Expectations…
Stock prices rise and fall from investors’ collective expectations for how much companies will make versus how much they will spend. Consumer spending is the fuel that drives company revenues. One of the primary influences on the level of demand from consumers is the interest rate environment. Low interest rates spur spending by reducing borrowing costs. Low interest rates also discourage saving since returns on cash stashed in places like savings accounts become less attractive, making it more likely consumers will choose to spend rather than save. In reverse, high interest rates dampen spending through elevated borrowing costs and by making it more likely consumers will choose to save instead of spend to take advantage of attractive returns on cash.

Fed’s Influence
With interest rates having a central impact on consumer demand, and therefore on company revenues, the rate setting function of the Federal Reserve system is perhaps the most closely watched and most influential factor for investors as they calculate their expectations for company sales. Although inflation has slowed notably, and the Fed has reacted by lowering rates, rates still remain historically elevated. While markets had been expecting continued, consecutive cuts through 2025, the rate cut projections released by the Fed at their last meeting revealed that they only plan to make two cuts in all of 2025. Despite inflation falling nearer to the Fed’s target of 2%, progress has been sporadic and bumpy.

Abrupt Pivot
The combination of stubborn prices paired with potentially inflationary policies of the incoming presidential administration, such as tariffs, may have contributed to the Fed’s willingness to pause rate cuts. This pivot from expecting ongoing cuts to a much more limited schedule seems to have been an abrupt adjustment for markets to digest, with stocks dipping since the Fed’s last meeting in December. Gauging the path forward for the Fed may remain a central narrative for markets in 2025, as it has been since they began talking about the possibility of rate increases in 2022. While the pace of rate cuts may be uncertain, there appears to be broad agreement that a soft landing is still possible, if not likely, with inflation continuing to fall back to desirable levels without high interest rates quelling demand so much that the overall economy is pushed into a recession. This is quite remarkable, considering that most economists expected rate hikes to cause at least a mild recession by 2023.

Stay the Course…
With the US labor market remaining robust in the face of an historic rate hiking cycle, the resilience of the US economy may serve as encouragement for investors to stick with a long-term plan of buying and holding a broadly diversified portfolio of US stocks. When considering the impact of the passage of time as a year ends and another begins, it may be appropriate to reflect on how time and compounding interest is the investor’s ally. Those who have been in the market for the last 5 years have seen a gain of 80%. Those who have stayed invested for the past 10 years are sitting on gains just shy of 200%, while those who have been in the market for 20 years have gains of 400%. So, for those who have yet to start setting aside a portion of their income for their future, a good New Year’s resolution might be to get invested and stay invested. Now is always the best time to get in the market for long-term retirement investors.

January 1, 2025