2024 10 Don't Go Chasing Waterfalls

As the vibrant summer months draw to a close, we reflect on a year marked by technological leaps, market resilience, and the upcoming election. In our previous letter, we discussed the AI-driven surge in tech stocks and the challenges posed by a narrowly focused market. In this issue, we’ll explore some of the big events that marked Q3 and ways you might stay grounded as we head into the election and the last quarter of the year.

Don’t Fear the Election, and Don’t Chase Waterfalls

The upcoming election is stirring plenty of conversation, but when it comes to market returns following a presidential election, history suggests that which party is in the white house has no impact on long term market results.

The graphic below highlights market performance across two timeframes: the first two years (on the left) and the full four years (on the right) following a presidential election. On the left, we see the two-year returns under several different scenarios—whether it's a Democratic or Republican president, divided Congress or a sweep. There’s quite a bit of divergence here, making it challenging to draw firm conclusions, though it does emphasize the volatility that can occur early in a president's term.

One possible reason for these swings in the two-year results is that the mid-term elections act as a "right-sizing event" that realigns policy expectations. This could explain why markets tend to stabilize in the second half of a presidential term.

On the right-hand side of the graphic, you’ll see market returns over a four-year span. Here, the story is much clearer: regardless of who occupies the White House, the market tends to deliver similar results over the long run. So, while short-term volatility is common, the long-term market impact of a presidential election tends to even out.

As we approach the upcoming election, it’s important to stay the course with your investment strategy. In the words of iconic TLC: “Don't go chasing waterfalls / Please stick to the rivers and the lakes that you're used to.” Letting short-term events, like the election, alter your long-term strategy can lead to unnecessary risks. Stay focused on your long-term goals and avoid making reactionary changes based on short-term uncertainty.

Note: chart provided by Jurrien Timmer at Fidelity.

Quarter in Review: Fed Rate Cuts and New Market Highs

Last month, the Federal Reserve made its first rate cut since early 2020, reducing the fed funds rate by 50 basis points (0.50%), bringing it to 4.75%-5.00%. This marks the end of the most aggressive rate hike cycle in over 40 years.

Some investors were initially concerned that such a significant cut might indicate worries about the economy. While the unemployment rate has risen slightly and job growth has slowed, most indicators suggest continued economic expansion. Fed Chair Jerome Powell’s comments reassured markets, as he emphasized that a soft landing is still possible.

So, why did the Fed opt for a larger 50 bp cut instead of the more typical 25 bp reduction? Usually, the Fed prefers gradual policy adjustments unless it's responding to unexpected economic shifts. Powell explained that the larger cut was a preemptive move—a form of insurance against a potential economic slowdown. He noted that it’s better to support the labor market when it’s strong, rather than waiting for signs of rising layoffs.

Overall, the Fed is walking a fine line. Cutting rates too slowly could risk pushing the economy into recession, while cutting too quickly could fuel inflation.

In the long run, whether the cut was 25 or 50 basis points may not make much difference, but for now, it’s a significant move.

Profit growth, moderating inflation, stable or falling interest rates, and modest economic growth have traditionally provided strong support for equities. In September, both the Dow and the S&P 500 reached record highs. While the Fed initially misjudged inflation, it has since regained credibility as inflation has slowed without triggering a recession.

We're thrilled to see new highs in our portfolios, but it's important to stay mindful of market realities. Historically, the broad stock market index experiences a 10% market decline once per year (which hasn’t happened in 2023), a 30% decline every five years, and on three occasions since WWII the market has dropped by 50%. While it's great to enjoy these moments, it's crucial not to get swept up in euphoria. Stay focused on long-term goals and be prepared for the natural ups and downs of the market.

The Bizarre Story of the Japanese Yen Carry Trade

From mid-July to early August, market indexes dropped over 5% from recent highs. While declines like this are normal and occur periodically, the cause isn’t always clear. Usually, we can point to factors like negative economic data, but sometimes, there’s no obvious explanation.

This time, a potential culprit is something most people have never heard of: the Japanese Yen Carry Trade. With Japan’s interest rates much lower than those in the U.S., speculators borrowed Yen at low rates, converted it to dollars, and bought U.S. Treasuries yielding 5%. It was a profitable strategy—until it wasn’t. When the Japanese central bank raised rates, the Japanese market fell, the Fed hinted at rate hikes, and the Yen-to-Dollar exchange rate shifted. This likely forced high-risk traders to reduce exposure, which contributed to the decline in the U.S. market.

While this theory is speculative (since there’s no central record of how much money was involved), the market rebounded just as quickly, and the Yen Carry Trade faded from the spotlight almost as fast as it appeared.

October is Cybersecurity Month!

I know I sound like a broken record, but cybersecurity is too important to ignore. There are three key actions that can significantly improve your security:

Enable two-factor authentication (2FA) on everything. This extra layer of security significantly reduces the chances of your accounts being compromised.
Use a password manager to create and store strong, unique passwords for all your accounts. It’s an easy way to protect against hacking.
Lock your credit reports with the three major credit reporting agencies. This prevents unauthorized access and new accounts being opened in your name.

These steps may seem simple, but they make a huge difference in protecting your personal information. Stay proactive and stay secure!

Chart of the Month

Recently, Florida was hit by two back-to-back hurricanes. While I’m not an expert on the science, I do know that warm ocean waters are the primary fuel for hurricanes. The chart below, from a recent New York Times article, highlights that the Gulf of Mexico was unusually warm this summer.

As always, thank you for choosing us as your financial advisor. We are honored and humbled by your trust.

Best,

Chris Duke

October 21, 2024

DISCLOSURES

This is being provided for informational purposes only and should not be construed as a recommendation to buy or sell any specific securities. Past performance is no guarantee of future results, and all investing involves risk. Index returns shown are not reflective of actual performance nor reflect fees and expenses applicable to investing. One cannot invest directly in an index. The views expressed are those of Chris Duke and do not necessarily reflect the views of Mutual Advisors, LLC, or any of its affiliates

Investment advisory services are offered through Mutual Advisors, LLC, DBA Context Wealth, an SEC-registered investment adviser.