As many of our clients know, we’ve recently been conducting our quarterly reviews, and one consistent theme has emerged—the robust returns we’ve experienced over the past nine months. For those who couldn’t attend these reviews or are simply curious about our market outlook, this article offers a summary of our thoughts, insights, and observations.
Market Environment: A Bullish Outlook Despite Uncertainty
The key takeaway from our recent discussions is that our main asset allocation tool has been bouncing between two scenarios: a bullish low-growth, low-inflation environment and a middling-inflation, low-growth environment. Yet, we’ve remained anchored to the more optimistic low-growth, low-inflation scenario—a backdrop that typically signals a "risk-on" environment.
This environment invites a mindset of focusing on the potential for positive outcomes. Instead of viewing the market from a lens of fear or imminent collapse, it’s important to frame it as an opportunity: what good things can happen? This bullish stance has been in place since October 2022, and shortly after, we became very optimistic about the equity market's future prospects. Historically, this type of environment is where poor economic data begins to stabilize and even show signs of improvement.
Source: CPWM Market Cycle - Internal
We believe that the continued low inflation, even with slow growth, provides fertile ground for equities to perform well. When poor economic data bottoms out, it tends to create an opportunity for forward-looking investors. This outlook provides a critical context for navigating today's market, where risks are present but manageable within a long-term, forward-focused strategy.
Should You Raise Cash?
A question we’ve heard from a number of our clients is, “Should I be raising cash? Markets don’t go up forever.” While this is a reasonable concern, historically, raising cash because of strong performance often proves to be a poor practice.
Take, for example, the S&P 500’s performance through the first eight months of this year—it has registered its 15th-best start in history. Statistically speaking, strong starts usually lead to strong finishes. Human nature and the tendency for return chasing often drive this trend. Picture yourself as a portfolio manager who entered 2024 with a conservative mindset, expecting returns from GICs yielding around 5%, or believing the consensus forecast of a global recession.
Fast forward eight months, and the benchmark S&P 500 index is up by 18.4%. What happens next? These portfolio managers begin chasing performance, buying into the stocks that have performed well so far—perhaps Nvidia, BlackRock, or other top performers. This behavior, driven by a need to "catch up," pushes stock prices even higher. Human behavior, especially in the financial markets, has remained remarkably consistent over the decades.
Looking at historical data, there are a few rare years when strong starts did not lead to strong finishes. However, these years were marked by significant, statistically unusual events:
1933: In the midst of the Great Depression, the stock market was recovering from a 90% correction—a situation vastly different from today.
1987: The infamous crash occurred in October, leading to a 25% drop in a single day. Today, mechanisms like circuit breakers exist to prevent such drastic one-day declines.
1929: The onset of the Great Depression and the beginning of a prolonged 90% market correction. Despite bearish voices in the media, we don’t believe we’re facing a similar economic collapse today.
Source: S& P Historical Returns- Creative Planning@Charliebilello
Given the historical performance of the market, and the rare instances where strong starts didn’t lead to positive outcomes, the advice we’ve shared with clients remains: sticking with your long-term strategy and avoiding the temptation to raise cash prematurely often yields better results.
The Inflation Story: Nearing Its End?
One of the dominant themes over the past few years has been inflation. Last year, we spent a considerable amount of time explaining how inflation is calculated and why we believed significant disinflation was in the pipeline. In particular, we focused on two components of inflation—Food Away from Home (your restaurant bill) and Shelter (housing costs)—which together account for nearly 40% of the Consumer Price Index (CPI). These were highly elevated at the time, with inflation rates of 7.1% and 7.7%, respectively.
Fast forward to today, and our forecast has largely played out. Both of these components have seen substantial easing, though there’s still room for further improvement. If we see a 2% reduction in these categories over the next year (less improvement than we saw over the past 12 months), that alone could reduce the overall CPI by around 0.8%. Given that the last U.S. CPI report showed annual inflation at 2.4%, this change could bring inflation down to 1.6%.
While we’re not explicitly calling for such a drop, the implication is clear: significant disinflation is still in the pipeline, and the inflation conversation, in our view, is about to be over. The media—whether CNBC or BNN—may soon find it difficult to sustain the narrative of rising inflation if it continues its trend toward 2%.
Source: CPI-US Bureau of Labor Statistics
What Will Replace Inflation in the Market Narrative?
If inflation is no longer the primary focus, the question becomes: what will the market and media narrative shift to next? Our view is that attention will increasingly turn to the U.S. job market, which has begun to show signs of softening. While unemployment hasn’t reached alarming levels yet, there is a trend worth noting—unemployment has risen from a low of 3.5% in early 2023 to 4.2% by August.
This uptick in unemployment is still in its early days but could become more concerning if it continues. The key question that follows is: how will central banks respond to this data? In our view, rate cuts will come quickly and aggressively. The Federal Reserve has already cut interest rates twice (including a September rate cut), and we expect this to continue. We believe the Fed will make at least one cut per meeting until late spring or early summer of 2025. This would result in a total of seven cuts by mid-2025, leading to a significantly looser financial environment compared to today.
However, there is a caveat. If economic data shows unexpected strength, central banks may back off from this aggressive cutting cycle.
What If Rate Cuts Don’t Materialize?
The biggest unknown in the current environment is: what happens if the Federal Reserve doesn’t deliver aggressive rate cuts? If rate cuts fail to materialize, we believe the market might experience a “temper tantrum”—a short-term, liquidity-driven selloff.
While tight monetary policy was not the sole cause of the 2008 financial crisis, it certainly played a role in the unraveling of economic stability. Today, we have a central bank that we view as overly tight, but the situation is not analogous to 2008. The U.S. consumer sector has spent the past 16 years deleveraging from the excesses of 2008. This means the economy is not burdened by the same level of debt, and any market tantrum that occurs would likely be liquidity-driven and short-term in nature.
In contrast, when excess leverage bleeds into the system, it leads to more painful and sluggish recoveries. Balance sheets need to be repaired, and this process can take years. Currently, we do not see that kind of excess leverage in the system.
Source: U.S. Household Debt % of GDP Chart -Bloomberg
Final Thoughts: Looking Ahead to Year-End and Beyond
As always, we encourage you to reach out with any questions or concerns. If you haven’t yet scheduled your quarterly review, we’d love to hear from you and discuss how these trends impact your portfolio.
Thank you for your continued trust, and here’s to a prosperous end to the year and a successful 2025!
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