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For many investors, interest rates are back to normal and they expect sunny days in the low single digits to return soon. Consulting firm NEPC takes a different view.
You can’t blame people for expecting a return to what they consider the norm. There have been many years of low interest rates and subdued inflation. The post-pandemic spike in the consumer price index was a shock, but the CPI has fallen again and is at an annual rate of 3.4% as of December 2023, with the Federal Reserve expected to lower the inflation rate to around 2% midway through. I hope that.
The Fed, which has been raising interest rates to combat soaring inflation, believes its mission has been accomplished and is discussing lowering its benchmark federal funds rate to 5.50% from its current range of 5.25%. Many investors are praising the rate cut, expecting it to further boost the stock market.
According to Thursday’s NEPC webinar, such a booming scenario is highly unlikely. Philip Nelson, head of asset allocation at a consulting firm, said many people are “fixated on low inflation.” As a result, “the market becomes biased toward low interest rates.”
In fact, the futures market expects the federal funds rate to be cut by as much as six quarter points, to a range of 3.75% to 4.0% or even lower by the end of the year. Smart people on Wall Street predict that interest rate will fall between 2.1% and 2.5% in 2024. Economists at the International Monetary Fund say U.S. inflation should fall to 2.3% this year and remain around 2% through 2028.
Nelson warned that while a widespread “behavioral bias” against low interest rates is fueling expectations of lower future costs of capital, economic reality will intrude. He noted that federal debt is rising and will eventually “require higher interest rates” to attract buyers.
Meanwhile, in a related paranoia, NEPC strategists argued that investors remain enamored with the stock market’s bullish performance and believe there is more to come.
The problem, as NEPC CIO Tim McCusker points out, is that the S&P 500’s recent gains have only regained ground lost in the 2022 downturn. The index’s new high of 4,894.16 set on Thursday was only slightly higher than its January 3, 2022 high of 4,796.56. Therefore, he said, “This was a round trip.”
What’s more, he sees the “Magnificent Seven” mega-tech companies that have boosted the overall market as living on borrowed time. Mr. Nelson asserted that “pricing is aimed at perfection,” and noted that the stock price performance of Tesla Inc., a member of Mag7, is showing signs of decline amid management guidance that growth in electric vehicle sales may slow. He pointed out that
For the group to maintain its high position, Nelson continued, “we will need very high profit growth.” For misty-eyed investors, such talk is a bitter tonic.
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Tags: behavioral biases, future markets, inflation, interest rates, Magnificent Seven, NEPC, Philip Nelson, S&P 500, Tim McCusker
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