Betting on the Fed

I have a usual process for beginning each day at the office. First, I start off with some kind of procrastination, such as with taking a quick walk, listening to a song that was stuck in my head, or on some special days even taking an early morning pre-work nap! However, I eventually get settled in and start opening up and logging in to all of the programs that I need to do my job. This sounds simple, but logging in to five different websites, each with a different username and password, with most requiring a two-step verification, isn’t easy, especially if my brain and fingers haven’t had time to warm up yet. The worst part of it all, though, is addressing my email mailbox. Each morning, I have at least 50-60 new emails I must wade through to get to the 5-10 I might need. The most important ones are obviously those that come from you all, and I am always worried I’ll miss one when throwing out the unending junk.

There are, however, some non-client emails that I do welcome, such as my weekly delivery of “Three Financial Facts of the Week.” It comes from a regional sales director of ValueLine funds, and the facts are always interesting. One fact from two weeks ago had to do with the new age of sports gambling, which if legal in your state is now as easy as downloading an app on your phone. In January of 2019 the total dollars bet in the U.S. was $1.1 billion. In January of 2024 that number had risen to $14 billion. I, like Dad, have never been much of a betting man, and while I don’t mean to be judgmental, a quick web search will yield countless stories about the growing problem this new sports betting is creating for the financial health of Americans.

A related MarketWatch article in my email also stuck out to me, titled “Bets on wild stock-market swings boom as traders face most uncertain Fed rate decision in recent memory.” Trading volatility always picks up at election time, but the news has really been pushing uncertainty about the upcoming Federal Funds rate cut. The gamification of everything in our society today creates real havoc if proper restraints are not in place, especially when we are referring to people and money. It really drives me crazy to see people betting their dollars on such silly things as market swings and then calling this “investing.” What’s worse though, is that the financial news also allows this behavior to be passed off as “investing” instead of calling it out as the reckless speculation that it is.
 
I believe that the first cut of the Federal Funds rate by the Fed is nothing to get worked up about. I also don’t believe that trying to predict how many more cuts from now until year’s end and into 2025 will yield any special investment return. Interest rates were kept very low for 14 years. They have only been at this higher rate now for about two years. Even if the Federal Reserve were to cut the rate by a quarter percentage point every meeting until next year, that would leave the rate at 3.25% - 3.50%. Over that period, interest producing accounts and fixed income would provide less yield, but the cost of borrowing would also decline. All our lives will likely adjust accordingly, and the world should continue to remain upright.
 
As for the election… well, we are less than two months away, and the drama has never been better. The news stories, politician sound bites, and the ever popular “I approve this message” commercials are in full swing. The messaging is unavoidable, and it churns everyone’s blood pressure up. This of course can also affect stock market behavior. People absorb the back-and-forth vitriol, process it all as uncertainty and fear, and then trade those emotions in the market. I am going to offer a summary of multiple letters and studies I’ve recently read on the relationship between election time and stock market returns.
 
The general points of most studies involve tracking the performance of the S&P 500 based on various factors. Are returns different in election years vs. non-election years? How do markets react leading up to the election and following the election? Does a change of party-control affect returns? What if one party controls the presidency and congress vs. split control? Is there any outperformance or underperformance of specific sectors?  Most studies reference back to either the mid-70s or mid-20s as their starting point. And what are the major findings of all of these different studies? Except for a very few cherry-picked timeframes… there are no specific truths to be found. Markets don’t do significantly better or worse depending upon which candidate wins and which loses. Market returns resemble average market returns of non-election years. Close to 75% of election years are positive, as are the years that directly follow elections, so again similar to “most” years. Findings also show that investors who remain invested throughout the process outperform those who go fully to cash, or who plan on staying in cash until “getting a feel for the new administration” before reinvesting.
 
One finding that does stand out is that market volatility is directly related to how close and contentious an election race is. The closer the vote, and the dirtier the fighting, the more volatile the stock markets are leading up to election day. In the weeks just before people head to the polls, the market will show a heightened withdrawal. Then the week following the election, the markets will recover some of the decline, and will usually continue to rise until year’s end. And why would that be a common model for these close and contentious elections? Well, if you think about it, the closer an election is, the least confident either side is that their candidate will win. The fighting gets to be bad, with both sides saying the other side’s win will be disastrous for our American way of life. Uncertainty is extremely high, so worried Americans sell their equities and go to cash (or other less risky assets). Then the election is over. Now only one group of voting constituents believes the world is ending, while the other group is certain that with their elected candidate running the show, our country’s future is bright and inviting. Those people go back to their accounts and reinvest.
 
To conclude, this year continues to be a good one for the equity markets and for our portfolios. Most of the volatility has been “good” volatility, or “upside” volatility, the kind people like. It would not surprise me to see some fear-related downside volatility leading up to the election. Any market movements tied to the changing federal funds rate should be temporary, as most things (other than bets!) should already be factored into people’s projections. Despite the excited talk of the candidates and their supporters, the economy is still strong, unemployment is still below the long-run average, while employment opportunity remains available, and corporate earnings and capital spending (companies investing in themselves for future growth) continues to increase.

Please call us with any of your concerns. From possible taxation changes to rumors of a collapsing dollar or the strange email you received saying there was a problem with your brokerage account, we will hear out your concerns and offer what understanding and solutions we may.
 
Sincerely,
 
Justin Anderson