The Federal Open Market Committee (FOMC), a regularly scheduled meeting of the Federal Reserve System Board of Governors, held its September meeting from the 19th through the 20th this month. The conclusion? Keep the federal funds rate the same at a target of 5.25 – 5.5% while continuing its balance sheet reduction.
Note: When the Fed refers to “balance sheet reduction”, it’s essentially deleting money from the base money supply. Step 1: buy Treasury bonds from a bank through a repurchase arrangement (QE), Step 2: hold the bond until maturity, Step 3: delete the Treasury principal payment transmitted to the Fed. This is currently happening at a clip of $60B per month, equivalent to roughly one Warren Buffet being deleted from the universe every other month.
Price action in the domestic bond market prior to the meeting predicted this outcome with accuracy, so the FOMC surprised no one. While the decision to maintain course was in line with market expectations, the meeting minutes and press conference indicate a decisively hawkish outlook. Since September 20th, both the S&P 500 and NASDAQ are down approximately -2.7%.
Looking at the projection materials published post-meeting, the FOMC suggests rates could kiss the 6% threshold before declining. Keep in mind that the Fed is notorious for inaccurately predicting future policy shifts.
The Fed’s more hawkish than expected language was hardly the catalyst for the recent stock market slide. The current pullback began in late August, with the DOW Jones Industrial average off -5.9% from its intra-year highs. Rather, it only reaffirmed the existing risk-off sentiment.
Back in late July, we harvested some of our high valuation positions within our client portfolios and I’m glad we did. Regular, drift style rebalancing does make a difference over time. Even so, the rebalance has only made a modest positive difference in the short run.
The quandary plaguing market analysists now is the increasing spread between the S&P 500 mega caps and its smaller components. You would think the recent selloff would have hit the higher valuation mega cap names the hardest, but it’s been quite the opposite.
Investors seem to be hiding out in the cavernous balance sheets of the Magnificent 7*, content in ignoring the higher-than-average multiples. Not long ago, the “defensive” equity play was to purchase telecom and utility stocks. Not anymore. Now the play is in technology. The bigger the better.
*The Magnificent 7 refers to Apple, Microsoft, Amazon, Tesla, Nvidia, Alphabet & Meta.
As we quickly approach the 2-year mark since the last all-time highs in most board stock indexes including the DOW, S&P 500 and MSCI ACWI, the market trajectory is decidedly bearish. Not a good sign for investors losing patience.
Times like this test the true mettle of your investment discipline. The crowd is piling into expensive mega caps with silicon dreams of artificial intelligence fueling pro forma flights of fancy. It’s never comfortable to be a contrarian. But eventually earnings matter and lofty expectations must be met. Just ask a veteran dot com investor.
While the mega caps may yet meet the high expectations, they are far from bargains today and remain ripe for harvest. Short-term minded investors would be wise to consider adding to their high quality, low-duration fixed income positions, now with real positive yields.
Longer-term minded investors should be patiently adding to their diversified equity portfolios, mindful of concentration risks. Out of vogue, I know, but prudent nonetheless. Just close your eyes for the next few years.
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