Insights

Second Quarter, 2024 Market Review

July 17, 2024

Dear Clients,

Twenty-two years—that’s how long it’s been since the Fed funds rate last hit 5.50%. Since the 2009 global financial crisis, interest rates in many developed countries, including the United States, were more or less at historically low levels, resulting in near-zero yields on cash and short-term investments. The landscape has quickly changed with the sharp rise in short-term rates over the past two years, and investors have poured into these now-attractive short-term investments like T-bills, CDs, and money markets. In fact, assets in money-market funds were driven to a record $6.12 trillion at the end of June, according to the Investment Company Institute.

Rate hikes have also inverted the Treasury yield curve, with short-term rates exceeding long-term rates since 2022. An inverted yield curve historically signals that monetary policy is too tight as investors often fear that high short-term rates will trigger a recession and anticipate a rate reduction, causing long-term rates to drop in expectation of a Fed policy shift.

Deciphering the Prolonged Yield Curve Inversion

The yield curve can invert at various points, with the spread between ten- and two-year Treasuries being a key measure. This spread first went negative on April 1, 2022. Although it briefly returned to normal, it inverted again on July 6 and has been inverted ever since.

The current inversion is notable for its length. As of June 30, it has lasted 726 days, the longest since at least 1976. The previous record was 623 days from August 18, 1978, to May 1, 1980, with another inversion occurring through much of 1981 and 1982.

Historically, yield curve inversions have consistently preceded recessions, but there is no guarantee that the pattern will repeat in the future. The limited historical data makes it hard to draw strong conclusions.

Despite fears, the U.S. economy is currently in a four-year expansion with few signs of an imminent recession. For instance, GDP growth has been positive for six consecutive quarters, though first-quarter growth this year (1.6%) was lower than the previous year (2.2%). Unemployment remains low at 3.8%.

While the yield curve remains inverted, predicting a recession based solely on this indicator is uncertain. The current expansion suggests that past patterns do not guarantee future outcomes.

Before 1976, there were recessions (1957-1958, 1960-1961) that occurred without preceding yield curve inversions and an inversion in 1966 that did not lead to a recession. This illustrates an important point: correlation does not imply causation. While two events may coincide, it doesn’t necessarily mean that one caused the other. It’s essential to consider multiple factors and avoid drawing conclusions based solely on historical patterns.

Avoid the “Cash Trap”

Over the past 30 years, cash has consistently failed to keep up with inflation. In contrast, riskier investments have generally offered better returns. For investors willing to accept more risk, the rewards have typically been worth it.

This trend underscores a fundamental principle of investing: the potential for higher returns often comes with increased risk. Diversifying across different asset classes can help manage this risk while still providing opportunities for growth. Moreover, staying invested in the market is crucial to capturing these gains.

The importance of staying invested is underscored by the impact of market fluctuations on investment performance. Missing just a few of the best trading days can significantly reduce overall returns. For instance, an equity investor who missed the 10 best trading days since 2003 would have seen their annualized returns more than halved.

While holding some cash is necessary for liquidity and emergencies, it’s crucial to recognize that excessive cash can become a financial liability. Despite the sense of security cash might provide, staying on the sidelines risks missing out on potential gains from holding a broad portfolio of stocks, bonds, and other riskier investments. Embracing calculated risks can lead to better financial outcomes and help safeguard against the eroding effects of inflation.

And don’t forget about taxes and fees—they can eat into returns, with interest payments from money-market funds generally taxed as ordinary income, not at the typically lower rates for dividends or capital gains. Additionally, money-market funds tend to charge higher fees than stock-index funds. On the other hand, Treasury Bills are state-tax exempt but subject to federal tax.

Wall Street has repeatedly been wrong about the path of interest rates. Earlier this year, investors were betting that the Federal Reserve would cut rates as many as six times in 2024.

The anxiety surrounding these decisions is understandable, especially given global instability that can lead to market volatility. Rather than attempting to time the markets or making emotional decisions, investors would benefit more from staying invested in a well-diversified portfolio.

If investors have planned for the long term, then one month, one year, or even two or three consecutive years of negative or neutral performance, though unnerving, should be expected and not derail their long-term approach. Of course, years when financial markets have positive returns feel better than those years with negative ones. For those who prefer the vernacular of modern finance or track markets on personal devices, green (up) is better than red (down). However, periods of poor returns are unavoidable and can even be necessary to experience if investors want to achieve the strong returns that reward investment in these volatile asset classes.

What we can also say unequivocally is that historically stocks have gone up and investors who have maintained discipline through market volatility have been paid and paid well.

Here are some closing index levels of the Standard & Poor’s 500 Index over the past five decades:

And that’s not all. If investors had instead put their money in a globally diversified portfolio and held it through the inevitable ups and downs, they were paid even more.

So, what gets in the way of all investors earning these long-term returns?  It’s really two things – poor planning and not staying disciplined during market volatility. Poor planning comes down to not having the right balance of high-risk, high-return long-term investments and low-risk, low-return short-term liquid investments. Successful investors have the intestinal fortitude to stick with a plan and not succumb to extrapolating today’s negative price movements into tomorrow’s end-of-the-world scenario. You don’t have to be a behavioral psychologist to understand the way investor psychology and lack of discipline can undermine portfolio returns. Of course, we recognize that it’s easier to have this understanding than it is to execute on it. 

If investors maintain focus on the long term, with an investment philosophy that bases stock, bond, and cash allocations on scientific principles aligned with their financial goals, and the understanding that this “down” cycle will eventually end, then they have planned well. By controlling every risk possible without undermining investment objectives, they will be just fine if history is any indication.

Thank you for your continued trust and partnership.

THE LOURDMURRAY TEAM

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¹ Source: Investment Company Institute. Money Market Fund assets from 1/1/2020 to 6/30/2024.
² Source: Avantis Investors. Data from 1/1/2022 to 6/30/2024.
³ Source: Avantis Investors. Data from 11/1/1976 to 6/30/2024.
⁴ Source: Morningstar. S&P 500 Index data from 1/1/2003 to 6/30/2024.
⁵ Source: Morningstar. S&P 500 Index data from 12/31/1975 to 6/30/2024.
⁶ Source: Morningstar, LourdMurray. Past performance is no guarantee of future results, and there is always the risk that an investor may lose money. The S&P 500 index data covers the period from 1/1/1990 to 6/30/2024. The LourdMurray Global Equity Model returns were derived from hypothetical backtesting of index data for the same period. The LourdMurray Global Equity Model includes fund management fees and advisory fees of 1%. These fees are deducted quarterly from the index returns. Indices are not available for direct investment, and their performance does not include trading costs associated with live strategies. The LourdMurray Global Equity Model performance assumes quarterly rebalancing and reinvestment of dividends.
⁷ Source: https://www.prlog.org/12750352-rebalance-to-combat-the-market-cycle-of-emotions.html