutrition was a primary cause of death. Less than 2% of workers are involved in food production today, but productivity has increased dramatically.
Although most stocks have only slightly increased in value in 2023, many of these companies are recovering from earnings slumps. Historically, growth spurts have followed these lows. However, the overall market presents a different picture. The S&P 500 index has increased by almost 13% year-to-date, while the Dow has decreased by 0.4%. In contrast, the NASDAQ has gained 22.66%. It’s important to note that a small number of stocks primarily drives the performance of the S&P and NASDAQ. Removing these stocks would significantly alter the performance of the indexes.
Throughout history, the S&P’s price-to-earnings ratio (PE) of the S&P has been around 16 to 1. However, in recent times, it has risen to 26 to 1, indicating that the market may be somewhat overvalued. If you remove the small number of outperforming stocks, the ratio drops and the market appears slightly undervalued. In 2023, the market seemed to be responding to this trend, and the larger group of stocks performed quite strongly. Many of these companies have already reported their third-quarter results, which have proven to be better than expected.
It’s worth considering your risk tolerance when deciding how to invest. Given the Federal Reserve’s potential to pause rate hikes and the possibility of declining inflation, investing in bonds or fixed-income instruments could be a good option. These investments allow you to lock in yields for the long term rather than just opting for short-term CDs or money markets.
Investing in bonds or fixed-income instruments is a great way to diversify your portfolio and reduce risk while generating a source of income. While cash rates are at their highest levels in over a decade, it’s important to remember that these rates are only designed for short-term investments.
I suggest contacting your broker to discuss your situation, goals, and risk tolerance, particularly if you haven’t reviewed your portfolio recently.
Remembering that diversification and asset allocation do not guarantee profits or protect against losses is crucial. Even holding onto investments for an extended period of time does not guarantee a profitable outcome. However, from my personal experience, I have found that this model works best for me.
If you are new to investing and the terms I mentioned sound unfamiliar, let me explain in more detail. The S&P 500 index consists of 500 widely held stocks and is generally considered a representation of the U.S. stock market. The NASDAQ composite is an index of securities traded on the NASDAQ system. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow”, is an index that represents 30 stocks of companies reviewed by the editors of the Wall Street Journal. Investing directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Therefore, individual investor’s results will vary.