The Federal Reserve cut interest rates for the second time this year. The move marks only the second time since 2008 that rates have been cut. While this move was in line with the consensus, it reiterates concerns that slowing economic growth and the ongoing tariff war with China could eventually bring on a recession. Many see the Fed’s latest move as “insurance” to help prevent the economy from slipping into recession. And, while we don’t see the data points that typically precede recession, we also don’t see anything that would suggest growth is about to pick back up. We may be in a “goldilocks” environment where growth rates as neither too low nor too high. This potential is supported by the fact that a non-recessionary environment paired with a second rate cut has typically been a pretty healthy environment for stocks.
What may be lost in all the rate cut hoopla is how lower short-term rates affect markets outside of stocks. In theory, lowering the Fed Funds Rate should allow borrowers to effectively gain access to funds at lower interest rates. On the flip side, savers who have come to enjoy higher rates on savings will now again start to face challenges in generating “safe” income.
The chart above shows the Fed Funds Rate over the past 12 years. What you will notice is the sharp drop off during the Great Financial Crisis when interest rates were slashed from around 5.5% to 0%, followed by a long period of stable rates. The Fed finally took action to move rates higher in Dec 2016. Rates had moved as high as 2.45% before changing course in Jul 2019.
Why Do We Care?
One of the biggest drivers of both the stock and bond markets is the presumed direction of interest rates. History tells us that the months following a second rate cut are usually pretty good for equity prices if there is no recession risk. This gives us guarded optimism that stock prices will continue to move higher into the year end and beyond. With that said, we are also aware that headwinds generated by ongoing tariff issues, slowing economic growth, and elevated valuations may prevent history from repeating itself. For these reasons, we still favor high quality US assets.
As interest rates fall, retirees who need predictable income will find it more difficult to generate cash without taking on excessive risk. From 2009 to 2016, savers earned almost nothing on short-term CDs and money markets. Luckily, rates have only moved down modestly and have a long way to go before we get to the levels seen 7 years ago. Currently, HCM is holding a strategic combination of fixed-income assets that balance the cash generating potential with a combination of credit and interest rate risk.
Lower rates highlight the importance of dividend growth strategies in well-rounded financial plans. HCM has long utilized dividend growth as one of the mainstays for clients who desire to live off their portfolio by receiving regular income while benefiting from potentially higher equity prices over time.
If rates continue move lower, the income gap between what one can earn on savings instruments and a dividend growth portfolio will continue to widen. By way of example, the average yield on the dividend growth ETF’s that HCM follows is around .50% higher than money market funds, while the HCM Dividend Growth Portfolio yields about 1% higher than money markets. Both are tax advantaged yields making the after-tax spread even wider for taxable investors. While there are certainly differences in short-term volatility between cash and stocks, dividend growth investing remains a powerful tool for retirees to generate dependable cash flow.
Predictions aside, we know the Federal Reserve has acknowledged that economic growth has slowed and has acted by lowering rates for the second time this year. Expectations around further rate cuts remain fluid, with some analysts seeing an additional .50% cut before year end while others believe rates will remain stable. No one, including us, sees rates rising anytime soon. So, portfolio planning must be based on this low income, slow growth world in which we now live.
Weekly Focus – Think About It
“Either you run the day, or the day runs you.”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Loss of -.49%
- Developed Foreign Markets (EFA) – Loss of -.58%
- Emerging Markets (EEM) – Loss of -1.49%
- Fixed Income (AGG) – Gain of 1.05%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- Oil prices spiked in reaction to a drone attack on critical Saudi Arabian infrastructure, sending the spot rate up as much as 15%.
- Stocks finished slightly lower following three straight weeks of gains ahead of the Federal Reserve’s decision to cut rates for the second time this year.
Eye on the Week Ahead
- September US and Eurozone PMI data will provide clues about the path of global economic growth, including to what extent global trade tensions are further spilling over into the manufacturing sectors.
- September US Consumer Confidence index will offer a signpost on US consumer health.
If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:
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