The Federal Reserve has a complicated task that is simply beyond the intellectual reach or interest of many Americans. Thus, to explain the hallowed body's activities to a populace whose eyes often glaze over at the talk of economics, many commentators have relied on metaphors over the years. The Fed can take away the punchbowl at a raging party. They can run out of bullets like Butch Cassidy and the Sundance Kid in Bolivia. Or they can use their bazooka to scare the economy straight. Milton Friedman compared their activities to a thermostat and one of my favorite metaphors compares the Fed to controlling the water supply to a farm.
But of all this cornucopia of Fed metaphor, perhaps the greatest white buffalo is the fabled and elusive soft landing. There has been a lot of Fed activity in the past decades, and a lot of it has been associated with either policy error or recession. Sometimes the recession has been very much on purpose, like when Volcker raised the Federal Funds rates to heights never since equaled. But our economy is strong and Powell's Fed is now has their bazooka aimed at keeping it that way. While there's been a bit of a slowdown in growth in 2024, growth is expected to continue and accelerate into 2025.
But one thing you don't find a lot of is soft landings where the economy is in rosy straights by cutting time. And as most of us have lived through two major market crises in our lifetimes, we've seen the Fed conduct emergency cuts to zero more than once. So, many economists who have been predicting recession had history on their side when they postulated that a soft landing was unlikely. But the Fed has now cut and the economic environment is positive:
Equal-weighted SPX rose to an all-time high yesterday.
New net highs in the stock market hit its third highest level of the year.
The Industrials sector just hit all-time highs.
Jobs are still growing, even if the growth is slowing.
GDP was recently revised upward, and economic growth and the consumer remain strong.
In other words, the Federal Reserve has stuck a soft landing for the ages. The soft landings Jay Powell has noted before (there were three in 1964, 1984, and 1993) all had far higher unemployment rates for most of the time they played out then we have now. Our economy is decidedly strong and now we have the Fed working with stocks and risk assets instead of against them.
The economy was largely immunized in many ways from higher Fed rates because many households and businesses had locked in lower effective rates on their debt. But the Fed will be more powerful on the way down with rate cuts, partially because of psychology, and partially because of real economy effects of lower interest payments. You can see below, that in the post-war period soft landings have been the rare exception.
Despite the rarity of soft landings, it is indeed officially the environment we now find ourselves in. The Federal Reserve has conducted its first cut and the economy is still in expansion. Growth has slowed and the momentum of the labor market has diminished, but jobs growth remains positive. The Federal Reserve has no explicitly stated that they do not wish to see pain in the labor market, and rather than focusing on vanquishing inflation, they are now focused on avoiding this pain. This is an incredibly bullish setup for markets, and the pace of cuts is less important than the general direction that rates are now headed.
Another very important consideration, as far as stocks go, is whether or not we are in a recession when cuts begin. The historic returns of stocks are far better if we are not in a recession when the Fed cutting cycle begins than if we are. This is our current situation. GDP is being revised upwards, Industrials just hit an all-time-high and Goldman Sachs recently found that consumer savings are much higher that bears would care to admit.
“.. Our estimates suggest a .. 5.2% saving rate after also accounting for adjustments that align income and spending with cashflow relevant to households .. only slightly below the average saving rate from 1990-2019 (5.8%) and support our view that downside risk to spending is more limited than commonly feared.”-Goldman Sachs Economics Research
The other thing is this; the declining rates will alleviate pressure on the multiples on the highest flying stocks that have been experiencing some headwinds lately. I also think these stocks continue to possess extraordinary earnings power which will be supportive of price, and given their market caps, of the index as a whole. Earnings strength is considerable across sectors, but it is by far the highest in Technology.
But while Technology has taken a breather the rest of the market has caught up. This breadth of gains is very bullish and the broad based strength across sectors is very encouraging. If you look at the gains at the sector level of the market on a YTD basis, it certainly doesn't scream recession. Strong markets stay strong, and the diversity of strength across sectors is incredibly encouraging given that once we pass the seasonal bumpiness, we should be entering more favorable seasonals on the back of strong fundamentals and a Fed that is cutting and trying to avoid carnage in the labor market.
There are many risks still facing the market and some could certainly emerge in a nasty way before the year is over. However, the fundamentals of the market are resilient and the earnings power of companies that cleared the dead wood in the COVID era is startling. Many companies have emerged as more resilient corporate entities that are more capable of outperforming analyst expectations.
If you look at a jet that weighs many tons coming in to land on an aircraft carrier, it looks like there's simply not enough room for it to land. It looks like it will go right over the side or crash. The physics involved are daunting, and that's why the plane needs some assistance in the form of cables to grab it and absorb momentum when it lands and a catapult to assist it in gaining momentum as it takes off. There have been several countervailing forces in the economy that have made it more resilient, and also more difficult to predict. But now that we are officially entering the Fed cutting cycle in a soft landing environment, prepare for stocks to have a joyous holiday season, perhaps after a bit of Halloween fright.
