In today’s Steady Investor, we examine the important factors affecting the market and what might lie ahead, including:
• The Fed retreats further from rate cuts in 2024
• Pension funds are pulling billions from the stock market
• Update on crude oil prices
The Fed Retreats Further from Rate Cuts in 2024 – It all started with the stickier-than-expected inflation (CPI) report last week when the Labor Department reported that prices for all items rose 3.5% year-over-year in March, which was slightly higher than economist expectations and marked an acceleration from February’s 3.2% print. On a month-over-month basis, prices rose 0.4%, which was also 0.1% higher than the street was expecting. Traders immediately scaled back expectations for rate cuts in 2024, which have been coming down for several months now. The Federal Reserve all but confirmed these dashed hopes last week. In a question-and-answer session held in Washington D.C. last week, Fed Chairman Jerome Powell struck a cautionary tone when asked about interest rate policy looking ahead in 2024, especially considering the CPI report. Powell seemed to hedge: “We think policy is well-positioned to handle the risks that we face,” adding that, “Right now, given the strength of the labor market and progress on inflation so far, it’s appropriate to allow restrictive policy further time to work.” In non-Fed speak: rates are likely fine where they are for now, and there is no rush to cut them. The good news for investors is that there is likely no change to the thesis that the interest rate cycle has peaked. With Fed funds currently in a range between 5.25% and 5.5% and CPI at 3.8%, policy is already quite restrictive—even a slight bump higher in inflation would not necessarily mean rate hikes. And it is also important to consider why the Fed might decide to hold rates steady for longer. If it is because economic growth is strong, the jobs market is strong, and inflation is running slightly hotter than expected, that is not a bad thing—and likely bodes well for corporate earnings, and by extension stocks.1
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Pension Funds are Pulling Billions from the Stock Market. A Cause for Concern? – A headline this week was rather jarring: pension funds were expected to pull $325 billion from the equity markets in 2024, nearly the double $191 billion in outflows reported in 2023. An exodus from stocks of this magnitude seems like an alarming signal, but a closer look tells us that a ‘shrug’ may be the more appropriate response. For one, pension funds for large companies and state and local governments held about $9 trillion in assets at the end of 2023, so $325 billion is not a very significant figure on a percentage basis. But more importantly, pension funds are largely undergoing a rebalance in portfolio given the recent surge in equity prices, which has increased many funds’ stock allocations relative to other asset classes. To be fair, some high-profile pension funds are also scaling back their equity allocations relative to other asset classes, particularly bonds which now offer more attractive yields. But it’s not a move driven by a bleak outlook for the stock market—it is more about being able to pursue a target rate of return with less need for equity-like returns, given that fixed income yields allow for this trade-off.3
Are Crude Oil Prices Heading for $100 a Barrel? Rising geopolitical tensions in the Middle East have put oil markets on edge, as the prospect of a wider-ranging war threatens global supplies. The U.S. has also contributed to price pressures as well, as 2023’s record production looks like it could teeter off, as previously lower prices and still-high interest rates have discouraged new investment, which is evident in steeply declining oil rig counts. The near-term risk of oil rising to $100 a barrel seems to be rising for a host of reasons, but medium term we would not expect it to become a major issue—from an economic or an inflationary standpoint. That’s because higher prices almost always lure producers back into the market. OPEC+ has scaled back production of oil by millions of barrels of oil a day in recent years, which tells us there is plenty of spare capacity available they could flip back on to take advantage of higher prices. Ditto for the U.S., where new technology allows producers to increase output fairly quickly. In our view, this available capacity that can be brought to market fairly quickly puts a cap on oil prices, which also provides a form of protection against a prolonged economic or inflationary shock.4
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Disclosure