The Fed Tailwind

On a Boy Scout canoeing trip years ago, my companions and I encountered a strong early Spring headwind on Lake Allatoona in Northwestern Georgia. Progress was slow and arduous, though we paddled as hard as possible.

It was exhausting. We longed for that headwind to die down — or, even better, to reverse course and give us some help!

That memory came to mind as I thought about recent stock market performance. For most of 2022/2023, the market (setting aside the performance of the "Magnificient Seven") struggled against the headwinds of interest rate hikes, slowing economic data, and recessionary concerns.

On that difficult day at Lake Allatoona, we weary Boy Scouts didn't get what we wanted. 🙁 But for the U.S. stock market, the '23/'23 headwinds appear to have given way to a reliable tailwind.

The Fed's dovish turn The market's tailwind began to blow at the December Fed meeting. As Reuters reported, the Fed "signaled in new economic projections that the historic tightening of U.S. monetary policy engineered over the last two years is at an end and lower borrowing costs are coming in 2024."

Fed data released in December hinted at three rate reductions for this year. Not surprisingly, markets overreacted and predicted six(!) cuts in '24, based on the idea that a recession was still likely. But as the weeks passed and economic data came in stronger than many expected, undercutting recession expectations, it became apparent that six cuts were unlikely.

Investors gradually started pricing those rate cuts out of the market. Heading into last week's Fed meeting, there was a reasonable question as to whether expecting even three rate reductions this year was now a stretch.

After all, if the purpose of rate-cutting is (in large part) to stimulate economic growth but the economy is already growing, why would the Fed cut at all? Especially with inflation still posting increases well above the Fed's target?

Good questions.

But even as market watchers grew concerned that the Fed might back off its rate-cut projection for this year, the Fed board reinforced that projection last week. Market analyst Charlie Bilello (and many others) concluded that the Fed has definitely turned dovish. View his X social media post . Things are changing

So far this year, the S&P 500 is up almost 10%, the 15th-best start to a year since 1928. And that performance is no longer being driven solely by the tech-oriented Magnificent Seven.

Three of those seven have struggled so far in 2024, despite the market's overall upbeat view on artificial intelligence. Two of the seven have posted a middling performance. Only Nvidia and Meta have continued to strongly outperform.

Instead, we're finally seeing the long-anticipated broadening out of the market rally. The S&P 500 "equal weight" index — which gives equal weight to each stock, thus neutralizing the distorting performance effect of the largest companies — is up more than 6% for the year (and has actually beat the market weight index over the past month). The "extended market" of small and midsize U.S. stocks is up about 5% YTD (as measured by Vanguard's VXF fund) and has also been particularly strong lately.

The way the wind is blowing

To be sure, market advances can be wiped out by market reversals. But, given the Fed's pronouncement last week, it appears that the headwinds of 2022 and 2023 have died down at last and that a "Fed tailwind" will blow for a while.

That said, even as you hope for the best, it's wise to be ready for the worst by having a long-term plan you can stick with. Enjoy the sunshine while you can, but keep an umbrella handy. And, to return to my initial metaphor, in investing as in canoeing, it's helpful to be realistic about which way the wind is blowing! Images used with permission.