Investment Review №329. It's time to take a risk

The Fed has resumed policy easing, reducing the interest rate by 25 basis points and indicating the possibility of two more rate cuts before the end of the year, whereas the market had anticipated only one more cut. This decision aims to balance rising risks in the labor market and a still steady inflation rate. Jerome Powell described this move as “risk management,” acknowledging the challenging nature of this decision at this stage of the economic cycle. However, the Fed remains divided in opinions. Cleveland Fed President Beth Hammack cautions that the policy remains only “very moderately” accommodative, and premature easing could reignite inflation. Conversely, Stephen Miran, a new Fed board member and head of President Trump’s Council of Economic Advisers, is advocating for a larger 50 basis point rate cut, reflecting political pressures and increasing uncertainty for investors—a topic I addressed in my July commentary. The Fed’s forecasts have shifted towards higher GDP growth in 2025, increased inflation in 2026, and lower unemployment projections for 2026-27. These significant multidirectional changes, given a strong economy and a cumulative 75 basis point rate cut predicted by the end of 2025, underscore the complexity of the current situation.

This stance has bolstered equities, even during a usually weak month, while driving yields on long-term Treasury bonds higher and resulting in a mixed market picture. The differing investor responses suggest that bond investors remain skeptical of the Fed’s dovish outlook. It is likely that these two investor bases will continue to follow their respective paths—Treasury yields stabilizing as key rates decline, while the stock market climbs to new historical highs, anticipating a yield curve decrease in response to rate cuts. In this scenario, banks and diversified financial firms, benefiting from rising net interest margins, are poised to emerge as the clear winners. I believe the financial sector could ascend to one of the top three sectors in terms of returns over the next 12 months (currently ranked fifth). The IT and Communication Services sectors are likely to maintain their leading positions, driven by AI monetization and sustainable cash flows, which help mitigate some risks. However, the leadership will remain narrow, with the Magnificent Seven, particularly Alphabet (GOOGL), continuing to be a promising trade, as I analyzed previously.

Additionally, it’s worth noting that the “Sell America” trend persists among strategists from various investment firms, due to the unstable macroeconomic and geopolitical environment. Nevertheless, there is a nuance that bolsters my confidence in the overall growth of the U.S. market. Globally, as the Fed eases its policy while other central banks slow or halt rate cuts, this divergence suggests a potential unexploited stimulus for the U.S. stock market, contrasting with the dwindling monetary “fuel” in other countries. This isn’t to say that there are no opportunities outside the U.S., but it does highlight the competitive edge of the American market.