Stocks Plunge 1100 Points as Fed Forecasts Fewer Rate Cuts
Something smells rotten in Denmark; rate cut causes a market meltdown.
Normally, any hint of a lower interest rate to come sparks a rally in the equity markets. A confirmed cut in the Federal Funds rate, as what happened Wednesday afternoon, will usually set off a veritable stampede into stocks. Interest rate reductions are the stuff that releases animal spirits in the stock market, causing prices to soar.
No matter how many times the Dunkin’ Corporation insists “America runs on Dunkin”, it is cheap money that is the fuel that America runs on. Stocks slumped, the dollar soared and the cost of borrowing money became more expensive on Wednesday, as the Fed struck a hawkish tone on the economy, despite cutting the short-term interest rate it controls.
The S&P 500 index dropped 3 percent, its biggest decline since the start of August. The Russell 2000 index of smaller companies that are more closely tied to the domestic economy tumbled more than 4 percent. The Dow Jones industrial average fell for a 10th-straight day, its longest losing streak since October 1974.
There Were Telltale Signs
In the lead up to this debacle, there were several canaries in the coal mine indicating over-valuation if you were attuned to them. A company known as Zapata Computing Holdings (ZPTA) was among a group of companies that gave us a heads-up recently.
This company purported to utilize AI in its collaboration with other companies to further their revenues and profits. AI being all the rage, investors poured their money into this tiny company, betting that Zapata’s applications, incorporating AI methods, would bring real wealth.
Things just didn’t work out the way they had hoped. Investors saw the price of their shares tumble from $.75 to less than a penny in a few short weeks as investor sentiment soured on unfulfilled prospects.
Then a curious thing happened. Zapata announced it was laying off its entire staff. The company would stop functioning as a going concern. Normally, this would be reflected in the final implosion of a company’s share price, as if less than a penny was not sufficient enough.
A funny thing happened on the way to bankruptcy. All of a sudden, the volume of shares traded each day rose, and kept rising as the share price began to skyrocket. What were once virtually worthless, shares began to double and triple, working their way up from $.01 to $.25 in a matter of days. Investors were coining fortunes capturing capital gains of 25,000% as the price rose, for no known reason, to $.25 a share.
Nonsense like this is usually a pretty good tell that the foundation in the markets is getting pretty shaky and non-sustainable.
For ten days, it was clear that only the Magnificent Seven, the huge growth stocks, including the likes of Amazon, Microsoft, Google and Apple were the only stocks running away and making daily records. They, and the alone, were inflating the S&P 500 index and the Nasdaq to unsustainable heights because they are over-weighted in those indices. The vast majority of the other stocks in those indexes were either marking time or actually falling.
The Fed Rate Cut
The Federal Reserve lowered interest rates on Wednesday but did so while simultaneously raising forecasts for economic growth next year and dialing down expectations for rate cuts next year and beyond. That meant longer-term measures of interest rates rose, pushing government bond yields higher and pausing the stock market’s post-election rally.
The two-year Treasury yield, which tends to track interest rate expectations, rose ten basis points (0.1 percentage points), to 4.36 percent, a big move in that market. It was the yield’s biggest jump in more than two months.
As well as balancing inflation that is cooling slowly — a case for keeping rates elevated — and a labor market that is holding up but cracking, a case for lowering rates, the Fed will soon need to take into account policies put in place by the incoming Trump administration.
Those policies are broadly expected to be simulative for the economy, potentially speeding up inflation again, but details are light and the Fed has publicly said that it is unwilling to factor potential policy proposals into its forecast until those details are known.
This, however, doesn’t stop economists, analysts and individual investors from drawing conclusions of their own and anticipating their effects on the markets as they trade on these conclusions.
Policies of the incoming administration are broadly accepted by economists to be inflationary and will cause American consumers to pay substantially higher prices on a wide swath of goods. These include imposition of tariffs on our biggest trade partners, Mexico and Canada, as well as additional tariffs on China. Huge tax cuts for large corporations and the rich will, like those of the first Trump administration, cause huge deficits in the budget and require floating of large amounts of debt, again, causing further pressure on interest rates. Higher rates will again increase pressure on prices throughout the economy.
Higher rates will also strengthen the dollar. Though this sounds good to the uninitiated in the ways of money, a stronger dollar makes it more difficult for American exporters to sell their goods abroad. Negative consequences such as these feed into a weakening of the economy, even as higher interest rates are taking a toll on consumer’s ability to buy.
The main takeaway from Wednesday’s Fed meeting was that inflation risks are back, and the Fed is clearly concerned, Additional rate cuts, if any, will be few and far between.
The U.S. dollar also sharply strengthened on Wednesday, rising 1.1 percent to its highest level since November 2022 — another sign of continued economic strength, especially compared with other major economies around the world that are facing greater headwinds.
Your Takeaway
Caution and patience are clearly required at this stage. A move that would normally grease the wheels of an economy has obviously put the brakes on what was a gang-buster rally. A look under the hood revealed more weakness than originally perceived and investors must pause to deal with a new reality.
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Best,
George Schneider, M.A.
Founder and publisher
Retirement: One Dividend At A Time
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: I am long all RODAT Portfolio names. The Portfolio continues to build dividend income with reliable, dependable equities which have long histories of increasing the dividend.
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