FINANCIAL FOCUS
Interested-ED
In this installation of Financial Focus, we will discuss the topic of “Interest” in the U.S. economy. As always, we will provide some education and commentary for the inexperienced and/or uninformed.
The U.S. economy has been on “thin ice” for quite some time, despite some reports to the contrary. As we discuss in other blogs, there are many underlying economic factors that are either unknown, unreported, or even revised. The most common weekly and monthly reports that are covered in the mainstream media generally include inflation, non-farm payroll (jobs created), unemployment levels, consumer spending and sentiment figures, as well as some housing sales information. The real numbers often suggest quite a different story, and many are affected by interest rates, or the perception of future interest rates.
As we often mention, and have covered in our publication When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), equity markets like to look ahead several months, which essentially turns investment into speculation, as investors and traders attempt to front-run the crowd and “get in” early. The quick reaction to certain news reports and financial announcements often causes volatility, panic selling, and FOMO (the fear of missing out). Interest rate sensitive sectors and equities are particularly vulnerable to these wild price swings, and the ever-changing expectations of potential Federal Reserve rate cuts throughout 2024 has helped create a volatile atmosphere.
For those who closely follow economic reports, you are well-aware of the repercussions that can accompany a report, or news item, and its subsequent effect on the markets. Often, however, the initial reaction is overdone, and markets usually revert to a mean in short order, as there are many ways to interpret the information. Long-term traders are largely unaffected by these reports, though occasionally there are important implications attached to a report.
Sectors that are truly affected by changes in interest rates (also discussed in detail in our publication) include Commodities (gold, precious metals, agriculture, etc.), Real Estate (homebuilders, home improvement), Technology (which tend to rely on heavy borrowing for Research & Development), Consumer Discretionary (Retail and luxury spending), Bond yields (popular in “risk-off” conditions), and Small Caps (30m – 3b market cap), as they are charged more than large-caps for borrowing.
Though it would seem logical that financial sector stocks would be interest dependent, they are only minimally affected. Banks and financial institutions mostly rely on the “spread” between their borrowing and lending rates, which move in tandem. The rare anomaly of the “inverted yield curve,” when short-term (2 yrs) rates are higher than long-term rates (10 yrs), which has been in effect for almost 2 years, has caused another banking crisis, thus creating “spread” issues for many financial institutions.
As noted, for several months throughout 2024, expectations of Federal reserve rate cuts have been overexaggerated, and unfounded. There is a gauge on the FRED (Federal Reserve Economic Data) website that tracks the sentiment for such interest rate change expectations, however it changes daily, and has very little merit, in our opinion. Each time Fed speaker Jerome Powell makes a statement, reactions are immediate and the market sways in one direction or the other, based on his forward-looking comments. Traders may be able to take advantage in the short-term, however, the gains or losses based on the comments is usually short-lived. For the record, the expectations for a cut reach far back to the end of 2023, which have all been false, and those jumping the gun to enter positions that would benefit from rate cuts have been hugely disappointed.
Also, the actual event of a rate cut, or cuts, is only beneficial for certain sectors, while detrimental to others, as mentioned above. The Fed is usually “behind the curve” with cuts, and/or hikes, as they do want to shock the markets. By the time they cut, it normally means the economy is already in, or close, to recession conditions, as the Fed consistently states they are “data dependent.” As we know from technical analysis/charts, data is a “lagging” indicator. Though rate cuts generally improve overall affordability and consumer sentiment, they usually come after a prolonged period of suffering. Rates are normally hiked to “cool” an over-heated economy to slow inflation, which adversely usually leads to higher inflation. Markets historically tend to fall after rate cuts, due to the perception, or reality, of recession - so be careful what you wish for!
For additional discussions and education, please continue to visit our BLOG section here on ASTRO-FIN, where we provide periodic updates on a variety of topics.
