Since March 2022, the Fed has embarked on a series of interest rate hikes with the aim of moderating economic growth and curbing inflationary pressures. Presently, the Federal Reserve’s target range for the federal funds rate rests between 5.25% and 5.5%. Looking back, the highest-ever recorded federal funds rate occurred in March 1980, reaching a staggering 20%. Conversely, during the financial crisis of December 2008, the federal funds rate plummeted to a historic low of 0.25%. These extreme values serve as benchmarks for understanding the fluctuations in interest rates over the years.
It’s worth noting that the average federal funds rate maintained by the Fed from 1971 to 2023 stands at approximately 5.42%. Despite the fact that the present federal funds rate is at a 22-year peak, it is situated within the bounds of the 50-year average, underscoring its relative position in the broader historical spectrum.
With the current rates at a 22-year high, we remain optimistic about the US stock market. Here are the top five reasons why:
Medium-Term Peak in Interest Rates
Our outlook suggests that interest rates are approaching a medium-term peak and are likely to gradually decrease over the coming years. The recent decline in inflation, which has dropped from a peak of 9.1% to 3.6%, can be attributed to improvements in the supply chain, supplier capacity expansion in response to higher prices, and the Fed’s efforts to suppress aggregate demand by employing high interest rates. Raising borrowing costs for consumers means they have less to spend on other goods and services. It also raises borrowing costs for businesses, reducing demand for investment and lowering profits. This lowers their ability to employ people or give inflation-busting pay rises. The Fed has now moved interest rates above the rate of inflation (5.3% vs. 3.6%) and will keep rates there for an extended period. Interest rates will shift to become a tailwind for the stock market in the next 12 months.
Robust Economic Fundamentals Driven by Biden’s Industrial Policy and Fiscal Spending
Despite the Fed’s effort to reduce demand, the US economy continues to exhibit strong fundamentals, including healthy GDP growth, low unemployment rates, and a resilient corporate sector. We believe one significant factor contributing to this strength is Biden’s industrial policy and the substantial fiscal spending (projected $6.4 trillion) by the US government in 2023.
While President Biden lacks the authority to directly influence the Fed’s interest rate decisions, he has been wielding his executive and fiscal spending authority to stimulate the economy. With the introduction of new laws, such as the CHIPS and Science Act and the Inflation Reduction Act of 2022, the Biden administration has been betting big on industrial policies to bring manufacturers back to the United States. It is estimated that these three pieces of legislation that were passed in about the last two years represent more than $1 trillion in new government spending on industrial policy targeted toward green energy, and semiconductor industries.
US Government Fiscal Spending expected to jump ahead of 2024 Election
With the 2024 election on the horizon, President Biden has a compelling incentive to continue leverage his fiscal spending powers to paint an optimistic picture of a thriving US economy, thereby enhancing his prospects for reelection. Biden has released the federal budget will jump from $6.4Tr to $6.9Tr for fiscal year 2024. The $6.9 trillion budget is higher than the roughly $6.4 trillion the administration expects the federal government to spend in 2023. It’s also higher than any time during the pandemic and about $2.5 trillion above the pre-pandemic level. This federal budget will be spent on social security payments, Medicare/Medicaid benefits, military/defense including support for the Ukraine conflict (nearly $100 billion), and net debt interest payment.
All these fiscal spending and new industry investments have created plenty of jobs in retail, health care, defense, manufacturing, and construction causing wages to rise which in turn drive up consumer spending which is 70% of US GDP.
AI Technology holds the potential to alleviate the significant labor-related growth bottleneck.
Presently, the US economy confronts a significant growth impediment in the form of a labor shortage spanning various sectors, from technology and manufacturing to service-oriented industries. The current US unemployment rate is at 3.8%, a very low figure by historical standards.
The recent advancements in AI models and algorithms, exemplified by innovations like ChatGPT, offer a promising outlook. These breakthroughs suggest that many routine and manual office tasks have the potential to be automated or collaboratively managed by software. As a result, human-AI partnerships can lead to substantial increases in productivity.
We anticipate that US multinational corporations will lead the initial wave of AI-driven automation adoption. They possess the requisite cloud and data infrastructure, as well as the technical expertise to implement this technology effectively. Additionally, their higher labor costs make AI projects particularly appealing in terms of potential return on investment (ROI). Assuming their AI adoption plan unfolds as intended in the next 5 years, US companies will likely sustain significant revenue and profit margin growth.
Elevated Commodity Price benefits the overall US economy
Recent elevated commodity prices are advantageous for the overall US economy. The United States stands as a net exporter of both fossil fuel energy, agricultural commodities, and minerals. These elevated commodity prices bolster the profits of these American exporters and contribute to the creation of new jobs within the country. Given that the US economy and its major companies primarily offer services and exhibit limited dependence on energy as an input factor compared to other economies, this situation underscores the benefits of favorable commodity pricing to the US.
Despite the current 22-year high in interest rates, our optimism for the US stock market remains. The anticipated medium-term peak in rates is poised to transition into a favorable tailwind for the market in the coming year. The resilience of the US economy, fortified by President Biden’s industrial policy and pre-2024 election fiscal spending initiatives, further bolsters our confidence. Additionally, the potential for enhanced productivity through AI technology and the advantageous impact of elevated commodity prices are likely to benefit both the US economy and its corporations.