Investment Climate Oct 2024: Return of 'Animal Spirits' ?
The S&P 500 stock index did come close to “correction” territory during the quarter with a bit over an 8% correction. However, the much anticipated change in direction by U.S. Federal Reserve (the Fed) officials finally came to pass as the central bank officials lowered the Federal Funds Rate target by 50 basis points (or half of a percentage point) in their September 18, 2024 meeting. This action drove the market index to yet another round of new highs towards the end of the quarter. Smaller company stock prices, as referenced by the Russell 2000, also reached their highest levels in a couple of years after a bit more than 10% correction during the quarter. Still, the small company index remains well below the all-time highs reached back in 2021, a continued sign of the difficulty smaller public company stock prices have had in outperforming their larger counterparts over the last three years.
Of note is that interest rates in the days following the rate cut by the Fed have actually risen (the 10 Year U.S. Treasury was 3.6% at September 18 and is now over 4%) , a sign that bond market participants (or “vigilantes” as they are often called) are not sure the Fed’s fight against inflation has been won. This is particularly notable because economic numbers have been somewhat mixed, or at least have not been robust, over the last few weeks and months. This underscores what we have argued for a very long time: The Fed should not be focused on economic growth and should only focus on price stability. Unfortunately, the “dual mandate” of “full employment” and price stability is in their charge. This is problematic for myriad reasons, but most importantly because the Fed mistakenly considers economic growth to be a harbinger of inflation, despite that idea being disproven consistently over the years.
Nonetheless, it does appear that overall, with likely fits and starts, inflation and interest rates will trend down in the coming quarters and years. We do believe a significant boost to that trend would be if some level of sanity comes with respect to the incessant spending we have witnessed by the government in recent years. According to the U.S. Treasury, the budget deficit will be close to $2 Trillion in 2024. Down significantly from the wild Covid years of over $3 Trillion, but still far in excess of the deficits in the five years between 2015 and 2019, which were under $1 Trillion. Granted, those were more normal economic times than what we have experienced recently. This “out of control” government spending, and the accompanying stultifying regulations that come with it, starve capital from the productive side of the economy, which is not healthy.
We believe this reality is why we have seen a very difficult environment for small business formation, as well as for mid-sized, more established companies to thrive. This is not a new phenomenon, but a trend that has been growing for the better part of the 21st century. Add to that a deteriorated geopolitical environment, a hotly contested presidential election season, and a general distrust of institutions across the spectrum of the developed world, and you have the ingredients of a challenging climate for typical investors to navigate.
Despite this period in which the value of “innovation” has been discounted, innovation has not stopped; it is simply not being recognized in the valuations of the companies delivering it. We are seeing incredible advancements in medical device technology, regenerative medicine, business processes, semiconductor manufacturing and design, engineering/construction and many more.
With a movement in government policy towards a more favorable environment for businesses (particularly small and mid-sized businesses) in which to operate, we could see those values reset upwards very quickly. We need only look to the environment that prevailed in the 1980s and 1990s for a template. Even in the absence of that, we believe it is quite likely that the animal spirits in investors will once again begin to recognize what is happening out there: that the significant values in growing companies which have emerged in the last couple of years as a result of continued innovation will once again receive the attention they deserve. Stay tuned.
