September has started and the markets are behaving as we are used to this month. The market has started with a decline and nervousness is starting to build ahead of one of the most important meetings of the US Federal Reserve (Fed), which the whole world is watching with many expectations.
Our team went through all the possible scenarios and thought about what would be the best move by the Fed for the global economy and markets. We have three options, and it has to be said that this is a bit of a Sophie's Choice, because there is currently no option that would ensure a smooth course. Let's go through the three options in turn.
- Cut interest rates by 50 basis points.
This scenario would give a clear signal to the market that the Fed sees problems in the economy and feels it is necessary to quickly and significantly cut interest rates to boost the economy. With official inflation in the US falling short of the Fed's long-term target (2%), the industrial sector is slowing significantly and unemployment is rising. Such a move, a 50 basis point cut, would bring considerable nervousness to the market and would likely be followed by declines in the stock market, despite the initial euphoria that such an impulse often brings.The so-called Japanese "carry trade" is also an important factor for short-term volatility. A cut in US interest rates at a time when Japanese monetary policy is tightening (for example, by further rate hikes) could lead to a sharp appreciation of the yen and further disrupt this debt spiral.
- A 25 basis point cut in interest rates.
This option is probably the most palatable and realistic. According to macroeconomic data, the US economy is slowing and unemployment is rising, but this move would be a clear signal that the Fed does not currently see a real threat of a major recession. It is believed that a recession may occur, but for now at most shallow, which would not be such bad news for equity markets.This scenario might not even significantly affect the "carry trade" with Japan, as the market already expects a rate cut of just 25 basis points.
- No interest rate cut at all.
This decision would surprise the market and would probably react negatively to it in the short term. Historically, interest rates have been cut whenever there was trouble on the horizon or when the economy was already in trouble. The situation now is that the US economy is still growing, but according to macroeconomic indicators, problems may be emerging. Not cutting interest rates would indicate that the risk of serious economic complications is higher, which would be perceived negatively by the markets.
What are we going to do about it now?
First and foremost, we are wary of the latest macroeconomic data ahead of the meeting. We are monitoring signals from Fed officials, but our investment strategy remains more or less unchanged. For us, the most important exposure is still in long-term government bonds such as TLT and GOVZ, which are slowly but surely gaining in value. We also focus on sensitive commodities, especially silver, which often shines in similar cycles.
As for equities, we prefer mainly dividend titles, addressing this through ETFs and defensive dividend titles such as Verizon (V). We allow for the possibility that a mild recession may come, and with these exposures, the Balance portfolio should be very resilient, as it has shown over the past 2-3 months, outperforming the S&P 500 by about 2%.
We have also ensured that the market could positively embrace a gradual reduction in interest rates, for example starting with a 25 basis point cut. Smaller market cap stocks, specifically the Russell 2000, could show decent gains as smaller companies often benefit most from monetary easing.
Thus, Balance's current portfolio allocation covers variations of the beginning of the interest rate cut cycle, and in this environment, the value of these assets should rise.
Disclaimer:
This article is provided for informational purposes only and should not be considered investment advice, a recommendation to buy or sell securities or any other financial products. The authors make no representations as to the accuracy, completeness or timeliness of the information contained in this article. Readers should consult a financial advisor or other professional if they need specific investment advice or if they have questions about their financial decisions. The authors of this article are not responsible for any loss or damage caused by the use of the information in this article. Past years' profits are no guarantee of future profits.
